The Treasury Department on Thursday released proposed rules to crack down on some blue-state efforts to circumvent a provision in the 2017 GOP tax law.
The guidance is designed to stop taxpayers from using charitable donations to get around the law’s $10,000 cap on the state and local tax (SALT) deduction.
{mosads}“Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families,” Treasury Secretary Steven Mnuchin said in a statement Thursday. “The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions.”
The SALT deduction cap is one of the most controversial provisions in the tax measure that Trump signed into law in December.
The White House and top congressional Republicans supported capping the SALT deduction, arguing that it subsidizes higher state taxes. But the deduction has been popular in high-tax, Democratic-leaning states like New York, New Jersey and California.
Almost every House Republican who voted against the tax law did so because of the SALT deduction cap. Democrats also took issue with the limit.
Some blue states have taken or are considering taking steps to try to circumvent the $10,000 cap. One way they have done this is by enacting legislation designed to convert state and local taxes to charitable contributions.
Under those efforts, taxpayers can make donations to funds set up by state and local governments and then get a credit against their state and local taxes for the contributions. The intention was for taxpayers to be able to deduct their donations on their federal tax returns by using the charitable contribution deduction.
But the Treasury Department said that under the proposed rules, taxpayers will be able to claim the federal charitable deduction only for the amount of their donations that exceeds the amount they received in credits — applying a longstanding “quid pro quo” principle to state and local tax credit programs.
For example, if a taxpayer donated $1,000 to a state charity and then received a 70-percent state tax credit, the taxpayer would only be able to claim a federal charitable deduction of $300, a senior Treasury official said.
The guidance includes an exception under which a taxpayer who receives a state tax credit of 15 percent or less for a donation to a charity can deduct the full amount of the contribution on their federal tax returns.
The senior Treasury official said the goal of the guidance was to “faithfully implement the tax-reform legislation that was enacted last year.” Treasury said that most people will be unaffected by the guidance, with about 5 percent of taxpayers expected to itemize their deductions and have state and local taxes exceeding $10,000.
Many tax experts expected the IRS to issue guidance that curbed states’ workarounds to the SALT deduction cap. But they were unsure how the agency would treat similarly structured state tax credit programs across the country that predate the tax law. Many states offer tax credits for residents who make contributions to things like rural hospitals and scholarships for private schools.
Treasury said that its guidance applies both to the SALT cap workarounds and state tax-credit programs that existed before the tax law was enacted. But Mnuchin said that for almost every taxpayer, the guidance won’t impact federal tax benefits for contributions for school-choice programs.
House Ways and Means Committee Chairman Kevin Brady (R-Texas) praised the guidance.
“These Treasury regulations rightly close the door on improper tax evasion schemes conjured up by state and local politicians who insist on brutally taxing local families and businesses,” he said in a statement.
The proposed rules also won praise from some tax experts across the ideological spectrum.
Jared Walczak, a senior policy analyst at the right-leaning Tax Foundation, said that “the proposed regulations are consistent with the longstanding intent of the charitable deduction.”
Carl Davis, director of research at the left-leaning Institute on Taxation and Economic Policy, praised Treasury for taking the same approach to the SALT cap workarounds implemented by blue states and the private school tax credit programs more likely to exist in red states.
“All types of charitable credits should be on the same footing under federal tax law, and it seems that this regulation would close down the charitable tax credit dodge across the board,” he said in a statement.
But the guidance was criticized by Democratic politicians, who have viewed the tax law as an attack on blue states.
“Today, the Trump Administration doubled down on its attack on the middle class,” said Ways and Means Committee ranking member Richard Neal (D-Mass.). “The discriminatory Republican tax law capped the SALT deduction that average, hardworking families in many states rely on to afford owning their homes. The Administration’s new regulations block affected states’ attempts to cope with this significant change and protect residents from double taxation.”
New York Gov. Andrew Cuomo (D), who has enacted SALT cap workarounds that would become ineffective under the guidance, threatened legal action against the proposed rules.
“Now the IRS is hastily proposing politically motivated regulations to further the agenda of the Trump administration and block reforms that deliver relief to New York taxpayers. In New York, we will not stand for this abuse of government power,” he said. “We are confident that the recently enacted opportunities for charitable contributions to New York State and local governments are consistent with federal law and follow well-established precedent. And make no mistake: we will use every tool at our disposal, including litigation, to fight back.”
Rep. Bill Pascrell (D-N.J.), a member of the Ways and Means Committee, said he’s consulting with New Jersey Gov. Phil Murphy (D) about the state’s options in the wake of the guidance’s release.
“That Trump wants to block our state from seeking relief to their bad policies is an outrage,” he said. “None of us will take it lying down.”
The proposed rules were also blasted by the American Federation for Children, a school choice advocacy group.
John Schilling, president of the group, said the the guidance “will harm state tax credit scholarship programs that are currently benefitting more than 250,000 students, most of whom are from lower-income and minority families.”
New York, New Jersey, Connecticut and Maryland have sued the federal government over the SALT cap, but tax experts expect the lawsuit to be unsuccessful, arguing that the U.S. Constitution gives Congress broad power to levy income taxes.
Updated at 6:22 p.m.