By now many of us in California have contemplated our fate regarding how the tax reform act passed by Congress last month will likely hurt Californians as a result of the federal limit on the state and local tax deduction for individual taxpayers.
In an effort to mitigate the limit of this deduction for Californians, state lawmakers have quickly looked to alternatives.
New Tax Plan – limited deduction
For residents of California and other high tax states, a major item of concern in the tax act is the cutback of deductions for state and local taxes (SALT). Taxpayers will now be able to deduct only up to $10,000 in SALT, including property taxes. According to this recent LA Times article, limiting the SALT deduction could affect as many as 6 million Californians. California taxpayers accounts for almost 20% of all SALT deductions, which is the highest state in the nation. Other states with large amounts of SALT deductions include New York, New Jersey and Connecticut, perhaps not coincidentally – all “blue” states.
How to mitigate the problem?
One option proposed last week by Senate President pro Tempore Kevin de Leon (D – Los Angeles), would be to recast state and local taxes as charitable contributions, which remain fully deductible under the GOP tax act. SB227 (known as the “Protect California Taxpayers Act”) would allow California taxpayers to make a charitable donation to a government entity, the California Excellence Fund, in the amount of their state taxes. They would then receive a dollar for dollar tax credit on their CA tax return in the amount of the donation. (For example, a taxpayer owing $15,000 in property taxes, might pay this amount to the Excellence Fund. The taxpayer then gets a tax credit for the entire $15,000 on their CA return. On the federal tax return, the taxpayer correctly classifies this amount as a charitable contribution, which is not limited to the $10,000 SALT rule. So, by essentially reclassifying the property tax as a contribution, the taxpayer still gets the full deduction for the entire $15,000, rather than just $10,000 on their federal return.)
Playing Devil’s Advocate?
So, that all sounds good. But will the IRS allow it? Will Congress?
What constitutes a charity? The Internal Revenue Service (IRS) and federal courts have ruled that government entities can qualify as charities for the purpose of the charitable deduction, even when the donor receives a full state or local tax credit in return. California and other states already have similar programs in place. For example, CA has a College Access Fund, which grants a 50% tax credit for contributions to the Cal Grants Program, which aids low-income college students. 17 additional states use a similar model to fund private education.
While the proposal is certainly creative, and has some defendable history behind it, we recommend to be cautiously optimistic about its ultimate passage in the state and then whether Congress will find a way to shut it down by passing further clarifying legislation.
For more information regarding this act published by the San Joe Mercury News, click here.
Stay tuned for further updates!
Have a question? Contact Monika Miles. Your comments are always welcome!