The U.S. Department of the Treasury and the Internal Revenue Service (IRS) this week squashed attempts by some states to circumvent the federal cap on the deductibility of state and local taxes (SALT).
Tax reform capped SALT deductions at $10,000 – a move of particular import in states like Maryland. In response, some states passed legislation to allow local governments to create charitable funds to pay for local services and offer property tax credits to incentivize residents to give. Those taxpayers could then write off the payment as a charitable deduction on their federal income tax return – cap free.
Under the final regulations, a taxpayer making payments to an entity eligible to receive tax-deductible contributions must reduce the federal charitable contribution deduction by the amount of any state or local tax credit that the taxpayer receives or expects to receive in return.
For example, if a state grants a 70 percent state tax credit pursuant to a state tax credit program, and an itemizing taxpayer contributes $1,000 pursuant to that program, the taxpayer receives a $700 state tax credit. A taxpayer who itemizes deductions must reduce the $1,000 federal charitable contribution deduction by the $700 state tax credit, leaving a federal charitable contribution deduction of $300.
The regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their charitable contribution deductions.
According to Governing:
The new IRS rule squashes charitable-trust-loophole laws passed by Connecticut, New Jersey, New York and Oregon. Similar proposals are pending in California and Illinois.
But the IRS language is so broad that it also applies to long-established state-run trusts (for things like environmental preservation and charter schools), which give out tax credits in exchange for donations. Dozens of states — not just high-tax or Democratically controlled ones — have these trusts. The rule applies to any donation from an individual who has already hit the state and local tax deduction cap.
In the meantime, Maryland Attorney General Brian Frosh has joined Maryland with Connecticut, New Jersey, and New York in suing the federal government over capping the SALT deduction. The claim alleges that the new $10,000 SALT cap violates the U.S. Constitution’s Equal Protection Clause and the 10th Amendment, which protects states’ rights.