Government Acts to Stop High-tax States from Skirting $10K Cap 

Government Acts to Stop High-Tax States from Skirting $10K Cap

WASHINGTON —

The Trump administration has laid down rules aimed at preventing residents in high-tax states from avoiding a new cap on widely popular state and local tax deductions. The action over the new Republican tax law pits the government against high-tax, heavily Democratic states in an election-year showdown.

The Treasury Department's rules released Thursday target moves by states like New York, New Jersey and California — where residents could see substantial increases in their federal tax bills next spring because of the $10,000 cap on state and local deductions. Experts say the issue likely will have to be resolved by the federal courts.

Four states — Connecticut, Maryland, New Jersey and New York — already have sued the federal government over the deduction cap, asserting it's aimed at hurting a group of Democratic states and tramples on their constitutional budget-making authority.

A dozen states have taken or are considering measures to get around the cap. Most of the workarounds take advantage of federal deductions for charitable contributions — which aren't capped — in place of the old deductions for paying state and local income taxes. So people's state and local taxes exceeding $10,000, which can't be deducted, are turned into deductible charitable donations.

The new rules' "dollar-for-dollar" limit also applies to many other states that already have charitable funds offering tax breaks, senior Treasury officials said. Those states include solidly Republican ones and others with relatively low taxes. In those programs, donors to schools, hospitals or land conservation programs can get their state taxes reduced in return — plus a charitable deduction on their federal tax returns.

The limit means taxpayers only can deduct as a charitable contribution the portion of their donation for which they don't also get a state tax credit.

But some experts said the Treasury rules seem to be designed to protect those existing charitable programs in some states. An exception to the "dollar-for-dollar" requirement "plainly appears to be designed to protect certain … pre-existing state regimes," said Daniel Rosen, a tax lawyer at Baker McKenzie who is a former IRS official.

Treasury said it expects that only about 1 percent of all U.S. taxpayers would see a reduction of their tax credits for donations to private-school voucher fund. Several states — Alabama, Arizona, Georgia, Montana and South Carolina — allow taxpayers who donate to private-school funds to get a 100 percent credit against their state taxes, according to data compiled by the Institute on Taxation and Economic Policy.

How do the limits work under the new rules?

Dollar-for-dollar: When a taxpayer receives a benefit in return for donating to charity, the taxpayer should only be able to deduct the net value of the donation as a charitable contribution, Treasury says.

An example: You donate $1,000 to a charity in a state that offers a 70 percent tax credit, so $700 in this case. You would only be able to claim a $300 charitable deduction on your federal return.

There is an exception. If the state tax credits don't exceed 15 percent of the amount donated, so up to a $150 state tax credit on a $1,000 donation, the taxpayer could claim the full amount as a charitable deduction.

Why is this important?

Taxpayers could have less incentive to donate without getting a deduction or having the deduction reduced.

All states rely on property and income taxes to fund an array of services such as education, health care and public safety. Advocates for restoring the full state and local deductions say that the reduced property tax deduction brings a decrease in the value of taxpayers' homes, possibly spurring residents of high-tax states to move elsewhere and crimping funding for local programs.

What's happening in the high-tax states?

Measures designed to work around the $10,000 cap have been adopted in Connecticut, New Jersey, New York and Oregon, and introduced or explored publicly by officials in California, Illinois, Maryland, Nebraska, Rhode Island, Virginia, Washington and the District of Columbia.

New York Gov. Andrew Cuomo, a Democrat, has called the state-local deduction cap an "assault" on New York by Trump and Republican lawmakers in Washington.

In some key "blue" states:

— Connecticut has a new law establishing a state charitable fund; donors can get tax credits in exchange for giving.

— In New Jersey, where high local property taxes are the major issue, the state is allowing local schools and governments to use the charitable workaround. But so far, no towns have notified authorities that they've set up funds to receive contributions — because state regulators haven't issued the necessary rules, experts say.

— New York is offering three options: One like Connecticut's, one like New Jersey's and another to let employers pay payroll taxes for employees, who would receive credits to cancel out the income taxes they would have paid otherwise.

— In Maryland, about 500,000 residents — over 18 percent of state taxpayers — will together lose $6.5 billion in state and local deductions, according to state estimates.

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