Governors claim IRS notice of forthcoming SALT rules is an attack

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WASHINGTON – New York Gov. Andrew Cuomo is calling the Internal Revenue Service’s plans to propose regulations on the federal deduction for state and local taxes a direct attack by the Trump administration.

New Jersey Gov. Phil Murphy and Connecticut Gov. Dannel Malloy voiced similar sentiments after the IRS announced on Wednesday that it will propose rules to address the charitable deductions that states have established in response to the recently enacted $10,000 federal cap on household deductions for state and local taxes.

New York, New Jersey and Connecticut are the first states to create charitable funds that taxpayers can contribute to in order to claim a charitable deduction in lieu of paying state and local taxes.

The IRS notice said that “taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes,” not state law.

“The federal government passed a disastrous tax bill that put corporations over people and specifically targeted New York and other Democratic states with the elimination of full state and local tax deductibility,” Cuomo said in a release. “New York was the first to take action to protect our residents from this hostile assault and ensure New York families weren't being used as a piggy bank to pay for tax cuts for big corporations. “

"Now, the administration appears poised to attack again through new tax regulations, showing its true hostility to New Yorkers and middle-class taxpayers," Cuomo said.

Leigh R.J. Appleby, a spokesperson for Malloy, told CNBC it was “no surprise that the Trump administration is once again targeting Connecticut taxpayers."

Connecticut’s workaround will “ensure [its] residents aren't double taxed because of the Trump/GOP tax law," the spokesperson said.

Thirty-three states, including California, previously enacted 113 different tax credits that can be deducted from federal taxes, according to a report issued several months ago by eight law professors.

“For the federal government to permit certain states to allow for charitable deductions, but not others that are following the same principles, is unconscionable. Once again, President Trump is unfairly targeting the hardworking people of New Jersey,” Murphy said.

Most of the earlier state tax credits cover only a fraction of the donations – for instance, 25% or 50% -- but few cover the full amounts.

Among those that do are: a 100% South Carolina tax credit for donations of up to $2 million to the Industry Partnership Fund at the South Carolina Research Authority; a 100% credit in Alabama for up to 50% of a taxpayer’s tax liability for donations to scholarship granting organizations; and two 100% tax credits in Montana for educational donations up to $150 per taxpayer.

Jared Walczak, a senior policy analyst at the Tax Foundation, said the new workarounds are different from the earlier charitable credits.

“For something to be considered genuinely a charitable contribution for the purposes of the deduction, it needs to both have some degree of charitable intent and it needs confer a charitable benefit,” Walczak said. “When a credit is provided by the state for a contribution to a third party, there is still a charitable benefit. When the state provides the credit and is the recipient, then there is no benefit or it is a very small one.”

California also has workaround legislation that has passed the State Senate and is awaiting action in the State Assembly.

The IRS notice is likely meant to slow the legislative fixes being enacted by states, said Howard Gleckman, a resident fellow at the Tax Policy Center.

Gleckman said the IRS notice sends a “very strong message" that the IRS is "not going to look favorably at the charitable workaround.”

It may mean the IRS is not going to have a formal regulatory response for a while, Gleckman added, explaining that it might make some state legislatures pause in their rush to enact workarounds.

New York State also enacted a new payroll tax for employers as an alternative workaround. The IRS notice made no mention of it, which Gleckman said may signal the IRS is “less comfortable rejecting that proposal.”

Complicating the IRS’ work is the fact that it and federal courts have previously upheld the legality of smaller scale charitable deductions established by states.

The IRS notice said the proposed regulations will address “the federal tax treatment of transfers to funds controlled by state and local governments (or other state-specified transferees) that the transferor can treat in whole or in part as satisfying state and local tax obligations.”

“The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the tax treatment of such transfers,” the notice said.

House Ways and Means Committee Chairman Kevin Brady, R-Texas, issued a statement applauding the IRS announcement for addressing what he termed as “gimmicks” in which “some politicians are still trying to discredit this new economic momentum in defense of high taxes and stagnant growth.”

The lawmakers who authored the tax law changes have emphasized that most households who have claimed a deduction for state and local taxes in the past won’t need to itemize it going forward because the standard deduction has been doubled to $24,000 for couples and $12,000 for individuals.

“There are many mayors and governors who do a good job of balancing budgets and creating jobs in their communities without high taxes,” Brady said. “And I encourage those few states that are trying to undermine our growing economy to instead focus on how they can lower their own taxes on their constituents and keep moving our economy forward.”

A report issued on May 7 by S&P Global shows that the impact of the new $10,000 SALT cap is concentrated at the county level in large areas of coastal California, Washington D.C., and greater New York City, which includes parts of Connecticut and northern New Jersey.

But 60% of the 117 counties that S&P found to be most affected by the SALT cap are in 20 states outside of New York, New Jersey and California.

Five counties in Kentucky – Boone, Campbell, Fayette, Oldham and Woodford – are included on the list. Wisconsin also has five at-risk counties while Oregon has six and Iowa has two.

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State and local finance State taxes Tax reform IRS Washington DC New York New Jersey Connecticut South Carolina Montana California Kentucky Oregon