WASHINGTON — The $10,000 federal cap on the deductibility of state and local taxes has led to a flurry of activity in red states to promote tax credits for taxpayers' efforts to make charitable donations to get around that cap.

That’s the finding of a survey by the Institute for Taxation and Economic Policy that highlights the difficult task the Internal Revenue Service faces in writing updated regulations to cover this part of the new tax law.

“Tax accountants, financial advisors, private schools, and other organizations are advertising tax credits for donating to private K-12 voucher funds as ways to ‘sidestep,’ ‘bypass,’ ‘circumvent,’ or ‘mitigate’ the impact of the federal SALT deduction cap,” said the report. “In Alabama, Arizona, Georgia, Louisiana, and Pennsylvania, these tax credits are being publicly marketed to potential donors as ways to ‘convert’ or ‘exchange’ capped SALT deductions for uncapped and more lucrative charitable deductions.”

Carl Davis, research director of the Institute on Taxation and Economic Policy in Washington, D.C.
Carl Davis, research director of the Institute on Taxation and Economic Policy in Washington, D.C. Provided photo

Carl Davis, the research director for ITEP who conducted the survey, said that in some states an individual who benefits from the state tax credits receives a 100% tax credit for his or her entire donation.

“If you get the money right back, after you quote unquote donated it, have you really donated anything at all?” Davis asked in an interview, adding, “The donor’s bank account looks no different after making the donation.”

The IRS announced on May 23 that it is working on regulations to enforce the cap on what previously was an unlimited personal deduction from federal income taxes for state and local taxes, also known as SALT.

New York and New Jersey have enacted new state laws allowing residents and homeowners to make charitable donations to school districts, local governments and the state as a workaround of the new federal cap.

The IRS and federal courts have previously upheld the legality of smaller scale charitable deductions from federal taxes that were established by 33 states.

“It’s widely understood the IRS is pursuing these regulations to crack down on the types of laws that were just enacted in New York and New Jersey,” Davis said. “That being said, it’s extremely important that the IRS not turn a blind eye to very similar state tax credits that have existed for many years in places like Arizona, Alabama, South Carolina, Georgia and elsewhere.”

Davis suggested that IRS should “start pursuing a broad fix for this problem and not just singling out the newest versions of these laws in New York.”

President Trump’s nominee to serve as next IRS commissioner, Charles Rettig, said at his Senate Finance Committee confirmation hearing last week that recently enacted state workarounds for the new SALT cap may present different legal issues than the earlier state laws.

Rettig, however, declined to predict how the IRS will treat the workarounds as it formulates new guidance on them.

“It's my understanding that there's a possibility that the post-tax-act situation could be not on all fours with the earlier position taken by the Internal Revenue Service in the 2010 chief counsel notice,” Retting said, using the “on all fours” legal term to refer to a lawsuit in which all the legal issues are identical.

Sen. Robert Menendez, D-N.J., told Rettig during the hearing that the IRS notice in stating it was developing a proposed SALT regulation was “fundamentally flawed” because it “contradicts decades of precedent and case law all the way up to the Supreme Court, and discriminates against states, apparently based on political affiliation.”

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