As Legislature nears adjournment for the year, two bills would counter federal tax reform’s limit on deducting state and local taxes by granting converting some of them into charitable contributions. However, the Internal Revenue Service is warning that such work-arounds would not be allowed.
California’s Democrat-dominated state government and the Republican-dominated federal government are engaged in so many conflicts that one needs a scorecard to keep track.
In fact, CALmatters has assembled a compendium of the Sacramento-vs.-Washington battles that must be constantly updated because new ones arise so frequently.
They range from the purely symbolic to those that could, depending on the outcome, affect the lives of real people. One of the latter is over the federal tax overhaul that Congress enacted and President Donald Trump signed.
One provision would limit personal income tax deductions for state and local taxes (SALT) to $10,000 per return.
The limit hits residents of high-taxing states such as California the hardest and elicited howls of protest from the state’s politicians – and those of other blue states – that it was nothing more than a political karate chop.
Some 6.1 million California residents claimed SALT deductions in 2015, reducing their federal taxable incomes by $18,438 on average, according to the Tax Policy Center. Only New York and Connecticut had a higher average.
While the limit would not directly affect the revenues of high-tax states, it would make their tax levies more burdensome because they could no longer be fully written off. That might make blue state taxpayers, especially high-income residents, less willing to pay up and even encourage some to flee to states, such as Nevada, Texas, Washington or Florida, which don’t levy income taxes.
As the protests reverberated, some clever folks came up with schemes that would, they said, counter the $10,000 limit by converting some state taxes into charitable donations that could then be deducted without limit.
In California, that scheming took the form of two bills that are still alive as the Legislature churns toward adjournment Friday.
Assemblywoman Autumn Burke, a Marina Del Rey Democrat, is carrying Assembly Bill 2217, which would allow taxpayers to contribute to nonprofits, colleges or K-12 public schools in exchange for an 80 percent tax credit.
Sen. Kevin de León, a Los Angeles Democrat and candidate for the U.S. Senate, would give taxpayers a 75 percent tax credit for contributing to the state’s college tuition fund in Senate Bill 227.
The Legislature may be tempted to thumb its nose at Washington by sending one or both of these bills to Gov. Jerry Brown. It also would be a big mistake, one that could subject Californians who took such “charitable deductions” to intense Internal Revenue Service scrutiny, interest and even fines.
Why? Because last week, the IRS and the Treasury Department specifically warned that such workarounds would be disallowed by promulgating new rules.
If the rules are in place by the end of the year, they would block major tax write-offs by requiring taxpayers to lower the value of their charitable deduction by the amount of any state or local tax credit received.
“Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families,” Treasury Secretary Steven T. Mnuchin said.
“The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions,” he said.
As tempting as passing the pending bills may be, it’s unlikely that California and other states, such as New York, planning similar maneuvers would prevail in an inevitable legal showdown.
The prudent step would be to allow some other state to fight the battle first without putting California taxpayers at risk.