Feds Crack Down on Blue-State Workarounds of Trump Tax Reform Deduction Limits

Andrew Cuomo promises lawsuits to protect state efforts to reclassify some state and local taxes as charitable contributions. Photo: Kevin Hagen/Getty Images

One of the really big deals in the 2017 Trump tax bill was the provision limiting the deductibility of state and local taxes (SALT). Designed pretty explicitly as a “screw the high-tax blue states” provision, and generating precious billions for cuts in corporate and high-end individual tax rates, the move enraged people in states like New York, California, New Jersey, and Connecticut, and lost Republicans some House votes (though not enough to endanger passage) of the bill. It limited the total SALT deduction (covering both state and local sales and income taxes and local property taxes) to $10,000; both types of deductions were unlimited previously.

About a third of taxpayers in New York and California have taken the SALT deduction in the recent past, with the average deduction being over $21,000 in New York and about $17,000 in the Golden State. Over 40 percent of taxpayers in Connecticut and Maryland took it, too. Unsurprisingly, state officials immediately began developing “workarounds” that would maintain the value of the SALT deduction without violating federal tax laws. The most common involves reclassifying some state tax payments as charitable contributions:

New York, Connecticut and New Jersey have adopted proposals allowing taxpayers, to varying degrees, to sidestep the SALT cap by recharacterizing their state and local tax payments as charitable contributions, which remain fully deductible. Other blue states like California and Illinois have considered similar moves.

Now the Empire is striking back at the Empire State and others, as the New York Times reports:

The Treasury Department moved on Thursday to block states from circumventing new federal limits on state and local tax deductions.

A proposed Treasury Department rule, certain to face legal challenges from several states, would limit the type of charitable contributions that Americans are allowed to deduct on their federal taxes. The rule would effectively exclude donations that are rewarded with state tax credits.

The new rule would deduct the value of any state tax credits from the amount deductible as a charitable contribution on federal forms, thus neutering the workaround.

There is a bit of a collateral damage problem, however:

[I]t could also adversely affect taxpayers in other states, where such credits were already being given for contributions made to certain private or charter schools and universities, land donated for conservation purposes and donations to housing assistance programs.

The private-school donations tax break is beloved of many Republicans, so that could be an issue depending on how the courts construe the rule during the inevitable litigation. And there will definitely be some of that, as Politico reports:

[New York Gov. Andrew] Cuomo denounced the new rules as “politically motivated,” adding: “We will use every tool at our disposal, including litigation, to fight back.” 

“In New York, we will not stand for this abuse of government power,” he said. “We are confident that the recently enacted opportunities for charitable contributions to New York State and local governments are consistent with federal law and follow well-established precedent.”

New York, along with Connecticut, Maryland, and New Jersey, is already in court alleging that the limitation on SALT deductions is an unconstitutional usurpation of state taxing powers.

It’s obviously a good thing politically for Cuomo, who is facing a left-bent primary challenge from Cynthia Nixon, to get into another public fight with the Trump administration. But the administration and its congressional allies clearly think their heartland base supporters love nothing better than sticking it to coastal “elites.” They’ll all see each other in court.

Feds Crack Down on State Workarounds of Tax Deduction Limits