State Tax Deduction Limitation: States Seek Plan to Counter

January 22, 2018

This article is co-authored by Michael Leonardis.

The new tax reform bill signed into law by President Trump on December 22nd places a $10,000 ceiling on the state and local tax (SALT) deduction. Some states are looking to offset the impact of the limitation to its residents through the use of charitable contributions. The previous state and local tax deduction allowed taxpayers who itemize on their returns to commingle their state income taxes and property taxes into one unlimited deduction. The new law caps that deductible amount going forward.

When the GOP tax bill passed late last year, it ushered in a new provision that would impact millions of Americans. For decades, taxpayers who itemized deductions could deduct the sum of either their state income tax or sales taxes paid, and property taxes, without limitation. Beginning in 2018, through one of the bill’s most controversial provisions, the SALT deduction is limited to $10,000. Not surprisingly, this threshold hits high-tax states such as California, Connecticut, and New York the hardest, and poses a threat to taxpayers who might see tens of thousands of dollars of deduction wiped away under the new plan.

However, these high-tax jurisdictions have not raised the white flag yet. Officials in California, New York, and New Jersey have all proposed plans to work around the SALT limitation. In fact, California Senate leader Kevon de León introduced legislation on January 4th to circumvent what he and many colleagues view as an attack on a long-standing tax benefit, especially to residents of states with higher income tax rates. The plan is to allow a dollar-for-dollar credit against their state’s income tax liability for taxpayers who contribute to certain state or municipal funds and charities. The plan would have a twofold benefit. It would increase the amount of the federal deduction for charitable contributions, and would also reduce the impact of the new $10,000 SALT deduction limitation by minimizing the taxpayer’s state income tax liability. This is an attractive prospect for high-tax states such as New Jersey, whose taxpayers routinely deduct more than $10,000 in state and local taxes. According to IRS data, Bergen County residents in the Garden State claimed an average of $28,257 in SALT deductions in 2015.

In the weeks to follow, it will be worthwhile to see how states react to a provision they never likely before considered. What will prove most important, however, is if any of the state ideas to offer a credit for charitable contributions pass muster with the IRS. Some tax scholars have cautioned the states against implementing such a scheme, arguing it violates the basic principles of the charitable deduction. However, the plan is still very much on the table for a handful of states that feel disproportionately impacted by the bill’s surprising provision. Of course, Aronson’s state and local tax professionals will be watching closely as these plans unfolds.

If you have questions about the future deductibility of your state and local taxes, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.