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IRS Denies State Workaround on State and Local Taxes

Published on: 13:11PM Aug 27, 2018

The new tax law prevents taxpayers from deducting more than $10,000 of personal income, sales and property taxes.  Now this is only for personal taxes.  All taxes that would normally be deducted on Schedule C, E, F and Form 4835 are not affected.

Many high tax states such as New York, New Jersey, etc. tried to do a workaround on this to allow their taxpayers to "contribute" to certain state sponsored charitable funds and in return, they would get a credit against their state income taxes or local property tax.  The IRS last week issued proposed regulations that essentially said nice try, but no go.

In the past, the IRS really did not care if a taxpayer contributed to these funds since both the charitable contribution or state or local tax payment was deductible (other than possibly for AMT purposes).  With the new tax law, that is no longer true.  The IRS considers these payments to be of a Quid Pro Quo nature (i.e. to be considered a charitable contribution the taxpayer cannot receive any benefit in return).  The Regs indicate that payments to these charities will be allowed, however, the deduction on the tax return will need to be reduced by any credit received by the taxpayer against income or property tax.  However, if the credit is less than 15% of the contribution, there is no reduction required in that case.

Many states had allowed credits against income tax in prior years that the IRS did not have an issue with.  Going forward, all of these contributions will now result in a reduction in the amount allowed as a charitable contribution.  

The bottom line is any payments to any charity that results in a reduction in personal taxes will be reduced by that reduction (other than the 15% de minimis amount).