SALT Battle Lines to Watch With IRS Rules Nearing

June 4, 2019, 5:26 PM

The 2017 tax law’s limit on the state and local tax deduction has remained one of the most polarizing elements of the federal overhaul, and the IRS could soon be addressing last-ditch efforts by states to preserve the tax perk.

The Internal Revenue Service is expected to release final rules in the coming days on charitable contributions and state and local tax credits. The White House’s Office of Information and Regulation Affairs sent the package back to the Treasury Department on May 31, according to the office’s website.

The impact of the $10,000 SALT deduction cap remains in dispute and politically sensitive. The IRS guidance is likely to curb state efforts, and could further inflame opponents—ranging from governors like New York’s Andrew M. Cuomo (D) to lawmakers in high-tax states like California and Connecticut. The rules may set up more debate at the state level about how to cope.

“An interesting question here is what, if anything, can be done about it,” said Matthew Green, a politics professor at the Catholic University of America. “Will it just be a talking point, or will governors find a way to address it? This could continue to be an issue for people in those high-tax states. I can’t see those states dramatically changing their tax codes.”

A Workaround

Proposed IRS guidance from August 2018 took aim at a popular workaround option. Some states, such as New York, offered programs that would allow their residents to skirt the deduction cap by creating charitable funds where donors could get a state tax credit in exchange for donations.

“The concern here now is you have a disparity between the treatment of taxes paid to states and charitable donations,” said Hayes Holderness, an assistant professor of law at the University of Richmond School of Law. . “It sets up this strange tension in the code that I think was unintended where you could sort of work around one part of the code by using another part of the code.”

The strategy was likely appealing because some states already offered tax credits for donations to certain entities, like private schools or development funds, which would qualify for a charitable deduction at the federal level, Holderness said.

“There was a pretty clear avenue to expand those programs because states already had them and felt the pressure from the new SALT cap,” Holderness said.

SALT Proposals in Congress

Democrats in high-tax states seized on the cap after the tax overhaul, saying it has hurt their constituents. They have since grappled with another reality: fully restoring the deduction would mostly help the wealthy. Lawmakers have offered a handful of bills to try and ease the cap, which is a challenging goal in a divided Congress.

Several lawmakers from New York and New Jersey are calling for an outright repeal of the limit on the state and local tax deduction. A proposal from New Jersey Democrats (H.R. 1142, S. 437) would repeal the cap and raise the top income tax rate.

Rep. Bill Pascrell (D-N.J.), who introduced the measure in the House, focused on the issue during a June 4 House Ways and Means Committee Members’ Day hearing.

“My state got hammered by the 2017 law. Because of the SALT cap, the IRS is literally taxing New Jerseyians on their taxes,” he said.

Illinois Democratic representatives Lauren Underwood and Sean Casten also have a bill (H.R. 1757) that would increase the cap to $15,000 for individuals and $30,000 for couples. The current cap doesn’t differentiate between singles and couples.

“Right now it seems like it’s a political question of whether the blue states can get together on this,” said Philip Hackney, a professor at the University of Pittsburgh School of Law. “The problem with any of these proposals seems to be the Senate. I don’t see the Republicans having any interest in helping Democrats.”

Political Outlook

Income inequality promises to be a key focus for Democratic presidential candidates in the 2020 campaign, with some hopefuls already offering proposals to increase taxes on the rich. However, the SALT debate may not end up being a top issue.

“It’s a little difficult because anything you do to raise the cap is mostly going to help high-income people,” said Frank Sammartino, a senior fellow at the Urban-Brookings Tax Policy Center. “While it’s an important constituency, it’s “not everybody that’s affected. I don’t know, given all the other issues, how much it could be very prominent in the campaign.”

Still, the sense that the federal tax changes punished taxpayers in high-tax states could have a lasting impact, Green said.

“People just finished paying their taxes for the first time since the Republican tax bill, so it’s still fresh in people’s minds,” he said.

—With assistance from Robert Lee.

To contact the reporter on this story: Kelly Zegers in Washington at kzegers@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com

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