The IRS can issue the formal guidance on the legality of the workarounds of a SALT deduction cap. On the other hand, the tax community is just on pins & needles.
What’s SALT Deduction Cap and Why Is It So Important?
Before the enactment of the Tax Cuts & Jobs Act, the taxpayers who had itemized were allowed for deducting the whole value of main local as well as state tax payments by the federal income. It decreases the federal income tax liability. It substantially decreased the tax liabilities for several high-earning filers, especially those who live in the high-tax states. So, under this new law, local as well as state tax or SALT deduction is generally capped at 10,000 dollars.
Whereas there are so many filers who are yet better off because of the lower rates as well as some other reforms. A few states have admired that degree to which uncapped deductions decreased an effective cost of the taxes. Also, they’ve sought to grow the workarounds for retaining the prior benefit. And, definitely, these decreased rates were supposed to assist pay for. There is a common strategy to establish the government-linked “charitable” funds that allow the taxpayers for making the voluntary contribution to their state charity (hence eligible for a charitable deduction) and get the offsetting tax credit, decreasing the state tax liability.
But IRS is not about to go with this, is it?
Probably no. IRS has actually tipped the hand in a notice that it has issued about the guidance that is based on a well-established rule of the “substance over form.” Actually, idea is that IRS does not care much about the nomenclature: you could also call this the charitable contribution, a tax payment, or whatever you could think up. In case it is some kind of payment that is made in the satisfaction of tax liability then it is the tax payment.
IRS would be on some solid footing with strong determination. Regulations, case law, existing law, and the guidance point out this direction. IRS has already broad latitude for establishing the principles governing what actually constitutes the charitable contribution.
Why Is There Suspense?
Whereas some people are expecting for the different result, many observers hope that the IRS will not allow such intentional as well as new SALT workarounds which have been just adopted by some of the states along with New York. However, there is a broader effect, one which impacts most if not all the states. The taxpayers in the whole country have an access to the state tax credits that are designed in order to promote the charitable giving, a few quite generous than the remaining.
Generally speaking, those could be divided into 2 buckets that are the neighborhood assistance credits that give relief of the substantial tax for businesses and individuals who give for the social welfare (food pantries, free clinics, mental health services and more). The other one is scholarship tax credits. They are for those taxpayers who assist endow the school choice scholarship. Latter must be quite prominent in the red states while the first one could be found everywhere.
Such programs weren’t actually designed as the SALT deduction cap workarounds. Typically, these were designed before SALT cap but quite generous ones could also function in the same direction, with the contribution usually yielding some financial advantages to a donor. IRS has allowed the taxpayers for taking the federal deductions for these kinds of incentivized contributions when this just made some difference in the liability for the alternative minimum tax filers, but the IRS guidance can implicate such programs.
Could such charitable preferences be differentiated from the SALT deduction cap workarounds?
Probably. There’re so many distinguishing elements. The current limitations to claim SALT deduction attempt to receive at the idea of the donative intent. The notion is that you are making some kind of contribution for a cause other than self-benefit. Primarily, they do it in 2 ways. Firstly, by making you decrease that amount which you deduct by some benefit that you get due to your contribution. Secondly, by requiring some decrease for a liability that your contribution typically imposes on a recipient.
It is good to take advice from a tax preparer regarding the SALT deduction cap to avoid legal issues.
