On the surface, high tax states such as New York seem to be hardest hit by a new limitation on the State and Local Tax (SALT) deduction. For previous tax years, taxpayers had the ability to write off all of their SALT payments against their ordinary income. This deduction has now been limited to $10,000 starting with 2018 tax filings.
Let’s leave conversations for another day about New York’s budget and the fact that many New Yorkers previously paid the Alternative Minimum Tax because of the high SALT deduction. In the meantime, the Fiscal Year 2019 NY State budget just enacted several provisions to mitigate the effects of the SALT limitation on New Yorkers.
Charitable Gift Trust Fund: In this workaround, either the State or your local government or school district can create a trust that will accept charitable contributions. If the trust is created by your local school district, these contributions will go to the school district. The State intends to create two funds, one for elementary and secondary public school support, and one for services relating to health care.
As enacted, a donation to the local trust would result in a 95% credit (or less as determined by the local authority) against the property tax of the taxpayer. If the donation is made to the State fund, the taxpayers will receive an 85% credit against their personal income taxes.
The thought behind this is that the taxpayer for federal purposes will take a charitable contribution for the full amount of the donation, and will also receive a credit against income taxes. The hope is that this mirrors the taxpayer’s federal tax liability prior to the enactment. (However, on May 23, 2018, the IRS issued Notice 2018-54 informing taxpayers that they intend to issue proposed regulations addressing the federal income tax treatment of these “contributions.” The regulations are to clarify that the code follows “substance over form” principles, implying that under this test these “contributions” may not be deductible.)
Employer compensation expense tax: This is a second workaround whereby New York tries to shift the employee’s tax liability to the employer (which has no deduction limitations as related to taxes). This would be an optional payroll tax of 5% (phased in over three years) on employees’ wages over $40,000. The employee would then get a credit (based upon a formula) against personal income taxes for the amount paid by the employer. This would most likely result in the employer trying to pass this tax on to the employee, which would most likely not be warmly received. This being an optional tax, our opinion is that it will be a little-used workaround. (Although Notice 2018-54 does not mention this tax implicitly, these types of workarounds will also be reviewed for tax treatment.)
Any revamps to the State’s income tax law can seriously impact the federal budget by reducing tax revenues. By some estimates earlier in the year, Bloomberg reported that the proposed payroll tax workaround could mean more than $50 billion less in anticipated federal tax revenue from New York taxpayers. Let’s just say that the IRS will likely challenge such workarounds. If you are concerned about the impact of the Tax Cuts and Jobs Act of 2017 on your business or personal tax situation, contact us soon to schedule a consultation and plan ahead.