Since its conception, the state and local tax cap (SALT cap) included in the Tax Cuts and Jobs Act of 2017 has been a source of debate. Taxpayers in high-tax jurisdictions are disproportionately impacted by the SALT cap, which caps deductions for state and local taxes at $10,000. This problem has prompted numerous states to devise alternatives to the SALT limit. The IRS recently approved one such workaround established by New York, New Jersey, and Connecticut. This workaround entails the establishment of state-level charitable funds to which taxpayers may contribute in exchange for a reduction in their state income tax. Educators, medical professionals, and environmentalists benefit from these charity donations. In this piece, we'll examine the IRS decision on the state-level charity funds workaround, including its consequences for taxpayers and state governments, as well as the benefits and drawbacks of that option.

Background

The SALT limit was enacted as part of the tax cut and job act (TCJA) of 2017. Individuals can only deduct state and local taxes up to $10,000 on their federal income tax returns because of the cap. Taxpayers in states with high taxes, like New York, New Jersey, and California, will be hit more by this cap. Federal taxes are increased because these taxpayers can no longer deduct the entire amount of their state and local taxes. This has prompted several states to find ways around the SALT limit. There are ways around the SALT cap, including tax benefits at the state level. Taxpayers and state governments need clarity because the IRS needs to be faster to accept these alternatives.

The Green Light

The IRS recently approved one such workaround established by New York, New Jersey, and Connecticut. This workaround entails the establishment of state-level charitable funds to which taxpayers may contribute in exchange for a reduction in their state income tax. Educators, medical professionals, and environmentalists benefit from these charity donations. This loophole allows taxpayers to contribute to the charity of their choice while also helping from a total state tax credit on their contribution. If they itemize their deductions on their federal tax return, their donation qualifies as a charitable deduction. Charitable deductions are exempt from the SALT cap. Therefore taxpayers can use them to reduce the overall effect of the cap. The IRS has ruled that taxpayers can take a federal tax deduction for charitable contributions if they also receive a state tax credit of no more than 15% of the total amount of the gift. If a taxpayer gives $10,000 to a state charity and gets a $1,500 tax credit from the state, the individual can deduct $8,500 from their federal taxes.

The Pros And Cons

The IRS has recently approved a workaround to the state and local tax cap (SALT cap) that involves charitable funds on the state level.

Pros:

• Reduces the burden of the SALT cap for taxpayers residing in high-tax states.
• Promotes giving to nonprofits and helps those in need.
• Boosts state coffers by getting people to give to state-run charities.

Cons:

• The workaround is controversial since some believe it defeats the goal of the SALT cap.
• It helps high-income taxpayers because they are the ones who can afford to make sizable contributions to charity.
• It could motivate some taxpayers to shift their tax liability onto those less able to make sizable charitable contributions.
• Taxpayers may use the loophole to avoid paying taxes to the federal government, which could result in a loss of revenue.

Conclusion

Taxpayers in high-tax states can breathe a sigh of relief thanks to the new IRS judgment on the state-level charitable fund's workaround, but the finding also calls into question the efficacy and purpose of the SALT cap. This loophole enables taxpayers to reduce their tax liability despite the SALT cap and promotes giving to worthy causes. But critics say it's a tax loophole that only favors the wealthy. Both open questions are whether the IRS will continue to permit these kinds of workarounds and whether or not additional states will enact similar policies. The SALT cap is still controversial, and the IRS decision could have far-reaching effects on individuals and state governments.