WASHINGTON – Treasury Department tax experts are skeptical about states allowing taxpayers to make charitable contributions to circumvent a new cap on deductions for state and local taxes, a department official said Thursday.
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The comments from Thomas West, the tax legislative counsel, serve as a warning to lawmakers in New York, New Jersey and California who are considering encouraging such donations with new state tax breaks.
The department is monitoring what states are doing and may issue a more formal notice if warranted to protect federal tax revenue, said Mr. West, who was speaking at a conference on Thursday. Treasury Secretary Steven Mnuchin previously called the idea "ridiculous."
"We are skeptical that some of these [ideas] would work," Mr. West said.
Lawmakers in high-tax states are considering ways of responding to the new tax law, which limits the individual deduction for state and local taxes to $10,000.
One option being considered in some states would take advantage of the fact that charitable contributions remain deductible against federal income taxes. States could set up funds and then give taxpayers a credit against their state and local income or property taxes for donations.
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That way, for example, people making $20,000 contributions to a New York state fund could take the charitable deduction on their federal returns, just as they used to be able to fully deduct state and local taxes. Then, they could get a discount of up to $20,000 on their local taxes.
Some legal experts say that approach would work under existing law.
Taxpayers typically can't get credit for a donation when they get something of value from a charity in return, but tax benefits haven't typically been treated that way. Many states have similar credits in place already, such as state income tax credits for conservation easement donations.
But Mr. West said the closer the benefit gets to 100%, the more questionable it is.
"That becomes something else," he said.
Treasury could perhaps use the "substance over form" legal doctrine to challenge the maneuvers as impermissible because of the intent and result of the transactions, he said.
Issuing formal guidance as states are considering the idea could head off the maneuvers by states or discourage individuals from claiming the break. The alternative would be audits after taxpayers claim the benefits on their federal tax returns, which could be more difficult and time-consuming for the government.
Mr. West was less critical about the legal justification for another idea being considered in New York, which would replace part of the state income tax with a payroll tax, which would be deductible for employers.
California State Senate President Kevin de Leon, a Democrat, called the warning from the U.S. Treasury "a shot across the bow" and said he would press forward.
"It is my duty to do everything within my power to protect the taxpayers of California against a very capricious, mean-spirited tax policy that unfairly targets Californians," he said.
"We hope that the officials at the IRS are not politicized by the Treasury and the White House to undermine what is already an accepted tax rule by many states throughout the country, but especially red states, who take advantage of this opportunity to allow taxpayers to make charitable contributions to a state general fund, receive a tax credit and therefore deduct it form their federal returns," he said.
--Alejandro Lazo contributed to this article.
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(END) Dow Jones Newswires
January 25, 2018 17:34 ET (22:34 GMT)