The Internal Revenue Service put the tri-state area on notice: The charitable workarounds New York, New Jersey and Connecticut approved following the new federal cap on deductions for state and local taxes aren’t acceptable to the federal government.
Taxpayers who itemize will only be eligible for a federal deduction that’s a small fraction of their charitable donations for property tax payments, according to proposed regulations published in the Federal Register Thursday. The charitable contribution strategies in high-tax states were created so taxpayers would be able to write off the full donation amount from their federal taxes.
The Treasury Department regulations say taxpayers can receive a federal tax write-off equal to the difference between the state tax credits they get and their charitable donations. That means a New Jersey taxpayer who makes a $30,000 charitable donation to pay property taxes and receives a $27,000 state tax credit would only be able to write off $3,000 on a federal tax bill.
“Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families,” Treasury Secretary Steven Mnuchin said in a statement. “The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions.”
Last year’s tax overhaul created a $10,000 limit for state and local tax deductions, a pittance for Northeastern states that have high property taxes. New York Governor Andrew Cuomo and New Jersey Governor Phil Murphy signed legislation allowing local governments to set up charitable organizations to accept property tax payments. In turn, homeowners receive credits for those donations to offset federal taxable income.
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New Jersey gives taxpayers a 90 percent state tax credit for donations made to local municipalities, counties and school districts. Under the IRS proposal, only 10 percent of the donation amount would now be eligible for a federal tax break. New York provides an 85 percent state credit.
Connecticut approved similar legislation and one of three California bills to allow taxpayers to make charitable contributions has advanced through its first Assembly committee.
The Treasury rules provide some leeway for states that provide credits of 15 percent or less of the donation amount. In those cases, taxpayers can deduct the full charitable contribution on their federal taxes.
Municipalities had been awaiting IRS guidance before creating the charitable funds. The IRS had warned taxpayers in May to proceed with caution after the states approved the maneuvers involving charitable organizations to circumvent the new federal limits. The rules released Thursday are likely to be contested by those states.