Taxpayers in New York and Connecticut still have a few potential options to avoid the hit from a new cap on state and local tax deductions, while residents of other high-tax jurisdictions may only have creative estate planning as a last resort.
The Internal Revenue Service focused its proposed regulations last week on blocking the charitable programs approved by some high-tax states to skirt the $10,000 federal limit on so-called SALT deductions. It remained silent on other workarounds some states have in place to get around the cap.
The most popular mechanism to avoid the limit had been to allow taxpayers to make “charitable contributions” for their property tax payments, which would then have been eligible for a full federal tax write-off.
But New York and Connecticut included some Plan B options in their legislation to ease the potential tax hike for residents. Connecticut allows owners of so-called pass-through businesses -- such as partnerships, limited liability companies and S corporations -- to take bigger federal deductions to absorb some of the SALT hit. New York created a way for employers to shield their employees from the deduction cap. And tax advisers say a series of complex transactions involving trusts could effectively get around the $10,000 limit.
The back-up plans are still risky -- each with their downsides -- and it’s possible the IRS could ultimately block them, too. For some taxpayers, though, the tax pain is too great not to at least try.
Steve Rossman, a shareholder at accounting firm Drucker & Scaccetti in Philadelphia, said some taxpayers are still keen to minimize their liabilities, and are interested in other options, even if they require some additional work.
“People will try everything that’s within the boundaries of the law, versus losing a huge state tax deduction,” Rossman said.
The cap will increase New Yorkers’ federal taxes by $14.3 billion in 2018, and an additional $121 billion from 2019 to 2025, according to an analysis by the New York State Department of Taxation and Finance. Connecticut taxpayers will see an additional $2.8 billion federal income tax liability as a result of the SALT cap in 2018, the state’s estimates show.
Connecticut Pass-Through Tax
Connecticut Governor Dannel Malloy signed legislation in May that sets a 6.99 percent levy -- the state’s top marginal individual income tax rate -- on pass-through entities, which report their income on owners’ personal returns.
Pass-through owners then get a credit equal to 93 percent of the owner’s share of tax paid by the business. The strategy effectively lets pass-through owners take bigger federal write-offs to help offset their previously unlimited SALT deductions.