New York is gearing up for battle against the IRS – the State budget, which passed on Saturday, includes two loopholes that affect the federal state and local tax (SALT) deduction.
Before 2018, taxpayers enjoyed no cap on the SALT deduction, which includes state and local withholdings and estimated payments, real estate taxes, personal property taxes, etc.
Thanks to the Tax Cuts and Jobs Act, the deduction is now limited to a total of $10,000.
Clearly, this affects high-tax/high-income states like New York the most and could cause a substantial loss of deductions for their residents.
Let’s take a look at how Governor Cuomo and the rest of the State government is fighting for the NY taxpayers.
The budget created two charitable funds run by the State of New York: one for education, and one for health.
The idea is to have taxpayers “donate” to these funds the amount of their property tax bill, in lieu of paying the State taxing authority. Taxpayers will also receive a state tax credit up to 85% of the amount donated in the year following the donation.
The payment would then be deductible in full as a charitable contribution, which is unlimited (up to 50% of your AGI).
Reality check: I don’t see the IRS approving this.
Contributions to government entities are allowed under Section 170 of the Code, but only if the donation is “made for exclusively public purposes”. This is certainly not a public purpose.
There are also other factors that pose a problem as to the deductibility of these “contributions”.
Publication 526 states that charitable contributions are only deductible to the extent the contributor received no benefit in return for the contribution. It seems pretty clear that taxpayers will be receiving a benefit for the contribution by means of circumventing the SALT deduction limit and receiving a NYS tax credit.
Various court cases have also ruled against the deductibility of charitable contributions for which the intent was not charitable. In other words, the contribution is not made out of the goodness of the taxpayer’s heart; it’s made for some element of personal gain.
The budget provides an option for employers to pay for their employees’ payroll deductions instead of withholding them from their employees’ paychecks.
This would result in a lower gross pay for the employees (same net check, though) and an increased deduction for the employer.
Lower gross wages for employees will mean less income tax and less withholding required to be paid in. Increased payroll deductions for employers will mean less taxable income and lower business taxes.
Reality check: I don’t see many employers implementing or employees taking advantage of this.
It would be a headache for employers to have to restructure wages, contracts, and other payroll-related items.
Not all employees will grasp the concept – a gross pay cut doesn’t sound appealing without all the facts, even if the net check remains the same.
Even with all the facts, it could affect certain employee benefits, such as employer matching of retirement contributions. Employer match contributions are up to a percentage of gross wages. Lower gross wages = lower maximum employer match.
The State’s attitude seems to be that it’s “worth trying” to create plans that will restore some of the New Yorkers’ lost deductions.
I would agree.
The worst case scenario would be that:
- The IRS disallows all deductions for the “charitable contributions” to the State funds
- Employers do not implement the new payroll tax provision
- Employees do not participate in the new payroll tax provision
In that case, we’d be in the same position we’re in now.
It will be interesting to see how the provisions in the budget unfold. Either way, it’s nice to see New York going to bat for its residents.
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Nick Aiola is a CPA and the owner of Aiola CPA, PLLC. Nick and his team provide the highest quality of tax and advisory services to real estate investors and individuals and business owners in the real estate industry.
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