These Are the Tricks States May Use to Cushion the Loss of SALT Deduction

GOP Releases Final Tax Cut Bill

Everything You Need to Know About the GOP Tax-Overhaul Bill

How Americas Top Wealth Manager Delivers the Ultimate Client Experience

Exploiting tax loopholes is a sport associated with rich people and their fancy accountants. State governments may have to start getting fancy, too.

Republican Senate and House negotiators in Washington agreed last week on a $10,000 cap on state and local tax deductions, or SALT. In high-tax states, that’s bad news. Personal taxes are poised to rise for 13 percent of New Yorkers and 11 percent of California and New Jersey residents, according to an analysis by left-leaning Institute on Taxation and Economic Policy, conducted after the bill’s final details were announced.

Financial planners and law professors to the rescue. It’s possible, they say, to concoct workarounds, like replacing income tax with payroll tax, and turning state tax into charitable donations. Far-fetched? Perhaps. But tax experts are already formulating ways to stop the feds from grabbing more take-home pay from Californians, New Yorkers and New Jerseyans while folks across America buy boats with the money they save.

“There are many hundreds of billions of dollars on the table over the next decade,” said David Kamin, a New York University School of Law professor. “There’s a lot of incentive for states to shift into forms of taxation that remain deductible.”

SALT opponents say the deduction encourages states to increase taxes because of the indirect subsidy by Washington. Those who oppose the new cap argue that states like New York and New Jersey pay more in federal taxes than they get back in federal spending, and that putting federal taxes in front of state and local levies violates states’ constitutional rights.

For now, not much is brewing in affected state capitals except discussion, but then again, the Republican tax proposals aren’t yet law. State legislators will have a lot of decisions to make about how their tax codes will change, so a stratagem to offset the loss of the SALT deduction could be part of bigger overhauls, said Darien Shanske, professor at the University of California-Davis School of Law.

“No one likes paying more in taxes,” Shanske said. “It’s likely to be especially aggravating to pay more in taxes when others are paying less.”

One tactic: Allow residents to make charitable gifts to the state instead of paying income tax.

That would involve legislators encouraging residents to donate to, say, New Jersey (insert quip here), instead of paying income taxes. The self-interested philanthropists who took up the state on the offer would receive a state income-tax credit for the full amount of their gift, which would qualify for a federal deduction.

Wealthy taxpayers already use a similar ploy in 18 states that offer at least partial tax credits in return for donations to nonprofits that grant tuition vouchers to private and religious schools. It especially appeals to affluent filers who pay the alternative minimum tax, which doesn’t allow them to claim deductions for state and local levies.

In a memo released in 2011, the Internal Revenue Service gave its blessing for taxpayers to claim federal deductions on those gifts. The combination of a 100 percent state-tax credit and a federal deduction actually makes the gifts profitable for some donors, said Carl Davis, research director for the Institute on Taxation and Economic Policy.

“It’s really just a mechanism in state law that lets people launder state income-tax payments and convert them into charitable contributions,” Davis said.

Alas, it would involve a loophole that’s easy to close, he said.

“Under the current rules, it’s workable,’’ he said. “But I don’t see Congress or the IRS letting a state get away with it very long.”

The charitable-gift gambit isn’t the only potential loophole. States could quit relying on income tax, paid by individuals, and switch to payroll taxes, levied on employers, according to a Dec. 7 report, “The Games People Play,” by a group of tax experts that includes Kamin and Shanske.

If employers pay the payroll tax and reduce employees’ salaries by the same amount, workers wouldn’t have to deduct anything and would wind up being paid the same amount. That would allow states to collect the same revenue while preserving individuals’ deductions on federal returns.

Channeling collections into payroll taxes would also allow both itemizers and non-itemizers to benefit, and states would keep more money within their borders.

States with progressive income-tax rates would need to devise a system of tax credits to make payroll taxes hit the right rates. Union contracts guaranteeing certain wage levels could be a challenge, as would explaining the changes so they don’t read as a tax hike when workers get their pay stubs.

The complexity of such tactics would probably be the main deterrent. Whether states respond may depend on whether residents complain loudly enough. As the new tax law takes effect, working to circumvent the SALT cap could be good politics in the blue states hit hardest by the change. 

The tactics amount to a zero-sum game between state and federal governments. To the degree that statehouses succeed in clawing back part or all of their SALT deductions, federal tax collectors would miss out on revenue they’re depending on to fund the corporate tax cuts at the center of the overhaul plan.

“The question is,’’ Davis said, “how far are the states going to push the envelope?”

Copyright 2017 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

You are signed up!

Your resource for news, research and analysis to help you deliver more effective outcomes to your clients. width:300px!important;max-height:36px; ThinkAdvisor TechCenter

ThinkAdvisor’s TechCenter is an educational resource designed to give you a competitive edge by keeping you abreast of new tech innovations and need-to-know information that can be applied to your business. width:300px!important;max-height:36px; Financial Education Resource Center Financial Education Resource Center

ThinkAdvisor and the College for Financial Planning have partnered to bring you a series of helpful educational tools that you can use to take your career to the next level. padding: 0px;width: inherit; ETF & Smart Beta Research ETF & Smart Beta Research

A survey of advisors nationwide reveals how the use of ETFs is expanding and what factors are likely to further support this trend. Resources 13 Tips to Keep Your Marketing Plan Afloat

Reviewing this paper and incorporating the steps included into your 2018 marketing plan will enable you to be effective and take advantage of the huge…

Financial firms are failing to manage text messaging risk in the workplace. This guide explores how firms are exposed, the challenges of compliance and steps…

Investors need to invest differently in bull markets than they do in bear markets. Learn the importance of risk management during both and the best…

Join this webcast to see how Trisha Qualy, Director of Wealth Management at AdvisorNet Financial, took client assets from $100 million to $1.3 billion in…

Join this complimentary webcast to learn innovative strategies that have proven effective in containing rising health costs.

Join this conversation as a panel of experts provides tips and best practices to optimize your tech resources for business growth.

Leave a Reply

Your email address will not be published. Required fields are marked *