IRS Responds to State Legislative Attempts to Circumvent Limitation on SALT Deduction

(Parker Tax Publishing June 2018)

The IRS issued a notice informing taxpayers that it intends to propose regulations addressing the federal income tax treatment of certain payments made by taxpayers for which taxpayers receive a credit against their state and local taxes. The notice was issued as several states are considering legislation intended to circumvent TCJA's limitation on the deduction for state and local taxes. Notice 2018-54.

The Tax Cuts and Jobs Act of 2017 (TCJA) limits an individual's deduction under Code Sec. 164 for the aggregate amount of state and local taxes paid during the calendar year to $10,000 ($5,000 in the case of a married individual filing a separate return). State and local tax payments in excess of those amounts are not deductible. This new limitation applies to tax years beginning after December 31, 2017, and before January 1, 2026.

In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay. The aim of these proposals is to allow taxpayers to characterize such transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities.

In response to the state initiatives, the IRS issued Notice 2018-54. The notice informs taxpayers that the Department of the Treasury and the IRS intend to propose regulations addressing the federal income tax treatment of payments made by taxpayers for which taxpayers receive a credit against their state and local taxes.

In the notice, the IRS stated that, despite state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes. In addition, the IRS said that it intends to propose regulations addressing the federal income tax treatment of transfers to funds controlled by state and local governments (or other state-specified transferees) that the transferor can treat in whole or in part as satisfying state and local tax obligations. The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers. According to the IRS, the proposed regulations will clarify the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.

For a discussion of the deductibility of state and local taxes, see Parker Tax ¶83,125.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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