Here's how Californians may be able to skirt SALT cap

Your tax reform questions answered
Your tax reform questions answered

A top lawmaker in California introduced a bill this week to protect state residents who will be hurt by a new $10,000 cap on how much they may deduct in state and local taxes on their federal returns.

The cap was one of the most controversial provisions included in a federal tax overhaul signed into law last month.

The proposed California workaround, by Senate leader Kevin de Leon, is the first of what are expected to be several legislative efforts in high-tax states to mitigate the impact of the SALT deduction cap on their residents.

The average state and local tax deduction claimed by Californians is well above the cap, at $18,438, according to de Leon's office.

To help ensure they can still deduct much or all of the state and local taxes they pay, de Leon has proposed letting residents make a charitable contribution to the state in exchange for a tax credit.

That way, the charitable contribution would be deductible on their federal return, since the new federal tax law doesn't limit deductions for charitable gifts except in certain instances.

Related: How high-tax states may try to get around the new SALT deduction cap

Here's how it would work: Californians would pay state and local taxes throughout the year just as they do now. But if they exceed $10,000 the resident taxpayer has a decision to make.

Say someone pays $19,000 total. At any point in the year, she could choose to make a $9,000 charitable contribution to the state. In exchange, the state would grant a tax credit, which would reduce her state tax bill by $9,000. When she files her federal tax return, she could deduct $10,000 for her state and local taxes plus $9,000 for her charitable contribution to the state.

Of course, that would require that taxpayer to pay $9,000 to the state before effectively getting it back as a tax credit when she files her return.

De Leon hopes to get the bill to the California Senate floor for a vote by the last week of January, his spokesman said.

Move could be viewed as legally questionable

Even if the California measure -- or measures like it in other states -- pass, some will argue the move is legally questionable.

For instance, a charitable contribution is typically not considered deductible if the donor benefits from it.

"If one purchases a $250 ticket to a benefit dinner, and the fair market value of the dinner is $50, then $200 can be deducted, not $250," Tax Foundation senior policy analyst Jared Walczak wrote in a paper examining the issue of proposed workarounds to the SALT deduction cap.

A contribution made in exchange for a 100% state tax credit, solely to lower a donor's federal tax liability, could be viewed as wholly benefiting the donor.

In addition, a contribution usually isn't considered deductible if it causes the recipient (in this case, the state) to incur a liability (having to provide a tax credit), Walczak notes.

As with many tax issues, though, there are often good counterarguments backed by case law and precedent.

Kirk Stark, a tax law professor at UCLA, notes there are many past examples in which the IRS and the courts have blessed the federal deductibility of state-level charitable contributions made in exchange for state tax credits.

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