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California Governor Vetoes SALT Deduction Cap Workaround

Posted on Oct. 2, 2018

California Gov. Jerry Brown (D) has vetoed a bill to circumvent the federal state and local tax deduction cap, citing concerns about new federal regulations designed to counter such workarounds.

S.B. 539 would have increased from 50 percent to 75 percent the value of an existing tax credit awarded to taxpayers in return for donations to the state’s College Access Tax Credit program and would have doubled the size of the program from $500 million annually to $1 billion. The legislation was designed to help taxpayers get around the Tax Cuts and Jobs Act's $10,000 SALT deduction cap by allowing them to donate to the tuition program, claim the state tax credit, and simultaneously claim an uncapped charitable deduction for the contribution on their federal income tax returns.

“This measure started as a bold idea but because of adverse changes in the federal tax law, it now confuses an already complicated scheme and could invite intervention by the Internal Revenue Service,” Brown wrote in his September 29 veto letter. 

Other states — in particular, high-tax blue states like New YorkNew Jersey, and Oregon — have passed similar workarounds. In his veto letter, Brown pointed to proposed IRS regulations that would counter these workarounds by generally requiring taxpayers to subtract the value of state tax credits received in return for donations from the amount of any charitable deduction they claim against their federal taxes.

Darien Shanske, a tax expert at the University of California, Davis, told Tax Notes October 1 that Brown’s veto makes sense, given the uncertainty now hanging over states’ efforts to circumvent the SALT deduction cap because of the proposed regs. “Certainly it is reasonable for Gov. Brown to be concerned about taxpayer confusion in light of the new regulations,” Shanske said, adding that Brown is a "conservative guy" who doesn't like tax credits.

“This bill was already facing an uphill climb,” Shanske noted. 

Melody Thornton with the California Society of Certified Public Accountants told Tax Notes that she agrees with Brown’s decision, arguing that until the outcome of the federal regs is known, it would be risky for taxpayers to use charitable-deduction-style SALT cap workarounds created by progressive states’ leaders.

The proposed regs have been written so broadly that they also seem to apply to many preexisting state tax credit programs designed to encourage taxpayer donations. Shanske noted that under the proposed regs, California’s existing tax credit for donations to the College Access Tax Credit Fund — the program S.B. 539 sought to expand — would also have to be subtracted from the federal charitable deduction claimed for charitable donations.

“It’s not as if California doesn’t have a program that’s already affected by the regulations,” Shanske said. “I don’t know what California as a state is going to do vis-à-vis the new regulations.” He said the regs are likely to be challenged in court if they are passed.

Brown’s veto isn't necessarily evidence that progressive states have given up the fight against the SALT deduction cap or the IRS's proposed regs, according to Shanske. “It’s clear that New York [and] particularly New Jersey are going to pursue this matter very forcefully and competently,” he said.

David Wolfe with the Howard Jarvis Taxpayers Association in California said he agrees with Brown’s decision, arguing that “it would be a fool’s errand to go against the IRS.” The association has urged the state to respond to the SALT deduction cap by reforming its steeply progressive income tax structure.

“If you really care about . . . high-income taxpayers, why don’t you do broad-based income tax reduction and create a flatter income tax?” Wolfe said.

New York Gov. Andrew Cuomo (D) in a September 9 letter asked the Treasury Inspector General for Tax Administration to investigate whether the proposed regs are "a result of improper political influence by the President, the Treasury Secretary, or other political officials."

The proposed regs are intended to apply retroactively to contributions made after August 27, 2018, according to the IRS’s August 23 announcement. The deadline to submit comments is October 11. 

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