08 April 2019

The Cap on the SALT Deduction: The Charitable Sector’s Unexpected Fight After Tax Reform

As April 15, commonly referred to as Tax Day, approaches, the Alliance for Charitable Reform will issue a series of articles examining the topics impacting the charitable sector as a result of the passage of the Tax Cuts and Jobs Act. This article discusses the impact of the legislation’s cap on state and local taxes.

Perhaps one of the more intriguing and immediate developments for the charitable sector following the passage of 2017’s Tax Cuts and Jobs Act (TCJA) was the fight resulting from the cap on the deduction for state and local taxes (SALT). It not only developed into a tax fight but a broad discussion over the appropriate role of government and independent civil society, and the role the charitable deduction plays as a guardrail between the two.

To refresh your memory, prior to the passage of the TCJA, taxpayers who itemized were permitted to deduct the full amount of their state and local property, and sales or income taxes from their federal taxable income. But the TCJA capped the amount of state and local taxes that can be deducted at $10,000. As a result, some taxpayers saw their taxable income, and thus their taxes, increase.

In an effort to skirt the new cap, some high-tax states pursued policies to allow taxpayers to give money to a special fund set up by the state, ostensibly charitable in nature. Donors to the fund would receive tax credits, often on a dollar-for-dollar basis, that could be used to offset state income tax liabilities. The money coming in to the state’s coffers wouldn’t change, the money sent to the state by the taxpayer wouldn’t change, but the money given to the state would be deductible for federal tax purposes as a charitable contribution. In essence, taxpayers in those states would be converting non-deductible state and local tax payments into deductible charitable contributions to be controlled by the government.

Legislation would ultimately pass in New York, New Jersey, Connecticut and California to create a form of this “charitable” workaround, while elected officials in Illinois and Oregon openly discussed similar legislative options. In February 2018, ACR first weighed in on the issue on behalf of The Philanthropy Roundtable. Sean Parnell, vice president of public policy, wrote on the ACR blog at the time:

But what is being proposed is to declare the government itself a charity, worthy of the same consideration and treatment that is reserved for nonprofits that feed the hungry, house the homeless, heal the sick, enrich our culture, nurture our spirits, and educate the public. True, government does many of these things as well, but so does business. The government is not civil society, and changing tax policy to pretend that it is would threaten the integrity of both.

These schemes would turn the charitable deduction, an indispensable guardrail between government and civil society, into merely another tax dodge. This would make it even harder to defend the charitable deduction’s continued existence, let alone pushing to democratize giving by making the deduction available to all Americans. It threatens to erase the lines between government, which by its nature has to be somewhat inflexible and wide-ranging, and the millions of “little platoons” (as Edmund Burke once described the churches and local institutions that we would today call charities) that are idiosyncratic, diverse in approaches, and focused on particular missions.

Parnell would also send a letter to Treasury Secretary Steven Mnuchin in July 2018 expressing concern over the proposed workarounds because they would blur or even erase the distinction between government and civil society. However, he also stressed that any regulations from the Department of Treasury should also avoid negatively impacting those legitimate charitable entities established or controlled by government, like state universities or parks, or state tax credit programs that support legitimate charitable activities such as the many programs offering scholarships for low-income students.

The Department of Treasury issued its regulations just a month later, requiring a taxpayer to reduce the amount claimed as a federal charitable deduction by the amount received in state-issued tax credits. The regulations allow an exception of a full federal charitable deduction if the tax credit received is 15 percent or less of the value of the contribution. The regulations would apply not only to SALT workaround proposals from high-tax states, but to all initiatives offering a state tax credit, such as those providing scholarships for low-income students and contributions for land conservation, which worried many in the charitable sector.

ACR was pleased to see the integrity of the charitable deduction preserved in the regulations, but also concerned that legitimate charitable programs could be impacted by the regulations.

“Unfortunately, the regulations failed to distinguish between the tax avoidance schemes proposed by the SALT workarounds and credits to legitimate charitable programs. The Philanthropy Roundtable calls on Treasury to specifically revisit the issue of tax credits for legitimate charitable purposes,” stated Parnell at the time.

At the time of this writing, final regulations on the SALT deduction cap were under review at the Office of Information and Regulatory Affairs. The updated regulations could be announced any day.

The TCJA’s cap on the SALT deduction was one of those provisions that had an immediate impact on the charitable sector, causing it to engage on an issue that may not have been on the radar prior to the legislation’s passage. It is also an example of how even though tax reform legislation passed over a year ago, the process is always ongoing, causing the members of the sector to continually be engaged with elected officials and policy makers.

In the next post in ACR’s Tax Day series, we examine tax reform’s impact on the number of itemizers and what that means for charitable giving.