Speaker: SALT Workarounds Unlikely to Work as Planned

By:
Chris Gaetano
Published Date:
Jan 31, 2018
salt-216499_1920

While state governments are laboring to enact workarounds to the new $10,000 limit on state and local tax (SALT) deductions, attorney Mark Klein, a speaker at the Foundation for Accounting Education's conference "Impact of the New Tax Law: a Sid Kess Workshop," said it's unlikely that they will actually work the way they're intended. Speaking at the Society's Manhattan headquarters, Klein, a partner at  Hodgson Russ LLP, said that these efforts are largely political posturing rather than effective countermeasures.

"Our politicians need to show they are doing something to help us, but they are impotent in actually doing something," he said. 

As part of the Republican tax planned signed into law in December, the previously unlimited SALT deduction, which allowed people to write off state-level property, income and sales tax from their federal income, was capped at $10,000. This makes residents of higher tax states pay more than they had before: During his State of the State address, New York Gov.Andrew Cuomo said that limiting this deduction effectively raises New Yorkers' taxes by 20 to 25 percent across the board. The governor said there was no reason for this cap besides naked partisanship, arguing that it effectively robs blue states to pay for tax cuts in red states. 

In response to the SALT deduction cap, he and the governors of New Jersey, Connecticut and California have proposed a number of workarounds to help mitigate the damage. One option is to shift the income tax, which is subject to the cap, to a payroll tax, which is not. Cuomo formally proposed this shift through his budget document, and a later report outlined different ways it might theoretically be implemented. But Klein said that this measure isn't as simple as it might seem, as it might in fact even further increase taxes for some people, such as out-of-state workers. He asked his audience to imagine someone who lives in Connecticut but commutes to a job in New York. 

"They're going to pay full tax on their compensation in their home state, without any corresponding deduction or credit," he said. 

Further, by definition, the payroll tax would only be applicable to those on a payroll, which leaves out things like self-employment income or capital gains, both of which also represent a significant portion of revenue for the state. This means that the workaround would not cover as many people as an unlimited SALT deduction. The tax department report also mentioned that not everyone actually owes income tax, and so shifting to a payroll tax might actually harm lower-income workers. 

Another option is creating a not-for-profit entity that can fund public services, which people can donate to in return for a charitable deduction. While New York is considering this option too, it seems to be getting the most traction in California, where the state Senate recently passed a bill that would create such an entity. But Klein said it is extremely unlikely that this would work, since it flies in the face of many of the rules surrounding what counts as a charitable contribution. In general, for a charitable contribution to be eligible for a deduction, the taxpayer cannot receive value from it; otherwise it's more of a transaction. 

"It's difficult to understand how the feds would allow that. ... If you get state income tax [benefits] for every dollar you pay charitable, how voluntary are you? There's serious questions about whether that is a valid deduction, and that you receive no value from it," he said. 

While there is precedent for such a move, as an IRS memo from 2010 allowed contributions to a state tax credit program to be considered charitable contributions, Klein said it's unlikely that the Treasury Department would tolerate such a measure. He mentioned that U.S. Treasury Secretary Tim Mnuchin recently called the idea of substituting SALT deductions with charitable contributions "ridiculous" and warned that he would likely direct the IRS to audit those who try such a scheme. 

Beyond the SALT tax workarounds, Klein was similarly skeptical of New York's plan to close the carried interest loophole in the state. Carried interest is generally part of the compensation of a hedge fund manager, and counts as capital gains for federal tax purposes. While there had been discussion of changing this during the tax bill's negotiations, ultimately it remained a capital gain. New York, said Klein, "is quite upset about it" and so the governor proposed in his latest budget treating carried interest as ordinary income, as well as a further 17 percent surcharge.While Klein said "this sounds great," New York's fear is that these hedge funds will simply pick up and move to Connecticut, New Jersey, Massachusetts or Pennsylvania. Therefore, he said, the plan would not kick in until these states pass similar legislation. This, he said, makes it politically dead in the water. 

"This gives the governor cover. Lets him say, 'I'm out there trying to make things fair, but son of a gun, if all four states don't pass this, it goes nowhere.' And I can practically assure you those four states aren't going anywhere. What incentive do they have to help New York's tax situation?" he said. 

While the states determine their response to the SALT deduction cap, Klein said that he has many clients thinking of a workaround of their own: moving. But, he said, for many clients this is based on a misunderstanding of their own tax situations. 

"One thing a lot of my clients are talking about [is] leaving states like New York, New Jersey and Connecticut and going to Florida, Texas, Tennessee, Nevada, even Alaska! States with no or low income tax. A number of my clients say, 'This is outrageous! My inability to deduct my state and local taxes is killing me! I've got to go to Florida,' but then I look at their return and they've been in the [alternative minimum tax] forever anyway!" he said. "But they don't care. They just read they don't have a deduction they used to be entitled to." 

Click here to see more of the latest news from the NYSSCPA.