For personal state, local and property taxes paid beginning 2018, taxpayers are only allowed to deduct up to $10,000 on their tax returns. While the majority of taxpayers will not be affected by this change, some in the high-tax states (CA, NY, CT, IL, for example) may see their deductions reduced.
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. For example, the state of New York is considering having schools and some local government agencies set up nonprofit foundations, where the taxpayer makes a tax-deductible donation, and, in exchange, receives a tax credit. The goal 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.
A loose version of this is already available for teachers who incur unreimbursed classroom expenses that they don’t get to deduct because they don’t exceed the 2% adjusted gross income floor. Since donating to schools is deductible for charitable purposes, teachers can get an acknowledgement letter from the school and claim these expenses as charity. (I’ve discussed this in a prior blog)
The IRS is currently reviewing this and intends to publish clarifications as to whether or not this is allowable. I’m curious to know what they’ll say. From a taxpayer point of view, New York’s proposal appears desirable as it will create more deductions, AND the taxpayer will at least know exactly where his or her money is going. We shall see if it passes the IRS “smell test.”