WASHINGTON (Reuters) - The U.S. Treasury said on Wednesday that it will soon propose regulations aimed at recent state efforts to circumvent new Republican-enacted limits on a longstanding federal tax deduction for state and local tax payments.
The new rules will assert the authority of the Internal Revenue Service over workaround strategies, the Treasury and IRS said in a public notice. Most state workarounds have surfaced in “blue” states with Democratic majorities, where many taxpayers now face higher tax bills.
The Republican-controlled Congress capped the federal state and local tax (SALT) deduction at $10,000 in tax legislation that President Donald Trump signed into law in December. The move spawned official protests in states where the popular deduction has helped mitigate the burden of state and local taxes that fund local services including public education.
New York, New Jersey and Connecticut have already adopted measures that allow taxpayers to fund municipal governments by making tax-deductible charitable donations to specified funds in lieu of taxes. California, Illinois and Nebraska could follow a similar path.
New York allows taxpayers donating to state funds that support education and healthcare to receive up to 85 percent of their donation back in the form of a state tax credit.
The Trump administration suggested workarounds that use federal tax deductions could exceed the jurisdiction of state governments.
“The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers,” Treasury and the IRS said.
Republicans in Congress welcomed news of the impending regulations.
“I applaud the administration for responding to these gimmicks,” said Representative Kevin Brady, Republican chairman of the House Ways and Means Committee and a main author of the SALT deduction cap.
But the nonpartisan Institute on Taxation and Economic Policy, or ITEP, warned that narrow action could have unintended consequences for federal charitable donations if the government imposes arbitrary distinctions between different types of organizations. The group said Congress is better positioned to act fairly.
“The gifts being made under these schemes are not truly ‘charitable’ according to any commonsense definition of that word, since taxpayers are made financially better off by their gifts,” ITEP said in a report released on Wednesday.
“But fixing this problem will be more difficult than many observers have recognized,” it added.
Reporting by David Morgan; Editing by Chizu Nomiyama and Cynthia Osterman