Taxing Tuesday: New York Tries Its "Fix", Married Couple Base Scenario for Tax Calculator
by meep
I guess somebody’s got to try it:
New York OKs plan to skirt a controversial provision of the GOP tax law
New York lawmakers have passed two proposals to let state residents skirt the new $10,000 federal cap on state and local tax deductions. But the plan could still be knocked back by the IRS.
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Under one option, New York taxpayers will be able to make a charitable contribution to new state-run charitable funds to finance education and healthcare.For doing so, they will get a state tax credit worth 85% of their contribution — which effectively reduces their state tax bill by that amount. They could then deduct 100% of their contribution on their federal return, since there is no federal cap on charitable deductions.
That is, unless the IRS objects and disallows those tax filers from deducting those state contributions.
At issue: Does the money represent real charity or just tax avoidance since it’s paid in exchange for a personal financial benefit (i.e., the state tax credit)? The charity in question (the state), meanwhile, only gets a modest benefit worth 15% of the overall contribution.
Oh, this will be delicious. If/when the IRS knocks this down, the “charitable” folks are gonna get so screwed. They will have overpaid their state taxes — because they’re not getting 100% deduction. I can imagine it’s worth a try for those with huge state income tax bills, where the net result may be okay… but only if the IRS accepts the deduction.
Wouldn’t it be a kick in the teeth if the IRS recognizes only the 15% not being offset in the state tax? Enjoy being charitable!
Here’s the second part:
A second, more complicated option
The New York legislature approved a second, far more complex proposal to skirt the SALT deduction cap. But this option would not be a matter of choice for residents but rather for their employers.
Under the legislation, companies could opt to use an alternative employer compensation expense system. That system would shift the state tax burden from partially deductible personal income taxes paid by employees to fully deductible employer-side payroll taxes, according to University of Chicago law professor Daniel Hemel.
In exchange, employees’ paychecks would be lowered by some amount to reflect that removal of their state income tax burden.
“This might work in theory, since employees are … better off under the arrangement,” Walczak said. But due to contracts, union agreements and a human resistance to what will look like pay cuts, he noted, “[e]mployers can’t just slash salaries willy-nilly, even if there’s a good argument for it being to the employees’ benefit.”
However, if the people who are really getting screwed under the new rules are self-employed — like lawyers, financial planners, etc. — can they pay a payroll tax for themselves?
All I know is that lawyers and tax planning experts should be making out like bandits this year and next year.
TAX FOUNDATION’S TAKE
New York’s SALT Avoidance Scheme Could Actually Raise Your Taxes
Over the weekend, New York became the first state to create a state and local tax (SALT) deduction cap workaround—two workarounds, in fact, since New York does nothing on a small scale. Yet while the newly adopted budget encourages high-income taxpayers to take advantage of these provisions, they ought to come with a warning. Taxpayer Beware: these avoidance schemes may increase your total tax liability. They might even get you audited.
New York’s effort to preserve what amounts to a federal subsidy for high-income earners in a high-tax state comes in two flavors: a voluntary payroll tax and a contribution in lieu of taxes scheme. The first is an administrative nightmare that is only likely to benefit a select few; the second is a legally suspect workaround which actually increases New York tax payments while holding out the dubious hope of federal tax savings by pulling one over on the Internal Revenue Service (IRS).
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The new payroll tax may pass legal muster, but it helps very few taxpayers. For it to work, employers must be able to reduce compensation of their employees by the amount of the payroll tax obligation they voluntarily take on. This might work in theory, since employees are—or at least could be, absent the complexities attendant to the new system—better off under the arrangement, but in practice, wages are sticky. Employers can’t just slash salaries willy-nilly, even if there’s a good argument for it being to the employees’ benefit. There are contracts, labor agreements, minimum wage laws, and human nature to deal with. It might be an option for small groups of highly-compensated employees – think hedge funds and consultancies – but it’s a tough sell for a larger operation with a more diverse workforce.
And then there’s the Social Security aspects… it could really screw over middling-income employees if the base salary were lowered to make it all work out.
Then there’s the charitable contribution option, which is supposed to be available to all taxpayers who itemize, though if New York lawmakers had any confidence in their scheme, why bother with the payroll tax option, which is rendered duplicative?
The IRS is highly unlikely to go along with this charade, as these so-called contributions bear none of the hallmarks of genuine charity. The recipient (in this case, the state or a state-linked fund) receives only a modest benefit, quite small in terms of the overall “contribution”; the donor’s “gift” is motivated by personal financial benefit; and the contribution imposes a liability (in the form of the required compensatory credit) on the recipient. This is not a gift; it is a tax avoidance scheme.
What’s worse, it’s not even a particularly good one.
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One hopes that the IRS will clear up any uncertainty with formal guidance before taxpayers try to take advantage of this legally dubious scheme, but if that doesn’t happen, New York could be setting its residents up for a fall. They could face audits; they might be exposed to tax penalties; and their tax liability could actually go up.That’s because the tax credit New York offers isn’t dollar for dollar; it’s 85 percent for state tax liability and 95 percent for local liability. Someone trying to convert $50,000 in state and $50,000 in local tax liability into a deductible charitable contribution writes a $100,000 check to a new state-established fund, then gets tax credits against income tax liability worth $90,000.
If the IRS were to smile upon this scheme, high-income New Yorkers and the state government both win (though all other taxpayers, subsidizing this largesse, lose): the taxpayer gets a $100,000 federal tax deduction, worth $37,000 in lower federal taxes if all of it is exposed to the top marginal rate, while New York collects more revenue from that taxpayer than it otherwise would. On net, New York is up $10,000 and the wealthy taxpayer is up $27,000. Win-win, except, again, for the taxpayers nationwide who have to make up the difference or bear the cost of lower federal revenues.
I am not going to try to avail myself of either of these “fixes”. I think it’s setting one up for a fall, and I’d rather not end up paying more, with an audit to boot, because state politicians thought they’d be “clever”.
MORE WASTING OF MY TAX MONEY: SUING THE FEDS
Again, from the Tax Foundation: Connecticut v. the United States: A Preview of the SALT Limit Constitutional Challenge
Key Findings
New York Governor Andrew Cuomo has announced that his state and others will file a lawsuit challenging the federal tax law’s $10,000 cap on the state and local tax (SALT) deduction.
Governor Cuomo and his spokespeople have offered two main legal arguments: the SALT deduction cap violates the Equal Protection Clause, and the cap violates the Tenth Amendment.
The Equal Protection Clause protects against certain government classifications that burden or benefit one class of persons to the exclusion of others. But the SALT cap involves no facial classification, and does not in effect classify. Even if it did, it the standard for evaluation would be rational basis review which the federal tax bill easily meets.
The Tenth Amendment protects against federal laws designed to compel or commandeer states into implementing a federal law. The federal SALT deduction cap does not commandeer state legislative processes nor compel it to adopt a federal policy. While there may be pressure on a state to lower its taxes in response, this pressure is not so large as to deprive state policymakers of any choice in the matter.
Ugh, “facial classification”. All this legal mummery.
I tried searching on “facial classification based on”, because “facial classification” by itself gives you a bunch of plastic surgery sites. [Yes, I’ve switched over my search links to DuckDuckGo]
When I do such a search, I get a bunch of legal rulings/filings with phrases like:
“facial classification based on sex”
“facial classification based on gender”
“facial classifications on the basis of citizenship or alienage”
Let’s go to where it occurs in context:
EQUAL PROTECTION CLAUSE
The Fourteenth Amendment provides “[n]o State shall make or enforce any law which . . . deny to any person within [the State’s] jurisdiction the equal protection of the laws.” [2] While the Fourteenth Amendment applies only to state legislation, the Supreme Court has held that “the Due Process Clause of the Fifth Amendment provides guarantees against the Federal Government that are essentially identical to those provided against the States by the Fourteenth Amendment’s Equal Protection Clause.” [3] Thus, federal legislation cannot deny persons the equal protection of the laws.
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To determine whether there is an equal protection violation, there must first be a government classification, as the equal protection clause applies only to government classifications. [5] Government classifications occur when government action imposes a burden or confers a benefit on one class of persons to the exclusion of others. Government classifications may be “facial” [6] or “in effect.” [7] If the classification appears on the face of a statute, the Equal Protection Clause applies.
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In this case, the provision capping deductions for state and local taxes is unlikely to be considered a classification meriting strict or intermediate scrutiny. The SALT deduction cap provision neither facially classifies nor in effect classifies. Had the provision stated that the cap only applied to Democrats (or Republicans), then this could be a facial classification, but it does not. he provision also does not classify “in effect.” While the effect of the cap impacts high-tax states (many of which, but not all, tend to vote Democratic), the burdens of the cap are a result of income, property ownership, and the interplay of the tax system, and are indifferent to one’s state of residence or party affiliation. [20]
Basically, there’s nothing that says Yankees fans or whoever gets an additional tax. You have a higher income, you get a higher tax. It doesn’t matter where you live. The SALT cap applies to everybody equally.
There is no difference between this and the Alternative Minimum Tax which disproportionately affected people from New York, for example. There are caps or total removal of various deductions.
The whole argument is absurd.
There’s nothing inherent in New York having high taxes. The only reason the state really “needs” high taxes is because there is so much it wants to pay for, including past promises of bonds and pensions.
This conclusion, though:
Conclusion
The threatened lawsuit may be more a political exercise than a legal one, as a judge is unlikely to rule that the SALT deduction cap violates either the Equal Protection Clause or the Tenth Amendment. The concern that high state taxes might harm the competitiveness or attractiveness of a state like New York or Connecticut is a valid one, but the solution lays with revisiting those state tax rates rather than meritless litigation.
This may just be jawboning, trying to increase Democrat turnout for elections… in already fairly Democratic states.
I don’t think any of the “clever” fixes will work, and I don’t see any lawsuits getting very far.
MARRIED COUPLE SCENARIOS
The Tax Foundation has already done its own marriage penalty analysis, under the new tax rules (Here’s an older explainer about the concept in general). However, they’re just comparing what the people would have paid as single people under the new tax rules… not who is paying more compared to the old.
Here is an explanation of the broad impact:
Marriage penalties typically occur when two individuals with similar incomes marry. Prior to the Tax Cuts and Jobs Act (TCJA), the marriage penalty was especially pronounced for medium- to high-income earners because the income tax brackets for married couples at the top of the income tax schedule were not twice as wide as the equivalent brackets for single individuals. Currently, however, all tax brackets for married filers are exactly double those for single filers, except for the top 37 percent marginal rate. As such, marriage penalties are generally only felt at very high income levels.
So, once again, the TCJA soaks the rich. Why are the Democrats bitching? Isn’t that what they want?
There are Earned Income Tax Credit impacts, though:
For low-income individuals, the Earned Income Tax Credit (EITC) has a significant impact on marriage penalties and bonuses. Adding one partner’s income to the other partner’s income can easily push the combined income of the couple into the phaseout range, or further into the phase-in of the EITC, resulting in a reduction or increase of the couple’s combined after-tax income.
Their conclusion:
Fixing the Marriage Penalty
The reason there are marriage penalties and bonuses is that the U.S. tax code simultaneously attempts to satisfy three conflicting goals: equal treatment of married couples, equal treatment of married and unmarried couples, and progressive taxation. [3]To completely eliminate marriage penalties or bonuses in the tax code, it would require giving up one of these goals. For example, if the United States created a perfectly flat individual income tax with no provisions such as the Child Tax Credit or Earned Income Tax Credit, marriage penalties and bonuses would be eliminated. Likewise, if the United States kept its current progressive individual income tax but eliminated the ability for married couples to file jointly, there would also no longer be a penalty or bonus for marriage.
Changes that would eliminate marriage penalties and bonuses would drastically impact the current distribution of taxes paid and would be politically difficult to accomplish. As a result, Congress has opted to incrementally reduce the effects of the marriage penalty rather than regulate complete neutrality. In 2001, Congress passed a bill that widened the 15 percent tax bracket for married individuals. Next, Congress temporarily limited the marriage penalty in regard to the EITC. This temporary 2009 reform increased the level of income at which the EITC phased out for married couples and was made permanent in 2015. [5] Most recently, with the passage of the TCJA, all married brackets but the top marginal 37 percent bracket were set to be exactly double those of the single brackets, leading to less of an overall marriage penalty for middle- to high-income earners.
Thing is, this analysis isn’t comparing before/after — they’re comparing unmarried v. married under one code. I’m not interested in that.
So let’s get started, as we did with the single filers, with just the standard deduction.
BASE SCENARIO: CHECKING OUT THE STANDARD DEDUCTION
Here’s the calculator, if you’ve forgotten it:
So I’m going to keep it really simple: I’ll do a base scenario, with standard deduction, at the same income levels seen with the single filer scenarios – they will be split in two ways: 100/0 and 50/50. They should give the same results, either way.
I checked, and it gave the same before/after numbers no matter the split in income between spouses. So let’s look at what we get with the standard deduction.
Here are the before/after on absolute dollars paid:
And before/after on rates paid:
And here is the misleading difference graph:
So the decrease for married couples (assuming standard deduction only) is pretty nice compared to single filers. Check those single filers out, as a remembrance:
I can think of no sexier proposal than “Hey, you want to lower your taxes?”
And that’s it for today.
