STUMP » Articles » Federal Tax Avoidance Follies: A Splash of Reality » 7 January 2018, 09:24

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Federal Tax Avoidance Follies: A Splash of Reality  


7 January 2018, 09:24

But before the ugly reality, let us consider the beautiful delusions:


A nutshell from Governing Magazine:

Let the Tax Games Begin!

Now that tax reform is capping how much filers can deduct in state and local taxes, high-tax states are coming up with workarounds. This week, California’s Senate President Pro Tem Kevin de León began shopping a proposal that would allow taxpayers to pay part of their state tax bill as a tax-deductible charitable contribution to California’s general fund.

Here’s how it would work: The amount of state and local taxes people can deduct from their federal income is now capped at $10,000. However, taxpayers who pay more than that in California could make an additional “charitable” contribution — up to $20,000 — to the state’s general fund. The taxpayer would then receive a dollar-for-dollar tax credit against their state taxes owed.

The Takeaway: This is likely just the tip of the iceberg. California has the nation’s third-highest average itemized deduction amount behind New York and Connecticut.

For clues as to what’s next, a recent joint report by more than a dozen tax scholars and analysts may provide some answers. The authors suggest a few ways governments might try to shift toward other deductible taxes. The suggestions include converting taxes into a charitable contribution, instituting a state property tax and cutting back on income tax rates, and implementing a state payroll tax, which is deductible for employers, in place of an income tax.

De León is working with some of the professors who authored the report to craft his California plan. Lawmakers elsewhere may also look to do the same.

Some figuring from Accounting Today:

State governments are already gaming the Republican tax overhaul

Before the ink was dry on the Republican tax bill signed into law late last month, experts predicted that state governments would try to shield their residents from tax hikes they’ll suffer from a sharp reduction in state and local deductions.

It didn’t take long.

New York Governor Andrew Cuomo on Tuesday said that the new cap on SALT deductions was an act of “economic civil war,” and promised to fight back by suing the federal government and by changing the state’s tax code to shelter residents from the loss.

In California, Senate President Pro Tem Kevin de León plans to introduce legislation this week that would allow residents to donate to a state entity called the California Excellence Fund in lieu of paying taxes—a move intended to sidestep the new federal cap.

The California bill builds on a nascent movement among states to provide full and partial tax credits in return for donations that fund tuition vouchers for private and religious schools. In a memo released in 2011, the Internal Revenue Service gave its blessing for taxpayers to claim federal deductions on those gifts, providing at least some basis for the idea that the strategy could work.

Hmm, that “California Excellence Fund” puts me in mind of The Human Fund….

Last one (for today: Murphy, other top Dems look to offset Jersey pain after Trump gutted property tax breaks

Democrats in New Jersey are working to make an end run around the new federal tax law passed by Republicans in Congress and signed by President Donald Trump that could hit New Jersey taxpayers especially hard.

Congress last month approved a new tax bill that shrinks a federal tax break New Jerseyans receive to offset local and state taxes, capping it at $10,000 — which is less than many people in New Jersey currently pay.

U.S. Rep. Josh Gottheimer and Gov.-elect Phil Murphy on Friday announced a new plan they say will offset some of those losses by giving New Jerseyans a new tax write-off.

It would allow local and state governments to set up charitable “support funds,” to which residents can contribute in exchange for a tax credit.

Under this set-up, taxpayers could donate money to pay for things like schools and infrastructure while at the same time reducing their property tax burden and allowing them to write off the charitable donation on their federal taxes.

Gottheimer, D-5th district, said the New Jersey proposal was in line with programs already green-lighted by the Internal Revenue Service in states like Alabama and California, which allow residents to write off anywhere from half to all of their contributions on their federal taxes, offsetting the losses they’ll see from the deduction cap.

In only one of these pieces do you hear of what kind of state-run “charities” and donations are currently allowed: vouchers for private schools.

I don’t think shoving money into public schools for operational (or even capital) costs is considered a charity, DonorsChoose notwithstanding.


So, let us consider: what kinds of charities are allowed for federal income tax deductions?

As I hinted at above, one can’t merely set up a Human Fund (though there seem to be some legit charities called The Human Fund) and just claim that as charitable donations. Similarly for shoving money at states.

Let’s see what the Tax Foundation has to say:

State Strategies to Preserve SALT Deductions for High-Income Taxpayers: Will They Work?
January 5, 2018

Key Findings

Several states are exploring strategies to preserve the full state and local tax deduction for high-income residents, which is capped at $10,000 under the new tax law.

In California, legislation has been filed to allow residents to make contributions in lieu of taxes, making a voluntary contribution to a new California Excellence Fund and then claiming the full amount as a credit against state income tax liability, since the state and local tax deduction is capped but the charitable deduction is not.
Case law and IRS regulations generally require charitable intent for a contribution to be deductible, meaning that the individual does not receive a substantial benefit from the contribution. Against this requirement, the sole purpose of the proposed contributions in lieu of taxes proposal is financial gain.

While the availability of state tax credits does not disallow taking the federal charitable deduction for genuine charitable contributions, any such contribution to a governmental entity must be “solely for public purposes.”

You should really read the whole thing if you are still under the delusion that your state can set up an Excellence Fund and have this work. There’s a lot in there about payroll taxes as well, but I know of lots of reasons why that won’t work well that has nothing to do with federal income taxes.

Let me excerpt some of the wonky stuff:

Restrictions on the Charitable Deduction

First, while governmental entities are qualifying organizations for purposes of claiming the charitable deduction, expressly delineated at IRC § 170, contributions are only deductible if, per IRS guidance, the contribution “is solely for public purposes (for example, a gift to reduce the public debt or maintain a public park).”8 The requirement that charitable contributions have a charitable aspect is a significant challenge for this approach.

Internal Revenue Service Publication 526 outlines what qualifies as a deductible charitable contribution, specifically excluding contributions from which one benefits, to the extent of that benefit. For instance, if one purchases a $250 ticket to a benefit dinner, and the fair market value of the dinner is $50, then $200 can be deducted—not $250.9 Arguably, the benefit of, say, a $20,000 “contribution” to one’s state which yields a $20,000 credit against state tax liability is, in fact, $20,000, completely wiping out deductibility. The contributor actually receives two benefits: one, the benefit of government services, and two, the benefit of a reduction in overall tax liability.

The contribution is also not “solely for public purposes,” as it transparently serves no public purpose (it has no net effect on state revenue) and is intended to leave the giver in better shape financially. This is not an incidental outcome; it represents the intended purpose of the strategy, and it flies in the face of what the IRS considers a charitable contribution.

Second, the Internal Revenue Code stipulates that if, as the result of a charitable contribution, a liability is assumed by the recipient, the deductible value of the charitable contribution is reduced by the amount of that liability.10 Even if we ignore the benefit to the taxpayer, which itself likely rules out claiming the deduction, the liability undertaken by the state (in the form of being required to provide a dollar-for-dollar tax credit) could very well provide the basis for disallowing the deduction.

Then they get into tax case law.

Rich people have been trying to finesse this stuff ever since there have been income taxes. Do not think that this is going to work at all.

And the “beauty” of the state “clever plans” is that it won’t be the politicians who get audited (unless they’re dumb enough to try this on their own taxes… and they just might be), but the individuals who attempt to follow these clever plans with the clever help of their very clever politicians.

Who keep eliding over the reason current state-run charities are actually considered charities: people rarely get to deduct 100% of amounts donated to voucher programs from their state taxes — the benefit goes to somebody else, and there is a marginal reduction in state taxes.

A 2010 IRS memorandum considered whether, if a state provided a tax credit for contributions to either a state agency or a nonprofit charitable organization (at the taxpayer’s discretion), those contributions could be deducted for federal tax purposes. The memo, which is nonprecedential and does not constitute published guidance, concludes that they can, but with conditions that the contributions in lieu of taxes proposal could not meet.18

First, the scenario considered in the memo involved a credit for contributions to a range of both state and non-state entities, instead of only permitting the credit for payments to a state entity. Allowing a 100 percent credit for charitable contributions to a state agency of one’s choice or to a private charity might be consistent with the provisional findings of the 2010 memo, but it is highly doubtful whether any state would be willing to risk taxpayers being able to earmark their tax dollars, either to their favored government programs or to private charities.

Second, the memo itself considers the issue unresolved, observing that the office had analyzed similar issues twice before without resolution and with the suggestion that the issue “could be addressed in official public guidance.” The memo notes that “[a]t this time, published guidance on the issue is not contemplated.”19

Yeah, the issue may have been unresolved as of 2010 and til now… but you better believe if a strategy talked about quite loudly in public by state politicians would spur the IRS to resolve this lickety-split.

And again, it wouldn’t be the politicians who would get audited. You want to get audited with the excuse “well, I trusted these state politicians…”

Come on, nobody trusts Gov. Cuomo, not even Democrats. And even if you did, your stupidity wouldn’t save you from the kind ministrations of the IRS.


Here is another indication that state-based “cleverness” will not fly when it comes to a federal situation:

Attorney General Jeff Sessions put out a memo stating that, guess what, the DOJ enforces federal law, not state law.

It’s difficult to find non-commentary pieces on what Sessions actually did, but here is a nice explainer from a lawyer on what’s going on here.

The bottomline is that if you want the federal law changed with respect to marijuana, you actually have to change federal law with respect to marijuana. Changing state law ain’t gonna do squat.

Likewise, if you want to change how federal income taxes treat state and local taxes, you’re going to have to change federal law.

Being “clever” at the state level ain’t going to do anything but make some lawyers very rich.

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