September 24, 2018
Experts Corner

New federal tax rules create uncertainty in CT

Brenden Healy

As many Connecticut residents are painfully aware, the new federal tax law passed last December limits our ability to deduct the state and local taxes we pay each year.

Under the old rules, we could deduct Connecticut income tax, real estate tax and car taxes when we filed our annual tax return with the IRS. Under the new tax law, those state and local taxes we pay (also referred to as "SALT") are limited to a maximum deduction of $10,000.

Several states, including Connecticut, have made attempts to circumvent this new, $10,000 tax limit by reworking how and why the SALT taxes are paid.

As an example, and because the new tax law does not limit the charitable contribution deduction, some states are hoping to allow their local municipalities to recharacterize property taxes paid as a charitable deduction.

In theory, the person paying that property tax bill would be able to deduct the payment as a charitable contribution instead of deducting it as a property tax, which could be limited under the new tax rules.

A new Connecticut law allows municipalities to provide a property tax credit for donations to a community supporting organization, which is a charitable nonprofit that is organized exclusively to support municipal spending on programs and services, such as public education.

A municipality's governing body must annually approve the credit on or before Oct. 1. The municipality will determine the amount of the tax credit, which must not exceed the lesser of (A) the amount of property tax owed, or (B) 85 percent of the amount of voluntary, unrestricted and irrevocable cash donations made by or on behalf of the owner of a residential property located in the municipality to a community supporting organization during the calendar year preceding the year in which an application for the tax credit is filed.

In other words, Connecticut legislators crafted a way to convert your property taxes to a charitable contribution.

Unfortunately, the Internal Revenue Service (IRS) has essentially put the brakes on these new attempts. The federal agency issued proposed tax regulations concerning the availability of charitable contribution deductions when the person receives (or expects to receive) a corresponding state or local tax credit.

These proposed regulations are designed to block states and localities (like Connecticut) from setting up charitable funds to preserve the deductibility of state and local property taxes in response to the limitation on the SALT deduction imposed by the new law.

New York and New Jersey have also recently enacted legislation creating charitable funds and permitting localities to provide property tax credits in exchange for contributions to the funds.

Many states also provide various types of tax credits for contributions to governments or government-created funds, which were established prior to the federal tax law change last year. These proposed IRS regulations appear to try to block the recent SALT workarounds while preserving deductions for other types of state charitable tax credits.

In an Aug. 23, 2018, Treasury Department press release, Treasury Secretary Steven Mnuchin stated, "We appreciate the value of state tax credit programs, particularly school choice initiatives, and we believe the (IRS') proposed rule will have no impact on federal tax benefits for donations to school choice programs for about 99% of taxpayers compared to prior law."

In July, New York, Connecticut, New Jersey and Maryland filed a lawsuit in the U.S. District Court for the Southern District of New York claiming that the reduction of the SALT deduction enacted by the new tax law is unconstitutional and exceeds Congress' authority to impose a federal income tax.

There may be some tax relief to Connecticut residents as a result.

Brenden Healy is a CPA and partner at Hartford accounting and consulting firm Whittlesey.

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