New State and Local Tax Deduction
A hot topic from the Tax Cuts and Jobs Act (TCJA) tax reform for California and other high-income tax states was the limit to the State and Local Tax Deduction for individuals. Before the TCJA an individual was allowed to claim the following types of taxes as itemized deductions, even if they were not business related: (1) state, local and foreign real property taxes (2) state and local personal property taxes (3) state, local and foreign income taxes. This has been a huge benefit to reduce federal income taxes for high tax states with high property values resulting in large real estate taxes paid on personal residences. The average state and local deduction taken by the 6.1 million California residents who filed for it in 2015 was $18,438. The TCJA, that is effective from 2018-2025 now limits the itemized deduction for taxes paid by individual taxpayers to $10,000. Immediately following the news that this major tax reform was approved by Congress on December 22, 2017, states such as California and New York have been strategizing on how to get around this new $10,000 limit on the State and Local Tax Deduction for individuals.
The California legislature is considering two separate measures designed to protect California taxpayers from the TCJA. The first bill SB 581 creates the California Excellence Fund, and allows donors to direct a charitable contribution to one of the following institutions: University of California, K-12 public education, the California State University, Community Colleges or State Parks. The second bill SB 227 will allow California taxpayers to make charitable donations to schools and child care centers and receive a 85% tax credit for their contribution. The taxpayer will then be able to deduct the contribution from both state and federal taxes. This model is supported by 17 states that currently use it to fund private education.
Unfortunately, the IRS has responded with Notice 2018-54 to California and other states proposing similar legislation that they intend to propose regulations addressing the federal income tax treatment of these payments mentioned in the bills referenced above. The proposed regulations will specify that federal tax law, which includes substance-over-form principles, governs the proper characterization of these payments for federal income tax purposes that are being allowed as credits against state tax. In other words, the state’s classification of these payments will be irrelevant. Although, this response is discouraging for us living in California, it was to be expected. As we receive further guidance from the IRS we will continue to update you on how this issue is resolved.
Please feel free to contact our firm at (949)260-1430 on any follow up questions you may have regarding the State and Local Tax Deduction.