The workarounds for the TCJA enacted limits on state and local taxes (SALT) have now expanded into another state, with Connecticut adding its workaround to those already passed by New York and New Jersey. Connecticut Substitute Bill SB 11contains two different SALT workarounds.
The first workaround is a property tax credit based one, very similar to the one enacted by New Jersey earlier in May. The bill authorizes municipalities to provide a property tax credit to those donating to a “designated community supporting organization.” The credit could not exceed the lesser of:
- The amount of property tax owed or
- 85% of the donation to the designated community supporting organization.
The funds received by the organization will be made available to the municipality as a grant equal to the funds received under the program.
The second program is unlike those passed in New York and New Jersey. Connecticut will impose a 6.99% tax on the separately and non-separately stated items flowing to equity holders of the partnership or S corporation. The state will grant a tax credit to the equity holder equal to that holder’s share of the tax.
As with the other charitable contribution/tax credit structures enacted by New York and New Jersey, the argument is that the amount paid into the fund will be deductible as a charitable contribution under IRC §170 in full. Charitable contributions, unlike payments of state and local taxes, are only subject to a percentage of adjusted gross income limit that likely would not be exceeded by this contribution. Beginning in 2018, a deduction for state and local taxes under §164 is limited to $10,000 unless it is either paid or accrued in carrying on a trade or business or an activity described in IRC §212, per IRC §164(b)(6).
The second workaround is meant to exploit the trade or business and Section 212 activity exception for the deduction of taxes. In this case, the tax will be deducted in computing the taxpayer’s share of flow through income, with the credit effectively moving the state tax for the equity holders into the passthrough entity.
New York state took a different “business tax” approach to a SALT workaround. In that case, employers could elect to pay a 5% payroll tax on any wages paid to an employee in excess of $40,000 and the employee would then get a state tax credit for that amount. Obviously, an employer is likely to go down that path only if it can reduce the compensation paid to those employees to offset the extra cost of the tax.
As with the other workarounds, key questions are how the IRS will react to these workarounds and, ultimately, should the IRS challenge them, as many expect they will, how successful will the IRS be in mounting such challenges.
As well, a related question is what impact, if any, would a successful IRS attack on these SALT workaround charity/credit arrangements have on other state charity/credit arrangements that existed before TCJA. About two thirds of states already have some sort of charity/credit provision on their books and, until now, the IRS has not asserted that even a state tax credit equal to 100% of the contribution amounts to a receipt of property by the donor that must be offset against the charitable contribution.