Analysis of the $10000 SALT Cap, IRS Regulations, and Workarounds

This report provides a comprehensive analysis of the $10,000 State and Local Tax (SALT) cap introduced by the Tax Cuts and Jobs Act (TCJA). It examines the limitations on individual itemized deductions for state and local taxes and the responses from state legislatures, including the establishment of charitable funds to circumvent the cap. The report delves into the relevant Internal Revenue Code (IRC) provisions, specifically section 164(a) and 164(b)(6), and analyzes the IRS regulations and pronouncements addressing the SALT cap, such as the safe harbor provisions and the treatment of charitable contributions. It explores the issues arising from the cap, including the reduction in financial incentives for taxpayers involved in state tax credit programs. The report also discusses the IRS's approach to address these issues through the Federal Register and the application of the de minimis exception. References to relevant legal cases and publications are included.

Running head: ANALYSIS OF THE $10000 SALT CAP
To: Senior Partner
From:
Date: 19.8.2019
Re: Analysis of the $10000 SALT CAP

1ANALYSIS OF THE $10000 SALT CAP
Table of Contents
Issue and Conclusion...................................................................................................................2
Analysis........................................................................................................................................2
References....................................................................................................................................5

2ANALYSIS OF THE $10000 SALT CAP
Issue and Conclusion
In the given situation, the issue is related to the limitation of an individual’s itemized
deduction for State and Local Taxes (SALT) to $10000 per year. This limitation encouraged
many state legislatures to circumvent the tax rule and establish a charitable fund that provided a
100% deduction on the amount of contribution made. Other issues arising from this limitation
are related to the deductions available for contributions made to the section 170(c) entities and
people involved in contributing to state tax credit programs. The financial incentives of these
people declined due to the introduction of the cap by the Tax Cut and Jobs Act (TCJA) (Gamage
& Shanske, 2018). The treasury department and the Internal Revenue Services (IRS) published a
series of rules and regulations to address these issues in the form of Safe Harbor, ignoring the
15% credit and carrying forward of tax credit in case of states where such carrying forward was
allowed by the state legislations. Dollar-to-dollar bill credit was another step taken to mitigate
the risk of the taxpayers contributing under the tax credit schemes.
Analysis
Section 164(a) of the IRC code allows a deduction for the payment of certain taxes that
include state, local and foreign, real property taxes, state and local personal property taxes and
state and foreign, income, war profits and excess profit taxes. However, section 164(b) (6),
added by section 11042(a) of The Tax Cuts and Jobs Act (TCJA), provides that there would not
be any deduction allowed for foreign real property taxes under section 164(a)(1) and limits the
individual’s deductible tax limit to $10000. This is limited to $5000 in case of a married couple
filing a separate return. Also known as the State and Local Taxes (SALT) cap, this limit applies
to taxable years beginning after 31 December 2017 and ending before 1 January 2026. Due to

3ANALYSIS OF THE $10000 SALT CAP
this limit, many state legislatures estimated that they would suffer a loss in their revenues.
Hence, they decided to come up with a way that worked around the SALT cap deduction and
allowed them to collect the same amount for their funding as before. As the language in the
amendment made by the IRS did not mention anything about contributions made to charitable
institutions, this was identified as an area to exploit by the state legislatures. The most common
proposal was to create a state charitable fund to which individuals could contribute and gain a tax
credit equal to 100% of the amount contributed by them. This allowed the taxpayers with SALT
liabilities of more than $10000 to convert their excess liability into charitable contribution and
reduce the tax paid to the federal authorities. Apart from this, other issues arising from the
$10000 cap deduction include a reduction in the financial incentives of a section of taxpayers
who received more benefits by contributing to the state and local tax credit programs before the
introduction of the SALT cap (Walczak, 2018). People who contributed their income to section
170(c) entities would also not receive any tax credit on the tax payable for federal purposes. To
overcome the problem of charitable institutions set up by State authorities, the Treasury
Department and IRS published a set of regulations under sections 170 and 642(c) in the Federal
Register (83 FR 43563). These regulations state that if a taxpayer transfers a property for use or
makes a payment to an entity described under section 170(c), and receives or expects to receive a
tax credit for such a transfer or payment, then the tax credit received is treated as a benefit, or
quid pro quo, the Latin word for something for something. In United States v. American Bar
Endowment, 477 U.S. 105, 116-18 (1986), the court also suggested the same (Phipps, 1989).
This principle is used as a basis to reduce the taxpayer’s charitable contribution deduction
available under section 170(a). However, the final rules allow a deduction under charitable
contribution if the state government allows dollar-for-dollar state or local tax deductions and

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does not provide tax credits. The reason for this is the low risk associated with dollar-to-dollar
deductions being used as a way to circumvent from the $10000 cap. This is also done to
overcome the problems involved in calculating the tax liability of a person accurately. A de
minimis exception is also present in the final rules regarding the prohibition of a deduction under
state and local tax credits (Barker, 2019). This rule suggests that if the tax credit provided on the
transfer of a property or a payment does not exceed 15% of the value, then the tax credit
provided can be ignored by the taxpayer. These rules are effective from 13 August 2019 and
apply to any properties or payments made after 27 August 2018. Another notice, Notice 2019-12
was used to provide a safe harbor to individuals who make a payment under section 164 to an
entity described under section 170(c) and receive a tax credit in return for such payments. In
order to qualify for the safe harbor, taxpayers must itemize their payments for federal tax
purposes and have a SALT liability of less than $10000 in a year. The main purpose of the notice
is to minimize a situation in which people who contribute towards a state tax credit program and
itemize their deductions in their federal tax return are not allowed to claim deductions under
payments to section 170(c) organizations (Schreiber, 2019). In case of states that allow the
carrying forward of tax credits for taxes under section 164, the individual may carry forward the
amount for the years for which the tax credit is allowed to be carried forward.

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References
Barker, W. B. (2019). The Tax Cuts and Jobs Act of 2017: The SALT Deduction, Tax
Competition, and Double Taxation. San Diego L. Rev., 56, 73.
Gamage, D., & Shanske, D. (2018). The Future of SALT: A Broader Picture.
Phipps, D. M. (1989). A Line Drawn by Unsteady Hands: Section 170, Charitable Contributions,
and Return Benefits in Hernandez v. CIR. Akron L. Rev., 23, 575.
Schreiber, S. (2019). SALT deduction cap rules finalized, safe harbor proposed. Retrieved 20
August 2019, from https://www.journalofaccountancy.com/news/2019/jun/charitable-
contributions-avoid-salt-deduction-cap-201921453.html
Walczak, J. (2018). State Strategies to Preserve SALT Deductions for High-Income Taxpayers;
Will They Work. Tax Foundation.