In a press release and IRS Notice (Notice 2018-54) issued Wednesday, May 23rd, the IRS warned taxpayers to be wary of state efforts to circumvent new federal limits on deductions for state and local taxes. Under the recent tax overhaul, deductions for state and local taxes (including property taxes) are capped at $10,000. This cap is particularly detrimental for residents of states with high property taxes and/or state and local income taxes (for example, California, Massachusetts, New Jersey, New York and Connecticut).
To mitigate the adverse impact of the new $10,000 cap on state and local taxes, states have been considering alternative methods to raise revenue that would avoid the cap. New Jersey Governor Phil Murphy and New York Governor Andrew Cuomo have both signed legislation permitting local governments to set up charitable organizations that can accept property tax payments as donations (which could be deductible, without limitation, against federal taxable income).
Notice 2018-54 announces that the Department of Treasury and the IRS intend to propose regulations regarding the SALT deduction cap, and signals their view that tax payments in excess of the cap (regardless of how structured) are not deductible. In particular, the Notice highlights the approach taken by New York and New Jersey (structuring tax payments to allow taxpayers to characterize the payments as deductible charitable contributions), and warns that federal law, not state law, controls the proper characterization of payments for federal income tax purposes.