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Is it a tax or a donation?

September 3, 2018

As part of the TCJA passed by the Trump administration last year, one of the changes made was a limit to the personal deductibility of state taxes, real estate taxes, and personal property taxes to $10,000 in total.  Now, is that significant?  Maybe, maybe not.

 

Many people in higher tax states like California and the northeast will quickly run up against that limit.  Now before we get into whether it's fair or not, the practical impact of the entire adjusted tax structure needs to be taken into consideration.  Typically in years past, people with higher state income tax deductions also ran into the Alternative Minimum Tax (AMT).  Taxes were never allowed as a deduction for AMT calculations, so the practical effect is that there was no benefit to the deduction anyway.  In addition, under the new tax regime, the standard deduction is going to be $24,000 (up from $12,700) and tax rates overall are going to be lower.  Many people who would otherwise have lost some of this deduction are going to end up in a place where they aren't even itemizing anymore anyway, and even if they are, will be in a better place paying tax at a lower rate.

 

Now with that as my quick and dirty analysis, the people most outraged by the law change aren't taxpayers, they are state and local level politicians.  Because most of the more outspoken ones are of a political party opposed to the President, they feel they are being singled out and attacked in the form of the tax law change.  Some states have proposed legislation wherein taxpayers can make charitable contributions to the government in exchange for a reduced income or real estate tax, sometimes as much as dollar for dollar.  The theory from the states was that taxpayers were making charitable contributions, not tax payments, and there is no $10,000 limit on charity.

 

When these proposals first popped the reaction from IRS to these states was along the lines of, don't do it, this will end badly for you, and we are going to address this.  My reaction was pretty much the same.  Recently the IRS did issue formal guidance in the form of proposed regulations on the matter.  Their analysis mirrors my own.  

 

1) Calling a tax a charitable contribution is ridiculous.  Amongst other things, a contribution is a gift of generosity with no expectation of tangible reward with the exception of the benefit of the federal income tax deduction.  Anyone making this donation is doing so with donative intent but also in anticipation of the reward.  This is called substance over form.  Calling something other than what it is doesn't make it so.

2) There is a legal concept called quid pro quo, meaning giving something to get something.  Under the regulations covering charitable contributions is a long standing, well known provision wherein if you donate money or property, you can deduct the value of the gift less any goods or services you got in return.  That statement is actually required on any donation acknowledgement issued by a charity.  In other words, if you donate $1,000 and get a state tax credit of $850, you have a charitable donation of $150.  It's no different than if you donate $1,000 to a university and received tickets to a homecoming football game.  The value of the tickets reduces the value of the donation.

 

In any event, in response several states have actually filed suit to block this law claiming constitutional grounds stating this violates state sovereignty.  My instinct tells me they don't even have standing to file the suit, but if it does go forward it still has no merit as there is long standing Supreme Court case law where opinions have reference an opinion that states that deductions are a matter of legislative grace, not constitutional mandate.

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