New York and Connecticut Enact SALT Deduction Cap Workarounds Not Involving Charitable Contributions

New York and Connecticut both passed workarounds to the SALT deduction limitation that do not involve charitable contributions, but will the IRS challenge them?

By Jeff Glickman, SALT Partner

As a result of the federal tax reform’s limitation on the state and local tax deduction, much of the initial discussion at the state level focused on workarounds that involved permitting taxpayers to make charitable contributions to state/local funds in return for a state tax credit.  Several states have proposed or enacted such programs, including California, Illinois and New Jersey.[1]  However, New York and Connecticut recently became the first two states to enact workarounds that do not involve charitable contributions.  These particular programs impose new tax liabilities on businesses, which are not subject to a federal state and local tax deduction limit, and provide individuals with income tax credits.

On April 17, 2018, New York Governor Cuomo signed the state’s FY 2019 budget that included several reforms intended to assist New York taxpayers with the potential federal tax increases associated with state SALT deduction limitation.[2]  The most notable is a new Employer Compensation Expense Program (“ECEP”).  The ECEP is effective for tax yeas beginning Jan. 1, 2019 and is a voluntary tax on employers based on annual payroll expense for all covered employees whose wages exceed $40,000.  The tax rate is being phased in over three years: in 2019, the rate is 1.5 percent; in 2020, the rate is 3 percent; in 2021 and beyond, the rate is 5 percent.   Employers must opt-in by Dec. 1 prior to the year in which they want the election to take effect.  Employees whose employers pay the ECEP on their wages will receive a personal income tax credit.

It remains to be seen how many employers will participate in this program.  Employees will likely see their salaries reduced as a result of their employers’ participation in the ECEP in order to cover the ECEP tax, but the employee will receive a credit, so his or her net income tax result should remain basically the same.

On May 9, 2018, the Connecticut legislature passed SB11, which contains two reforms intended to assist Connecticut taxpayers with the potential federal tax increases associated with state SALT deduction limitation.[3]   One of those reforms establishes a 6.99 percent tax on the income of pass-through entities, effective for tax years commencing on or after Jan. 1, 2018.  Members of such pass-through entities would receive a personal income tax credit equal to 93.01 percent of the amount of tax paid by the pass-through entity attributable to such member.  The legislation also provides that if a nonresident’s only Connecticut source income is from one or more pass-through entities subject to the tax, then the nonresident is not required to file a Connecticut income tax return.  Finally, the new law allows residents a tax credit whose wages were subject to an employer tax of another state, essentially giving Connecticut residents that work in New York the benefit of New York’s ECEP tax program discussed above.

At this point, the federal income tax impact remains unclear.  On May 23, 2018, the IRS issued Notice 2018-54, informing taxpayers that it intends to issue regulations “addressing the federal income tax treatment of transfers to funds controlled by state and local governments (or other state-specified transferees) that the transferor can treat in whole or in part as satisfying state and local tax obligations. The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers.”  While this notice appears to focus on the charitable tax credit funds that are being proposed or enacted by states, there remains the possibility that the IRS will also look to address the federal tax treatment of other tax credit structures such as those discussed above.

Aprio’s SALT team is monitoring these issues closely and will continue to provide updates in future issues of the Aprio SALT newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the May 2018 SALT Newsletter. 

[1] California’s (SB227) and Illinois’ (HB4237) tax credit bills are still working their way through their respective state legislatures and would provide an income tax credit equal to 85 percent and 100 percent, respectively, for contributions to a state “Excellence Fund.”  New Jersey’s Governor Murphy signed legislation (S.1893) on May 4, 2018, that allows municipalities, counties, and school districts to establish charitable funds and provides donors with a property tax credit equal to up to 90 percent of the amount contributed.

[2] One establishes a state charitable gift fund and provides taxpayers a tax credit equal to 85 percent of amounts contributed.  Another authorizes local government to establish similar gift funds and provides taxpayers a real property tax credit for contributions made to such funds.

[3] One authorizes the establishment of a local charitable fund to receive cash contributions for which donors would receive a property tax credit equal to 85 percent of the amount contributed.

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