IRS Warns Taxpayers on Tactics to Avoid Property Deduction Caps

(Bloomberg) -- The Internal Revenue Service warned taxpayers to proceed with caution after states including New York and New Jersey approved workarounds involving charitable organizations to circumvent new federal limits on deductions for state and local taxes.

“Taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes,” the agency said in a press release Wednesday, the first time it’s weighed in on the matter. The Treasury Department and IRS intend to propose regulations addressing measures that would allow homeowners to declare property taxes as charitable deductions, which are still unlimited, according to the IRS.

The tax overhaul created a cap of $10,000 for state and local tax deductions, a pittance for states that have high property taxes such as New Jersey, New York and Connecticut. New Jersey Governor Phil Murphy signed legislation allowing local governments to set up charitable organizations that can accept property tax payments. In turn, homeowners can declare those “donations” as gifts to offset federal taxable income. New York Governor Andrew Cuomo signed similar legislation last month.

“I think it’s absolutely appropriate for Treasury to signal that these are tax evasion schemes, and it’s good for them to signal that early on,” House Ways and Means Chairman Kevin Brady of Texas said Wednesday.

Earlier this year, Treasury Secretary Steven Mnuchin called the proposals “ridiculous.”

IRS Penalties

Jared Walczak, a senior policy analyst with the Center for State Tax Policy at the Tax Foundation, said the “most legally dubious” way to circumvent the new cap involves recharacterizing so-called SALT payments as charitable contributions.

Still, states have invested a lot in designing workarounds, so "it would not be surprising to see litigation here," Walczak said.

“Calling an alligator a hairless, toothy, non-barking dog doesn’t make it so,” said Mark Klein, the chairman of law firm Hodgson Russ in New York. “I have grave concerns that taxpayers who ‘voluntarily’ give to these state and local charities could be subject to tax, interest and penalties if the IRS picks up on it.”

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