Economy

Why states may get away with creative income tax maneuvers

Why states may get away with creative income tax maneuvers

Now that higher-income taxpayer who pays $20,000 in property taxes and another $20,000 in state income taxes will see what would have been a $40,000 deduction, worth $14,000 in federal tax savings, limited to $10,000, worth $3,500 in federal tax savings. It's a rather complex shell game cooked up in the state senate.

Their employers don't pay corporate income taxes to the federal government so they would be gutted by the change. It's worth noting that you need to earn more than $140K in California in order to owe $10K in state taxes. Red states such as SC and Florida already offer generous tax credits to those who funnel money into state funds for private-school vouchers, for instance, while blue states like California use tax credits to promote environmental conservation and college scholarship donations, said Kirk Stark, professor of tax law and policy at UCLA School of Law, who is advising Democrats in California on the proposal. As might have been expected, states with high taxes are working hard to come up with solutions that protect their residents from the higher payouts trying to be imposed by the federal government. But much of the criticism of the bill is aimed at the new limit on the SALT deduction, a benefit that historically benefits upper-income earners. The average itemized SALT deduction in California was more than double the new $10,000 cap. The proposal is scheduled to be introduced into the state legislature this month. The fear is that taxpayers will realize that the Trump tax plan is a tax cut and not a tax hike as Democrats have been saying. It also promises to establish a new front in California's Trump-resistance efforts, which past year took on immigration enforcement and environmental regulatory rollbacks.

The problem with the strategy to allow tax-favored donations to state governments is that such contributions arguably wouldn't be deductible under federal law. If approved, it would establish a "California Excellence Fund" where residents could make a "contribution" equal to the amount of state tax they owe over the cap.

The new limit hits California and NY hardest, due to their high state taxes and large populations. Political observers say such a move by high-tax states could prompt Congress to change the rules for charitable donations. The truth is that the Trump tax plan will create pressure on high tax states to lower taxes, creating a win-win proposition for middle class taxpayers of high state and local taxes like New Jersey, New York and California. And while they claim to be fighting for the little guy, they're talking about the loss of a tax deduction which would only affect a portion of the income of those with earnings at the top end of the scale.

"I'm certainly not a constitutional lawyer, but the notion that this is not constitutional is something we want to pursue", said Phil Murphy, New Jersey's Democratic governor-elect. He is also believed to be considering a workaround that would shift tax burdens so that his state's residents wouldn't lose out on income tax deductions.

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True to their word, California got to work on a plan which would allow residents to avoid this pitfall and still be able to take the full SALT deduction next year.

It seems like a "win-win" for California, said Melissa Michelson, a professor of politics at Menlo College in Atherton. Tax officials in Cali are considering a similar idea, according to The Connecticut Mirror. These taxes, which are different from the ones that get withheld from employee paychecks, don't directly reduce the amount of money that workers receive, although they can have an impact on prevailing after-tax wage rates in certain areas.

"That's not a charitable contribution, that's paying off a debt", said Daniel Lathrope, who teaches tax law at the University of San Francisco. Perhaps the IRS should consider using them against defiant California legislators who are behaving like the large accounting and law firms that marketed gimmicky tax shelters at the turn of this century.

Actually, they're not. They're crying for themselves because the new $10,000 SALT-deduction limitation will make it more hard politically to raise taxes on upper-income families.


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