Tax Reform Bill: Cure Worse than the Ailment

PERSPECTIVE--The only thing as bad as Congress impulsively passing a tax reform bill, is conjuring a half-baked, equally impulsive countermeasure.

But that is precisely what State Senator Kevin de Leon and Assembly Member Autumn Burke (photo above)are proposing with SB227 and AB2217.  The latter is a recent development.

Both bills allow taxpayers to donate to charitable entities sanctioned or controlled by the state in return for tax credits on their California returns.  SB227 would have contributions funneled through a state entity named The California Excellence Fund. AB2217 would have qualified charitable entities pass 90% of the donations to the state’s general fund. The entities would issue “Golden State Credits” to the donors, who in turn would use then to reduce their tax liability to the state … and also deduct them as charitable contributions on their federal returns.

The bottom line is that a very high percentage of the donations end up in the state treasury.

The sponsors are counting on the precedent of similar programs in a number of states being condoned by the IRS.  However, many of these are essentially one-off credits and not part of a wide-ranging policy, as would be the case in California.

In the grand scheme of things, existing tax credit donations are relatively small, and were virtually irrelevant under the old tax law.  It did not really matter if one took a charitable deduction in lieu of one for state tax  – the total deductions, all other things being equal, were the same. Note that SALT deductions were not allowed if the taxpayer was subject to the AMT.

But if California, New York and other high-income states implement workarounds allowing higher income taxpayers to re-characterize state tax payments as charitable deductions across the board, rest assured the IRS will take a hard look.

If the states do not back down, the issue will end up in the courts and taxpayers who avail themselves of the credits would be at risk of owing penalties and fines if the IRS prevailed.

New York passed a version of the workaround which is similar to California’s (it also passed another that involves a payroll tax…not an approach California is pursuing).

If de Leon and Burke were smart, they would wait to see how New York’s plan is received by the IRS, then modify California’s accordingly, rather than subjecting the state’s higher income taxpayers to audits.  That could be the last straw that will send more of them to Nevada.

(Paul Hatfield is a CPA and serves as President of the Valley Village Homeowners Association. He blogs at Village to Village and contributes to CityWatch. The views presented are those of Mr. Hatfield and his alone and do not represent the opinions of Valley Village Homeowners Association or CityWatch. He can be reached at: phinnoho@aol.com.)

-cw