Analysis throws cold water on California’s federal tax cap work-around, but law professors deepen their case

SACRAMENTO — Letting Californians donate to their state instead of paying some of the taxes they owe is “unlikely to succeed” as a workaround for the new federal $10,000 cap on state and local deductions, a new report from a nonprofit tax policy group has concluded.

The analysis by the Washington, D.C.-based Tax Foundation casts doubt on plans by California and other high-tax, high-cost blue states to avoid the unpopular new rules by changing their own tax laws. California Senate Leader Kevin de León, also a candidate for U.S. Senate, is proposing legislation to give taxpayers a dollar-for-dollar credit on their state taxes if they contribute to a new California Excellence Fund — a contribution that, in theory, would be fully deductible on the federal tax bill.

“This proposal, while interesting, is fairly obviously in violation of existing law and jurisprudence,” said the report’s author, Jared Walczak. “Just because the IRS has not consistently cracked down on some minor efforts here and there does not mean it would it would turn a blind eye to a concerted effort to contravene the tax code by providing a contribution in lieu of taxes program.”

One problem with De Leon’s Senate Bill 227, Walczak wrote, is that the IRS can reclassify a so-called charitable contribution as a tax if it deems there wasn’t “charitable intent.” California’s plan could easily fall short of that standard, he said, because it offers state and federal tax benefits that are greater than the donation itself. In addition, he said, the proposal doesn’t offer the same tax-credit deal for contributions to any other causes.

Walczak makes some “completely reasonable arguments” and raises important concerns, but the lower courts and the IRS — whose opinions are bound by those rulings — has consistently allowed federal deductions for state-administered charitable funds, said UC Davis Law Professor Darien Shanske, who is among the tax scholars advising California on the alternative.

“It’s not some crazy loophole the states are creating,” Shanske said. “It’s instead a longstanding feature of the tax law that never mattered so much until the federal government made the changes to the tax structure that it made.”

Still, Shanske said, California might be on firmer legal ground if its new charitable fund has a defined and relatively narrow purpose and if it promises donors a benefit for their contribution that is less than a 100 percent tax credit.

Shanske expects that if the Senate proposal becomes law, Californians who itemize would still pay up to $10,000 in state and local taxes — the maximum amount they can deduct from their federal tax bills — and send the rest to the California Excellence Fund. “Unless there’s really strong guidance not to do this,” he said, “the biggest risk is the IRS rejects the donation and treats it as a tax in which case you’re back to where you are anyway.”

Source: mercurynews
Analysis throws cold water on California’s federal tax cap work-around, but law professors deepen their case