Although Regs. Sec. 1.170A-1(h) (3) (i) requires taxpayers to reduce their charitable contribution deduction by any benefits received or expected to be received in exchange for the donation (including state tax credits), it makes two exceptions. First, taxpayers do not have to reduce their federal charitable contribution deduction for credits received from the state if the dollar amount of the credits received or expected to be received is no more than 15% of a donation of cash or 15% of the fair market value (FMV) of a donation of property (Regs. Sec. 1.170A-1(h) (3) (vi)). Second, a charitable contribution deduction does not have to be reduced by state or local tax deductions if the amount of the deductions received or expected to be received does not exceed the amount of a donation of cash or the FMV of a donation of property (Regs. Sec. 1. 170A-1(h)(3)(ii)(A)). Although the regulations reduce the potential benefits of using these types of state programs, clients in these specific scenarios will continue to be able to use such programs and take the associated charitable contribution deduction.
For example, an individual makes a $10,000 cash donation to a qualified charity. In return for the cash donation, the individual receives a state tax credit of 75% of the $10,000 cash donation (expected state tax credit of $7,500). In this case, the federal charitable contribution deduction cannot exceed $2,500 ($10,000 donation – $7,500 state tax credit). Interestingly, this reduction applies even if the individual cannot claim the state tax credit in the same tax year.
As a second example where the exception applies, assume an individual donates an antique clock to a qualified charitable organization with an FMV of $50,000 at the time of the donation. In return for the donated clock, the individual expects to receive a state tax credit of 10% of the FMV of the antique clock. The state tax credit amount does not exceed 15% of the FMV of the antique clock. Therefore, the charitable contribution deduction is not reduced and remains $50,000.
Passthrough entity tax
Next, although complicated and an emerging area in state taxation, if individuals subject to the SALT limit are partners or shareholders in a passthrough entity (partnerships and S corporations), it is worth considering locating the entity in a state with a PTET. The basic idea of the PTET is that the passthrough entity elects to pay the state tax. The passthrough entity, because it is a business, is not subject to the SALT limit and can deduct the state tax in full without limitation, resulting in more significant tax savings. The partner or shareholder then, depending on the state statute, generally, either (1) claims a tax credit on their individual state return for their distributive share of the tax paid by the passthrough entity or (2) does not include their distributive share of income from the passthrough entity on their individual state tax return. The PTET column of the table “State Workarounds to the SALT Cap” provides a summary of AICPA data (“States With Enacted or Proposed Pass-Through Entity (PTE) Level Tax,” showing that (as of May 14, 2024) 36 states have enacted a PTET since the TCJA SALT limit was enacted, and one state has proposed a PTET bill). Nine states do not have any personal income tax levied on owners of passthrough entities, which leaves only four states and the District of Columbia that have not at least proposed some form of legislation for a PTET.
The rules of the PTET vary and require in-depth consideration. The following are some of the state-specific areas to consider: Are there owner restrictions? What are the compliance filing requirements? What is the interplay if the entity is operating in multiple states? Should the entity make estimated tax payments? Do the state tax rates differ for individuals vs. passthrough entities? While the PTET may result in tax savings to the individual partners or shareholders, there are multiple tax implications to consider and discuss with a client.
Working remotely
Another interesting aspect of tax planning has arisen thanks to the proliferation of remote and hybrid working environments. Although the number of people working remotely has certainly decreased as the COVID-19 pandemic restrictions have been lifted, many companies have adopted far more flexible work policies than existed before 2020 and have offered these alternatives to continue in order to attract talented workers. Tax advisers working with individual clients who work remotely may need to broaden their geographic scope when considering the various alternatives for their clients’ tax home and taxable activities.
While income can be taxed both in the state where it is earned and in the state where the taxpayer lives, all states with an income tax on wages offer credits for taxes paid to other states. Some states go further and offer reciprocity agreements with other states, which eliminates the need for taxpayers to file in both states and results in the taxpayer owing tax exclusively to the state of residence. Thirty reciprocity agreements are offered across 16 states and the District of Columbia, with each of those states participating in between one and seven agreements (Walczak, “Do Unto Others: The Case for State Income Tax Reciprocity,” Tax Foundation (Nov. 16, 2022)). Taxpayers who work remotely may be able to lower their SALT burden by moving to a lower-tax-rate state that has a reciprocity agreement with the state in which their employer is located. Also, taxpayers may be able to lower their non–income tax SALT by engaging in remote work while living in a state with lower property taxes.
Indeed, state and local taxes represent only one component of the work/life location decision. Still, the relevance of this factor increases when individuals who work remotely are not tied to any specific physical location. In this case, advisers and clients should consider not only the tax burden of the state where the taxpayer plans to work but also the various programs mentioned above to alleviate that burden.
STRATEGIES AMID UNCERTAINTY
While there is uncertainty as to whether the SALT limit will continue past 2025, it is clear that the current SALT limit restricts the amount of itemized deductions for current taxpayers, especially those in states With a high tax burden. To counter these effects, tax advisers can suggest to their clients, particularly those in high-tax-burden states, to bunch their itemized deductions Into a specific year and investigate whether the state offers a tax credit or deduction for donations to specific charities.
Suppose a client is also a partner or shareholder in a passthrough entity. In that case, the taxpayer may also consider locating the entity in a state with a PTET to avoid the SALT limit. Lastly, and probably most challenging to implement, a client may consider relocating to a state with a lower state income tax rate if they can work remotely. In addition to the tax planning opportunities discussed, there is also the strategy of waiting out Congress in hopes that it will let this part of the law sunset without extending it.
About the authors
Ann Boyd Davis, CPA, CGMA, Ph.D., is the David K. Morgan Faculty Fellow and a professor of accounting at Tennessee Technological University in Cookeville, Tenn. Beth Howard, CPA, Ph.D., is a professor of accounting at Tennessee Technological University. Rebekah D. Moore, CPA, Ph.D., is the Forvis Faculty Scholar and an assistant professor of accounting at James Madison University in Harrisonburg, Va. To comment on this article or to suggest an idea for another article, contact Paul Bonner at [email protected].
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