NJ Will Go to Court over SALT ‘Workaround’ After IRS Warns It Will Stymie It

John Reitmeyer | May 25, 2018 | Politics
After agency questions legality of NJ's new law, Attorney General Grewal gives notice that Murphy administration will defend it all the way

Attorney General Gurbir Grewal
Gov. Phil Murphy’s administration yesterday threatened to aggressively defend in court the new state law that was designed to sidestep a part of the GOP’s recent overhaul of the federal tax code that hurts many New Jersey residents. The threat came a day after the federal Internal Revenue Service officially cast doubt on the legality of the new law.

In a letter to the IRS yesterday, state Attorney General Gurbir Grewal warned the Trump administration not to “play politics,” saying New Jersey would have “no choice” but to go to court to defend the legality of its new law if the administration decides to press the issue.

“I ask you to think twice before going down that misguided road,” Grewal wrote.

The attorney general’s letter was issued a day after the IRS released a notice that indicated it would be drafting new rules to take on any new laws that have been passed in states like New Jersey to help residents get around a new cap on a longstanding federal income-tax write-off for state and local taxes that’s known as SALT.

The new $10,000 cap was part of the broader tax changes Trump signed into law last year, which also included a lowering of individual income-tax rates, an increase of the standard deduction, and significant tax cuts for corporations and those with large estates.

Big hit to New Jersey

To help pay for those tax cuts, the tax overhaul revised a number of federal deductions and exemptions, including by capping the SALT write-off. But the $10,000 cap on the deduction is considered to be too low a ceiling for many homeowners in high-cost New Jersey, where the average property-tax bill is about $8,700, and the average state income-tax liability is nearly $1,500. And it’s expected to impact a big slice of the state’s households, with an estimated 40 percent having taken advantage of the deduction before the federal tax changes were adopted.

To help New Jersey homeowners get around the new limit, Murphy signed into law earlier this month a bill that seeks to take advantage of the full income-tax deduction that is still allowed under the federal tax code for charitable contributions. Dubbed a “workaround” by its sponsors, the new law gives municipal and county governments and school districts in New Jersey the legal authority to create special charitable accounts to help pay for costly municipal services like public safety, education, and road maintenance that are usually funded through the property tax.

Equally as important, the law lets local governments offer residents who contribute to the new accounts a nearly dollar-for-dollar property-tax credit, effectively turning their property tax bill — at least on paper — into a tax-deductible charitable contribution.

But, even as Murphy and other supporters touted the new law during a bill-signing ceremony in East Rutherford, others have been raising concerns about whether the Trump administration would deem it to be legal. That’s because charitable contributions typically require the donors to not receive anything of significant value in return. In fact, a recent member poll conducted by the New Jersey Society of Certified Public Accountants found that more than 70 percent believe the workaround scheme will not pass muster with the IRS.

Hearing from the IRS

The IRS decided to weigh in with the notice issued earlier this week saying that taxpayers “should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.” The notice also warned that the “Treasury Department and the IRS intend to propose regulations addressing the federal income tax treatment of transfers to funds controlled by state and local governments.”

“The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers,” the notice said.

But in issuing the Murphy administration’s response yesterday, Grewal argued that 100 different charitable programs in 33 states could also be upended if the Trump administration decides to target New Jersey’s new law. He cited research indicating other states have offered credits for donations to charities that pursue natural-resources preservation, provide private-school tuition scholarships and financial aid for needy college students.

“The IRS’s longstanding approach, supported by precedent and policy, supports what New Jersey has done,” Grewal wrote in the letter.