The federal Tax Cuts and Jobs Act of 2017 (the Act) eliminated the full deductibility of state and local taxes (SALT) and capped deductions at $10,000. The law disproportionately hurts Democratic states like New York, where residents’ state and local taxes often exceed $10,000. To fight back, New York Assemblywoman Amy Paulin, who represents Scarsdale, proposed legislation that would make the full SALT deduction available to partnerships and other pass-through entities.
The proposal will be considered during the New York State legislative session this month.
As it stands now, the SALT cap only applies to deductions paid by individuals, but not by corporations. Since members or shareholders of partnerships typically pay income taxes individually, rather than at the entity level, they are subject to the SALT cap.
Paulin’s proposed legislation, however, would allow New York State partnerships and other pass-through business entities to elect to pay a tax to New York State, for which they would get a full federal deduction, with the tax payments offsetting the partners’ New York State income tax. This setup would be fiscally neutral to New York State, but would allow partners to take the full SALT deduction, which would otherwise be limited to $10,000 if the partners paid their income taxes directly to New York State.
Following passage of the Act in 2017, several states, including New Jersey and Connecticut, passed similar laws allowing pass-through entities to pay taxes at the entity level, and receive a credit on their state income taxes to offset it, which avoids the SALT cap. On Nov. 9, 2020, the IRS issued a notice which stated it would allow this arrangement to apply to tax payments made on or after that date.
“This is an opportunity that should not be missed,” said Paulin. “Now that the IRS has approved the taxation structure for partnerships and pass-through entities, we should quickly pass my bill and give much needed relief to New Yorkers who have been disproportionately affected by the SALT cap.”
The legislation will provide a “common-sense benefit” to New Yorkers, she added, and at no cost to New York State for the 2021 tax year.
In 2018, Paulin authored and passed a law that allowed deductions for contributions to charitable reserve funds in order to give relief to residents who had just lost the SALT deduction. The law gave counties, local governments and public school districts the option to authorize a real property tax credit of up to 95% of the amount of a property owner’s monetary contribution to the reserve funds.
Later in 2018, however, the IRS issued regulations denying that a taxpayer who makes a contribution to a charitable reserve fund could receive a state or local tax credit. A subsequent IRS notice then announced that businesses would be entitled to a full deduction for their contributions, creating an “arbitrary distinction,” Paulin said, between contributions made by businesses, whose full deductibility was preserved, and contributions made by individuals, which were not.
In response to the IRS’s regulations and conflicting positions on charitable reserve funds, Paulin formed and chaired a coalition of counties, cities, towns, villages and school districts in New York, called the Coalition for the Charitable Contribution Deduction (3CD). She filed a letter with and testified before the Treasury Department and the IRS, requesting the withdrawal of the proposed regulations under the Act which denied a full charitable deduction for donations from individuals to the charitable funds.
In 2019, working with the village of Scarsdale, a lawsuit was filed against the IRS, with the village of Scarsdale acting as plaintiff, seeking to overturn the IRS regulations as “arbitrary and capricious, and therefore invalid.”
Paulin has continued to take the lead role in the initiative, asserting that taxpayers should be entitled to the full charitable deduction for their donations to charitable reserve funds and similar vehicles. The lawsuit is ongoing.
“Together with the 3CD, we are hopeful that the IRS will issue new regulations that conform to established law and internal IRS rulings,” said Paulin, “and we are continuing our challenge to the regulations in federal court.”
Paulin said it’s “critically important” to take action to help minimize the SALT cap’s impact on residents, many of whom are struggling financially due to the pandemic.
“The establishment of charitable reserve funds to give a SALT deduction to individual residents, and the allowance of a SALT deduction for partnerships and pass-throughs, would provide tax relief to many New Yorkers right now, at a time when they need it the most.”