In the runup to the 2017 tax reform package, the State And Local Tax deduction “loophole” fell into the crosshairs. Lawmakers predicted that lowering the SALT limit to $10,000 a year would raise hundreds of billions of dollars. Besides, they asserted, this change will not affect 90 percent of taxpayers.
That’s very small comfort to a client who happens to the in the other 10 percent. Furthermore, if your tax client is among the 5 percent of Americans who pay significant state and local taxes, the news is even worse.
Until recently, states like New York, Connecticut, and New Jersey thought they had a viable workaround. Indeed, the plan was well-conceived. Essentially, taxpayers could re-categorize their SALT payments as charitable contributions. But the IRS recently blocked that plan, putting the SALT limitation workaround conundrum back at square one. Fortunately, square one is not such a bad place. There are several options for taxpayers feeling the pinch of the SALT cap.
Possibly the best, and most straightforward, solution to this problem has almost nothing to do with the Tax Code. Many states, including Florida, Nevada, Texas, and New Hampshire, have very low tax rates. These locales may be an alternative for people who reside in high-tax states like California and New Jersey.
There are some significant cons. Moving is expensive and disruptive. Furthermore, doctors, lawyers, and other professionals often face geographic restrictions. Additionally, relocating often has an emotional cost that may exceed the financial cost.
So, it is best to crunch the numbers. If the taxpayer is among the aforementioned 5 percent of households hardest hit by the SALT deduction change, a move may make financial sense. Even if the costs are significant in the short term, the savings could be even more significant over the long term.
The IRS giveth, and the IRS taketh away. Bureaucrats poured cold water all over the most popular workaround. But just a few weeks later, the IRS said that “Business taxpayers who make business-related payments to charities or government entities for which the taxpayers receive state or local tax credits can generally deduct the payments as business expenses.” So, if the business classifies taxes as business expenses, the IRS may allow the deduction.
Some major caveats apply. The Service offered no clarification as to what payments qualify as “business-related.” Existing rules suggest that the expenses must be directly related to the taxpayer’s business and come with “a reasonable expectation of financial return commensurate with the amount of the transfer.”
Many people transfer assets to grantor trusts to reduce their tax liability. Other people transfer their assets to non-grantor trusts to increase their tax liability.
Unlike grantor trusts, in non-grantor trusts, the person making the trust (grantor or settlor) loses control of the house or other property. Everything vests with the trustee. As a result, the non-grantor trust is a completely separate entity which must file its own income tax returns. In plain English, move the house to a non-grantor trust, and the trust claims the SALT tax deduction. The former owner may use the SALT deduction on other taxes.
There are some additional tax rules here as well. For example, if the beneficiary receives any income from the corpus (property in the trust), the beneficiary must file Form 1065 (Schedule K-1). And, the trust must timely issue the appropriate paperwork.
The SALT limit is just one of the major changes taking effect in January 2019. We can help you be ready for these changes.