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State-and-local tax deductibility: an update on the new cap

If you are a Californian with a high income, the $10,000 cap placed by the federal tax overhaul on state-and-local tax deductibility is about to hit you for the first time.

Here are three important things to know about the status of the change.

California’s proposed work-around to the cap did not work out.

A year ago, after the federal overhaul was passed, California and several other high-tax states sought workarounds on the new law.

The idea was to allow charitable donations toward schools and state government, with participating taxpayers getting state tax credits – and possibly even a federal charitable deduction.

The IRS, however, has moved aggressively to push back against this tactic. In late August of 2018, the IRS announced proposed rules preventing a federal charitable deduction for contributions to public services.

New York and three other states immediately announced they would challenge the IRS’s action. California was not one of them.

A little over a month later, however, Governor Brown vetoed SB 539, the bill passed by the California Legislature that would have granted certain state tax credits for taxpayers who donate to public services.

In his veto statement, the governor acknowledged the bill started as “bold idea.” But he was concerned that the bill had become overly complicated and invited conflicts with the IRS.

Many high-income Californians are affected by the cap on state-and-local tax deductibility.

As we noted in a post last year, many high-income Californians have taken the deduction for state-and-local taxes in recent years.

In 2015, about 2.5 million filers took a deduction for more than $10,000. Nearly 90 percent of them reported incomes measured in six figures.

High taxes can may make more Californians consider moves to another state or the creation of tax-avoiding trusts.

The cap on state-and-local tax deductibility is adding to the high tax burden already felt by many Californians.

Writing in Forbes a few months ago, Robert W. Wood noted two ways this is affecting taxpayers. It has led to more interest in moving out of state and in creating a trust to avoid California state taxes.

In short, the $10,000 cap on deductions for state and local taxes has now arrived. And for many Californians, it will make for an even bigger tax bite.

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