Allow me to wish you a solemn Martin Luther King Day.
Well, the 2018 Session has begun. Last week found me in three of my committees, Public Employment and Retirement, Judiciary, and Governance and Finance, where I also presented three of my bills. I also had to present a bill in the Senate Health Committee. Of the four, two have moved forward.
On top of these multi-hour commitments, I also attended four hearings for Public Employment and Retirement, Judiciary, and Governance and Finance (two). It was a packed week, as I actually attend scheduled committee meetings and hearings. And I engage. If you have access to the CalChannel, you saw plenty of me over the weekend, as these meetings were broadcast one after another.
The one meeting that caught the attention of those in the media was Governance and Finance’s discussion of SB 227 (de Leon), which attempts to make a state tax a deductible contribution on the Federal Income Tax Return, Schedule A (see MOORLACH UPDATE — Contribution Contrivance — January 6, 2018 january 6, 2018 john moorlach). After nearly two decades of income tax preparation experience in my first career, I had a few questions. Bloomberg News and The San Francisco Chronicle pick up a small portion of the fun in the two pieces below.
If you make estimated tax payments, then today is the due date for the first one. And we both know that you are not considering this required remittance as a charitable contribution. For my closing remarks during Committee, go to https://www.youtube.com/watch?v=KpAvd4OOi4c&feature=youtu.be
BONUS: I have a District fund raising event at the end of the month, January 26th at 5:30 p.m., and I would love for you to attend and to invite as many of your friends that are concerned about the direction of this state to participate, as well.
As you can see by this UPDATE, I’m engaged on your behalf and would really appreciate your support. Former Costa Mesa Mayor Steve Mensinger and current Costa Mesa Councilman Jim Righeimer are the hosts. We’re enjoying a great response and you will be glad that you attended.
For a copy of the invitation and an easy way to RSVP, please go to https://www.efundraisingconnections.com/c/Moorlach2020/EveningReceptionJan2018.
California End-Run Around Tax Deduction Cap Passes First Test
A bill to let California taxpayers make charitable contributions to the state as an end-run around the new cap on federal deductions for state and local tax payments passed its first legislative test Jan. 10.
California Senate President Pro Tempore Kevin De Leon (D) said his bill ( S.B. 227) is creating pressure on Congress to repeal the new $10,000 cap on federal deductions for taxes paid at the state and local level. It passed on a partisan 5-1 vote in the Senate Governance and Finance Committee, with Democrats favoring and one Republican opposing.
“This new tax law deliberately targets taxpayers in blue states,” De Leon said. “It is designed to shield millions of Californians from significant tax increases.”
The new federal tax law (Pub. L. No. 115-97), signed by President Donald Trump in December 2017, allows taxpayers to deduct up to $10,000 of property taxes, and state and local income or sales taxes. The previous law placed no limit on the amount of state and local taxes that could be deducted—and many high-tax states are exploring options to combat the slashed tax break.
As it is now written, De Leon’s bill would allow state taxpayers to receive a 100 percent credit for amounts they donate to the California Excellence Fund to satisfy their state income tax liabilities. Taxpayers could claim the credit as a charitable contribution to reduce their federal tax liabilities.
3 Million Californians
De Leon said at least 3 million Californians who pay more than $10,000 combined in state income tax and property tax would benefit from the measure.
The bill moves next to the Senate Appropriations Committee, where amendments may fill out the details. Possible amendments could reduce the credit from the 100 percent proposed and make at least some of the contributions voluntary.
Gov. Jerry Brown (D) said he is willing to consider the idea.
“Yes, I’m certainly open to it,” he told reporters at a news conference to release his proposed budget for the next fiscal year. “It looks interesting. I have two questions: Does it work, and if it does work, will the Internal Revenue Service issue a regulation and completely subvert it?”
The bill must pass the Senate by Jan. 31 to move to the Assembly, where it must pass by Aug. 31 to reach the governor’s desk.
Help for Wealthy?
De Leon tried to beat back criticism from two Republicans on the committee that the bill would mainly help wealthy people, could harm overall charitable giving, lacks detail, and could be undone by the IRS or Congress.
“It’s rich that you guys are trying to help the wealthy now in California, so welcome aboard,” Sen. John Moorlach (R) said.
Sen. Janet Nguyen (R), the committee vice chair, asked De Leon to add provisions to hold taxpayers harmless from penalties if the state enacts the bill and the IRS disallows federal deductions for the state credit.
De Leon said the Republicans were erroneously claiming the bill would mainly benefit the wealthy—and said the bill will withstand scrutiny.
“I want to be sure we don’t mischaracterize this measure as protecting the 1 percent,” he said. “Let’s not go to Armageddon.”
Two legal scholars who helped De Leon present the bill to the committee offered ideas for amendments that they said would better protect the bill from administrative or legal challenges.
Darien Shanske, professor from University of California, Davis School of Law, and Joseph Bankman, a law and business professor from Stanford University, said reducing the credit below 100 percent would make it more like similar but smaller-scale tax credit programs in California and more than 30 other states. Making some of the contribution voluntary, rather than a mandatory contribution to satisfy tax liability, would help overcome questions about the benefit a taxpayer receives from the contributions.
“The amendments would make it extremely unlikely it would face a realistic administrative or judicial challenge, and, even if it did, I can’t imagine a taxpayer would be penalized,” Bankman said.
An analysis of the bill from committee staff points out some of the weaknesses that amendments could address.
“This bill would enact the most generous tax credits ever allowed in California, which when combined with the federal charitable deduction, would afford the donating taxpayer benefits that exceed the amount contributed,” the staff analysis said.
Jim Gross, a lobbyist representing the California Society of CPAs, told the committee the group doesn’t have a position on the bill but has concerns. The idea to make at least some of the contributions voluntary would address some of those concerns, he said.
No other witnesses testified for or against the bill. In the brief hearing, lawmakers barely touched on the mechanics or finer points of the proposal, although Moorlach, a CPA, questioned how taxpayers should handle withholding of taxes from their wages, and whether they could simply tell their employer not to withhold at all.
Bankman said taxpayers can already adjust their withholding, and other options can be explored.
To contact the reporter on this story: Laura Mahoney in Sacramento, Calif., atlmahoney
To contact the editor responsible for this story: Ryan C. Tuck at rtuck
For More Information
Text of S.B. 227 is at http://src.bna.com/vpN.
Will plan to replace state-tax deduction with charitable donation fly?
A bill that would let Californians circumvent the limit placed on state tax and local deductions under the new federal tax law was passed by a state Senate committee last week after a group of law school professors defended the idea in a paper.
But the proposal still faces an uncertain future. U.S. Treasury Secretary Steven Mnuchin has called the idea “ridiculous.” The Internal Revenue Service reports to Treasury.
The Republican-crafted tax overhaul limits the itemized deduction for all state and local income, property and other taxes combined to $10,000 per federal return starting this year. Previously, this deduction was unlimited. The bill also reduces federal tax rates, partly in exchange for reducing deductions.
SB277, by state Senate President Pro Tem Kevin de León, D-Los Angeles, would let California taxpayers donate money to a new state fund and get a dollar-for-dollar state credit on their tax return. Theoretically, the donation would be deductible as a charitable contribution on their federal (but not state) tax return. This would let taxpayers offset the loss of any state income tax deduction while recouping their entire donation.
If you’ve been wondering how this would work, here goes:
Suppose you owe $13,000 in state income taxes and $10,000 in property taxes this year. In calendar 2018, you pay $13,000 in state income tax through payroll withholding. You pay your property taxes as usual.
Under the old law you could have deducted $23,000 in state income and property taxes on your federal return. Under the new one you can deduct only $10,000, so you have “lost” $13,000 in deductions.
To make up for this, before the end of 2018 you donate $13,000 to a newly created California Excellence Fund.
When you file your 2018 taxes, you deduct $13,000 as a charitable contribution on your federal return. If you are in the new 24 percent federal tax bracket, this saves you $3,120 and replaces what you lost.
On your state return, you claim a $13,000 tax credit, which unlike a deduction reduces your tax bill dollar for dollar. Because you already paid $13,000 through payroll withholding, you get a $13,000 refund.
Some caveats: This works only if all of your itemized deductions will exceed the new federal standard deduction of $12,000 for singles and $24,000 for married filing jointly.
You can’t use this credit against property taxes.
If you donate an amount over your state income tax liability — in this example $13,000 — you cannot get a refund for the excess, but you can use it to reduce state taxes in future years, said Darien Shanske of UC Davis, one of eight law school professors (six in California) who wrote the paper.
You cannot deduct this donation as a charitable contribution on your state tax return; backers say that would be double dipping. But it also seems to undermine the idea that this is a donation.
If you gave $1,000 to the United Way and the United Way gave you $1,000 in cash or $1,000 worth of “Hamilton” tickets, you would get no charitable deduction. If the United Way gave you $200 worth of “Hamilton” tickets you could deduct $800.
Federal tax law makes it clear that donors cannot deduct “the fair market value of the goods or services the (charitable) organization provides in return” for a donation. This is known as a quid pro quo.
So why would California taxpayers get to deduct their entire donation to the Excellence Fund if they get back the same amount as a credit?
“Treasury regulations don’t specifically address whether a reduction in state tax liability constitutes a good or service, instead defining ‘goods and services’ to mean ‘cash, property, services, benefits, and privileges,’ an analysis of the de León bill says.
An IRS Chief Counsel Advice Memoranda published in 2011 suggested that a contribution to a state agency would be deductible even if the taxpayer received a state tax credit in return.
The theory goes something like this: A donation to the Red Cross generates a state and federal tax deduction. The state deduction has value because it reduces your state taxes. But the IRS does not reduce your federal tax deduction because you are getting something of value from your state. By the same token, a state tax credit for a charitable donation should not reduce your federal deduction.
In the chief counsel memo, “The IRS gives itself an out,” said Dennis Ventry, another UC Davis professor who co-wrote the report. “It ruled that these contributions for tax credit programs are valid … except in unusual circumstances, but it never defined unusual circumstances.”
The bill analysis also noted that chief counsel advice memos “have no precedential value and cannot be relied upon by taxpayers.”
The academic paper analyzed numerous court decisions that upheld what it calls the Full Deduction Rule. It noted that more than 100 programs in 33 states have charitable tax-credit programs that take advantage of this rule to support a variety of causes, including ones that benefit private and religious schools. Almost all of these programs, however, offer less than a dollar-for-dollar credit, which means donors are not made whole and the program does raise money for a cause.
One such program is the California College Access Tax Credit Fund. Donors can write off 100 percent of their contribution as an itemized deduction on their federal, but not state, return. They get a state tax credit equal to 50 percent of their donation. Taxpayers gave $6.4 million to the fund in 2017 and $5.4 million in 2016. Half of that went back to taxpayers, the rest went to Cal Grants for college students.
Shanske and Ventry recommend that the state reduce the credit to less than 100 percent for the new Excellence Fund as well.
Jared Walczak of the Tax Foundation said in a paper that the de León proposal is “clever” but would face “serious headwinds.” Contributions to governmental entities can qualify for the charitable deduction if the contribution is “solely for public purposes,” such as reducing the debt or maintaining a park, he wrote. But in this case the contribution “serves no public purpose (it has no net effect on state revenue) and is intended to leave the giver in better shape financially.” This “flies in the face of what the IRS considers a charitable contribution.”
State Sen. John Moorlach, R-Costa Mesa (Orange County), was the sole vote against the bill in the Governance and Finance Committee last week. As a former accountant, he said he had difficulty “with the contrivance component of this.” State Sen. Janet Nguyen, another Orange County Republican, voiced concerns but did not vote on the bill. All five Democrats voted for it.
The bill, if it passes, would put tax advisers “in a really precarious place,” said Gina DeRosa, a CPA in Torrance. “A litigious client could sue us for either not recommending they contribute or recommending a contribution that is then reversed. It’s the impossible quandary.”
Greg Turner, a state and local tax attorney in Sacramento, said, “Without some IRS guidance, it’s going to be hard to recommend to a client to utilize this strategy.”
I’ll leave you with Mnuchin’s remarks at a press briefing last week. “Let me just say again from a Treasury standpoint and IRS, I don’t want to speculate on what people will do, but I think it’s one of the more ridiculous comments to think you can take a real estate tax that you are required to make and dress that up as a charitable contribution.”
Kathleen Pender is a San Francisco Chronicle columnist. Email: kpender Twitter: @kathpender
This e-mail has been sent by California State Senator John M. W. Moorlach, 37th District. If you no longer wish to subscribe, just let me know by responding with a request to do so.