New Jersey Lawmakers Try to Fool the Federal Taxman

‘Charity’ begins at home, but the IRS is likely to look askance at a scheme to avoid a deduction cap.

 
 

Rep. Josh Gottheimer (D., N.J.) speaks in his office in the Cannon House Office Building, Feb. 17, 2017.
Rep. Josh Gottheimer (D., N.J.) speaks in his office in the Cannon House Office Building, Feb. 17, 2017. PHOTO: BILL CLARK/ZUMA PRESS
 

Since enacting tax reform last December, many congressional Republicans have toured their home states to celebrate its success. But for the New Jersey Legislature, federal tax reform has created work of an unexpected kind, as Democratic lawmakers labor to shield constituents from the state-tax costs they’ve spent decades creating.

The issue is the reduction in the deduction for state and local taxes, or SALT. Starting this year, the annual deduction is capped at $10,000, a major hit to residents of high-tax states like New Jersey. The Garden State has the nation’s highest effective property-tax rates, and they’ve risen an average of more than 2% a year since 2004. Since Democrats controlled the Legislature that whole time, there’s little doubt whom voters will blame for the increased bite.

This looming political crisis might have presented an opportunity to begin controlling costs and returning the savings to taxpayers, but New Jersey’s Democrats have taken a different tack. Shortly after President Trump signed the tax reform into law, Rep. Josh Gottheimer concocted a nullification plan. The proposal would allow municipalities to create charitable funds to pay for public projects currently financed by state taxes. Residents would be invited to give to these funds and would in return receive a 90% credit on their property taxes. Because the federal cap on deductions for charitable contributions is much higher than for SALT—generally 50% of adjusted gross income—most “donors” would regain the ability to deduct almost all their property taxes. 

The state Senate passed the proposal Feb. 26, and the Assembly will take it up this month. Gov. Phil Murphy, a newly elected Democrat, has pledged to sign the bill, underscoring his party’s commitment to nullify rather than take advantage of the circumstances brought about by federal tax reform.

Will the Internal Revenue Service accept the scheme? Treasury Secretary Steven Mnuchin has already called it “ridiculous.” New Jersey Democrats are preparing a defense. Six law professors released a report the day before the state Senate vote, pointing out that 33 states grant tax credits for donations to charities, and that the IRS treats those contributions as charity rather than taxes. “I think this puts the IRS in a pickle,” says Mr. Gottheimer.

But there’s one major difference: In the other state programs, private charities like scholarship funds, soup kitchens and park-restoration groups are included in the list of beneficiaries for which donors can earn tax credits. That is consistent the Internal Revenue Code’s requirement that charitable contributions benefit someone other than the donor. By contrast, the New Jersey plan would fund exactly the same programs currently paid for by existing property taxes. That means the only benefit of the donations would be federal deductions for the donors themselves—a purely self-serving contribution.

Jared Walczak, a senior policy analyst at the Tax Foundation, points out that the 2010 memo in which the IRS allowed deductibility for some state charitable tax credits reserved the authority to distinguish good-faith programs from avoidance schemes. “The Legislature here is helping to establish the fact pattern,” Mr. Walczak says. “They are pursuing the change explicitly as a workaround.”

New Jersey isn’t alone in trying to shield its citizens from the full impact of state and local taxes. California and Connecticut have formulated similar plans to replace property taxes with charitable contributions, while New York’s version would create a new optional payroll tax employers could adopt in place of the state income tax. Mr. Walczak believes these workarounds are a Catch-22—the feasible ones like New Jersey’s won’t pass muster with the IRS, while permissible approaches like New York’s would be impossible to implement as companies would struggle to adjust employee pay to accommodate the new tax.

The SALT deduction cap is allowing New Jersey Democrats to have it both ways—to pose as tax cutters without cutting taxes: Mr. Gottheimer announced his plan while standing in front of a giant banner reading “Tax Cut Plan.” Meanwhile, the 2019 budget Gov. Murphy announced this week would raise $1.3 billion through an income-tax surcharge on the same high earners his party is claiming to help. 

But the IRS is likely to put an end to the workaround charade. Which leaves the Occam’s razor approach to tax relief: Simply reduce taxes.

Mr. Ukueberuwa is an assistant editorial features editor at the Journal.

Appeared in the March 17, 2018, print edition.

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