IRS Speaks On State Tax Workarounds… Taxpayers should be wary of supposed workarounds to the new $10,000 annual limit on deductions for personal state and local taxes, the IRS cautioned. New regulations may invoke long-standing substance-over-form doctrine to disallow schemes that would have taxpayers make purported charitable contributions, which are not subject to the dollar cap, in exchange for a substantially equal reduction in state income tax liability. Several states hurried to enact such schemes early this year after the new limit was included as part of the 2017 federal tax overhaul. Notice 2018-54.
…And Connecticut Answers. Lawmakers in Hartford responded to the new federal deduction limits by shifting a significant share of the tax burden from individuals to businesses operating as pass-through entities that file their own federal tax returns. Typically, pass-throughs such as partnerships, S corporations and multi-owner limited liability companies (LLCs) do not pay income-based taxes; their income is reported to owners who pay the taxes directly on their personal returns. But under legislation Connecticut enacted in May, such entities will pay taxes directly to the state, which will grant individual owners an offsetting credit for taxes on their share of that income. Proponents argue that because the tax is imposed upon and paid directly by the business, the new deduction limits will not apply. Not everyone may benefit; out-of-state owners may still owe individual taxes to their own states, and may not be able to claim offsetting credits for the business-level taxes paid to Connecticut. And single-owner LLCs are not covered because they are disregarded for federal tax purposes and do not file their own business tax returns. Affected businesses must pay quarterly estimated taxes retroactive to April 15 of this year, with special transition rules and penalty waivers. SN 2018(4); 2018 STT 111-18.
…And New Jersey Answers, Too. Gov. Phil Murphy signed legislation retroactively allowing Garden State homeowners to prepay their 2018 property taxes in 2017. Many individuals hurried to do exactly that in the year’s final days, in an effort to avoid the $10,000 annual limit that was due to take effect this year. But such payments might not be deductible for federal purposes, particularly if the state had no authorized mechanism to accept such early remittances. The new law could remove at least that vulnerability if the IRS decides to challenge taxpayers who deducted such payments on their 2017 returns. 2018 STT 79-1.