Will California outmaneuver a new federal cap on tax deductions?
California Democrats are toying with a brash scheme to skirt a new federal cap on state and local tax deductions: Instead of paying taxes to the Golden State, Californians would be allowed to donate the money to the state's coffers - and deduct the entire sum from their federal taxes.
SACRAMENTO, Calif. — California Democrats are toying with a brash scheme to skirt a new federal cap on state and local tax deductions: Instead of paying taxes to the Golden State, Californians would be allowed to donate the money to the state's coffers — and deduct the entire sum from their federal taxes.
The hastily drafted proposal — unveiled last week, when lawmakers returned from a months-long recess — strikes back at one of the least popular elements of the GOP's tax overhaul, one that that hit California and other high-tax, high-cost states the hardest. It also promises to establish a new front in California's Trump-resistance efforts, which last year took on immigration enforcement and environmental regulatory rollbacks.
"The Republican tax scam disproportionately harms California taxpayers," said Senate President Pro Tem Kevin de León, also a Democratic candidate for U.S. Senate, who introduced the proposal. "Our hard-earned tax dollars should not be subject to double taxation, especially not to line the pockets of the Trump family, hedge fund managers, and private jet owners."
The sweeping changes to the federal tax code — which also doubled the standard deduction and dramatically lowered the tax rates for corporations — have created consternation in California, where until this year, taxpayers could deduct an unlimited amount of state and local taxes from their federal tax bills.
The average state and local tax deduction for Californians who itemize was $22,000, according to the state Department of Finance. The new federal law caps that deduction at $10,000.
But Congress did not rewrite the rules that permit taxpayers to deduct charitable donations from their federal tax bills, opening the door for a possible end-run by the high-tax states of California, New York, and New Jersey. Red states such as South Carolina and Florida already offer generous tax credits to those who funnel money into state funds for private-school vouchers, for instance, while blue states like California use tax credits to promote environmental conservation and college scholarship donations, said Kirk Stark, professor of tax law and policy at UCLA School of Law, who is advising Democrats in California on the proposal.
People who donate to these state funds often receive a double-benefit: federal deductions on top of state tax credits, Stark said.
"This isn't some grand new thing," he said. "This is something that states all over the country have been doing for some time."
California lawmakers are considering a tax credit of 100 percent for the proposal — essentially allowing people to replace their tax payments with donations to a state fund. Californians who choose not to make the donation would still be required to pay state taxes.
Another work-around contemplated by tax scholars and blue-state politicians is even more complicated: replacing state income taxes — which are subject to the $10,000 cap — with employer payroll taxes, which are not. But that idea would almost certainly require employers to cut employee salaries, a move with wide-ranging implications.
The Senate's plan, which is likely to evolve in the coming months, now centers around the charitable-donation alternative. Political observers say such a move by high-tax states could prompt Congress to change the rules for charitable donations. But they predict the end-run will encounter little resistance in Sacramento.
"I think for lawmakers in Sacramento, this is a twofer," said Bill Whalen, a longtime GOP strategist now at Stanford's Hoover Institution. "It directs more money to Sacramento, and secondly, it complicates President Trump's life in that every dollar that somebody donates to Sacramento, that's potentially one less dollar going to the federal government. This messes up the equation behind the tax cut."
It seems like a "win-win" for California, said Melissa Michelson, a professor of politics at Menlo College in Atherton.
"If they could make it work so that there's no financial loss to the state," she said, "what's not to like, as long as California gets the revenue that it needs?"