Editor’s note: This article is part of a series on tax reform. Read another perspective here.
Unless California is trying to break the Guinness World Record for tax evasion, it’s hard to see what will be accomplished by the plan put forward by Senate Leader Kevin de León to get around the new federal tax law’s limitation on the deduction for state and local taxes.
“This is legal,” de León insisted, and he could be right, right now. But there is plenty of evidence to suggest that he won’t be right for very long.
The plan, now introduced in the state Senate as Senate Bill 227, would create something called the California Excellence Fund within the state’s General Fund, and if taxpayers chose to make donations to that special fund, they would receive a credit against their state income tax liability equal to the amount of their donation.
The state would end up with the same amount of revenue, but the taxpayer would be better off because donations to the California Excellence Fund would be considered charitable contributions, deductible on federal tax returns. This would get around the new $10,000 limit on the deduction for state taxes.
De León’s contention that this is legal is based on an Internal Revenue Service Chief Counsel Advice Memo from February, 2011. CCA 201105010 states that the payment of cash to a state agency that creates a tax benefit is “not regarded as a return benefit that negates charitable intent.” So it’s an allowable charitable deduction.
However, the CCA memo also warns, “there may be unusual circumstances in which it would be appropriate to recharacterize a payment of cash or property that was, in form, a charitable contribution as, in substance, a satisfaction of tax liability.” In other words, the IRS reserves the right to disallow the deduction in “unusual circumstances.” Possibly one such circumstance would be the entire state of California trying to evade federal taxes at the same time.
Even if the…