One of the changes that was made in the Tax Cuts and Jobs Act of 2017, which applies to our federal tax returns for this year, is a limitation on deductions for state and local tax. Simply put, you can only deduct up to $10,000 in state and local tax. If you paid more, too bad, tough cookies. (This limitation applies only to non-business taxes. If you have a business and it pays taxes, such as our state GET, those taxes are fully deductible.)
Some government officials in high-tax states, such as California (which is now one of the only states with a higher income tax rate than ours), were not too happy about the limitation. California is now trying to enact a workaround, and some Hawaii lawmakers are actively considering similar legislation.
Specifically, the California Senate has passed a bill that establishes a “California Excellence Fund” that will accept contributions from people. The fund will be used to fund public works and other government projects, and Californians will get an 85% tax credit for amounts contributed to the fund. So, for example, if you owe $85,000 in California tax and you contribute $100,000 to the fund, an $85,000 credit is generated so you no longer owe money to the state. If the taxpayer gets a charitable deduction for the $100,000, the taxpayer would get much more benefits because there is no limit on deductions for giving to charity.
Our advice on doing the same thing in Hawaii: three words. It. Doesn’t. Work.
The main reason why it doesn’t work is that taxpayers who get a benefit, or something of value, from a charitable donation can only deduct the difference between the money they paid out and the benefit they got in return. That’s why a taxpayer who buys tickets to a benefit dinner for $100, for example, gets a letter from the charity saying that the dinner was $30, so the taxpayer can deduct the $70 difference.
In the California Excellence Fund example, the taxpayers who “donated” $100,000 were able to avoid paying $85,000 that was otherwise owed to California. Relief from debt is a benefit to the taxpayer just like the meal in the benefit dinner, so the taxpayers in that example will have a deduction for contributions of $15,000. They don’t owe California tax now, so there is no state tax deduction. They are, in fact, worse off. If they instead paid their tax and gave $15,000 to another charity, they would get a $10,000 state tax deduction and a $15,000 charitable deduction. That way they could write off $25,000 for the same cash outlay.
In January, while the California Senate was considering the scheme, some alert reporter asked Treasury Secretary Mnuchin about it when he gave a press briefing on other issues.
His reaction: “Ridiculous.”
Although we are in the process of selecting a new commissioner of the Internal Revenue Service, whoever it is will report to Mr. Mnuchin. So, it’s probably safe to assume that the IRS will take a dim view of the California Excellence Fund contribution scheme.
Given all of that, what do you think about establishing a California Stupidity Fund here in Hawaii?
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