When the original tax cut package passed, much political hay was made over the caps on deductions for state and local taxes (SALT) which would primarily hit the top 10% of earners with a partial reduction in benefits they could realize when filing each year. Of course, the biggest hits would take place in the states with the highest state and local taxes. In other words, the larger blue states like California, New York and New Jersey.

They responded with clever schemes allowing their residents to get around the new rules and still take the deductions through legally dubious loopholes. California has set up a “California Excellence Fund” where high earners could simply “donate” the excess amount they would have owed to this ambiguous fund and then write it off as a “charitable contribution” to the state. Meanwhile, New York set up their own scheme to protect residents from what Governor Cuomo described as “their Constitutional right” to be protected from the massive state taxes his government imposes on them. But now the feds are fighting back. (Associated Press)

The Treasury Department’s rules released Thursday target moves by states like New York, New Jersey and California — where residents could see substantial increases in their federal tax bills next spring because of the $10,000 cap on state and local deductions. The cap was put in as a compromise to eliminating the deductions completely, as part of the massive GOP tax package pushed by President Donald Trump and enacted late last year. Experts say the issue likely will have to be resolved by the federal courts.

But the new rules’ “dollar-for-dollar” limit also applies to many other states that already have charitable funds offering tax breaks — and those programs too could be hurt by the rules. Those states include solidly Republican ones and others with relatively low taxes. In those programs, donors to schools, hospitals or land-conservation programs can get their state taxes reduced in return — plus a charitable deduction on their federal tax returns.

The limit means taxpayers only can deduct as a charitable contribution the portion of their donation for which they don’t also get a state tax credit.

This “dollar for dollar” rule is a little complicated and comes with some potential traps for the White House. On the surface, it’s basically a way to prevent these workaround schemes by not allowing a federal deduction for a charitable contribution where you receive a state deduction. You could describe it as a check on “double dipping” at first glance, but it also hits contributions from people in lower-income states (including many red states) for donations to popular, conservative causes such as private/charter schools. There are exceptions to the rule, but you get the drift.

Still, assuming this doesn’t get shot down in court (because every blue state is already firing up lawsuits against the White House over it), the total impact on lower-wage workers is going to remain negligible. Previous estimates already put the total number of people affected by the SALT deduction limitations at less than 1% of the population. People who don’t earn at those levels typically don’t/can’t make the significant charitable contributions required to take advantage of these schemes.

One other thing to keep an eye on is the fact that the new rule goes into effect almost immediately. The effective date is next week, so there could be a serious flood of cash coming into some charitable groups this weekend. If that’s the worst effect the new rule causes, I suppose things could be worse.