Newsletter from
Steve Richardson & Company, Certified Public Accountants

January 10, 2018

Tax Planning for limited state and local taxes

Dear Clients & Friends of the Firm:

Complex new tax laws create both problems and planning opportunities.  In this newsletter I am going to discuss the limitation on the deduction of state and local taxes (SALT), how good state law and good tax planning can help minimize the impact of the SALT limitation. I am also going to touch on how §529 education accounts can now be used.  Oddly enough, these three issues are related.

SALT (state and local taxes) are limited!

The new tax law limits the amount of state and local tax deductions to $10,000.  For some people, that is a problem.  This newsletter is not only written for taxpayers who pay more than $10,000 in SALT taxes; middle income taxpayer can enjoy substantial benefits from the “Alabama Accountability Act of 2013”.

Section 529 educational savings plans

In the past, these plans were really good; now they are much better!  The new 529 accounts can have a positive impact on elementary or secondary public, private, religious school or, in my opinion, a home school, up to a $10,000 limit per tax year. This is new!  More about this will be discussed later in this newsletter.

Alabama tax law leads the nation

In 2013, Alabama passed an unusual law called the “Alabama Accountability Act of 2013”; California and New York are considering similar laws for the sole purpose of getting around the $10,000 limitation of SALT deductions.

The 2013 Alabama law clearly was long before the 2017 federal tax bill but, without intending to, it neatly steps around the SALT limitation.

Alabama Accountability Act of 2013

This is a super cool law; it allows an Alabama taxpayer to make a contribution to certain pre-approved 501(c)(3) organizations dedicated to education – and – get a 100% Tax Credit against your Alabama income taxes!

A 100% Tax Credit

A Tax Credit is not some mundane tax deduction; it is a dollar-for-dollar off-set against Alabama income taxes.  For example, if you made a charitable contribution of $10,000 to one of these pre-approved 501(c)(3) organizations, you get dollar-for-dollar write off of $10,000 against Alabama income taxes – AND – a federal charitable deduction.

There is a limitation

You can only use this tax credit to off-set 50% of your State of Alabama income taxes.  Not a serious limitation from my point of view.

Why is this important?

Federal deductions for charitable contributions are not limited (well not very much – I’ll talk about that later) but deductions of Alabama taxes (SALT) are limited to $10,000.  We can now skip over the SALT limit.

But! That’s not all!

Ok, I know that sounds like a TV salesman; but, in this case it’s true!

If you spend $10,000 on one of these preapproved §501(c)(3) organizations, you spent $10,000.  You get a $10,000 dollar-for-dollar payback with a reduction in your Alabama taxes; there is no money lost; you are 100% made whole.

AND

Did I mention that you also get a federal tax deduction for a charitable donation?  If you are in a 32% tax bracket, your $10,000 tax deduction is worth $3,200.

Therefore

If you spend $10,000 under the Alabama Accountability Act, which allows you to pay $10,000 of the Alabama income tax that you were required to pay anyway, plus you get a federal tax deduction worth $3,200, then your $10,000 spending is worth $13,200 in cash!

That’s not hypothetical cash; this is real spending money!

What’s the catch?

That’s the point of this memo, there is no catch; this was the intent of the Alabama legislature.

The politics of this Act are complex and beyond the scope of this letter.  The intent of the law and the thought processes behind this law are very much a part of this letter.  When there is a tax controversy in court, the “intent” of the law becomes an important factor.

The Intent of the Law

The people in support of this law believe that Alabama has serious problems in Alabama’s education system for children and high school students.  (They’re right too.)  They also believe that State of Alabama Tax money, diverted to private sector organizations dedicated to education, can have a profound and positive impact on the quality of education.

The State of Alabama intentionally diverted tax money to private sector educational organizations with the hope that the quality of education in Alabama would be improved.

Is it working?

The short answer is yes.  I have visited many schools that are funded, in part, by the Alabama Accountability Act of 2013, and they are, without exception, outstanding!

My only reservation is that the substantial improvements in the quality of education, related to this act, do not reach enough students.  But, the impact on students it does reach is profound!

Lessening the Burdens of Government

Lessening the Burdens of Government has long been the underlying basis for Tax Exemption under IRC Section 501(c)(3).  The burdens of government are the health, education and general welfare of the citizens; these demands are too general and too complex to be managed by government alone.  In any government, a functional partnership must exist between the government and private sector for there to be any hope of success.

By deliberately moving money from the public sector (the State of Alabama), to the private sector, (the various pre-approved §501(c)(3) charitable organizations), Alabama has made an effort to increase the amount of funds targeted to a specific public issue (education) by relying more on the private sector.

There’s no Catch – except?

As I said, there are no catches; except for one small catch that will not have any relevance to most taxpayers.  The new tax law now allows a charitable tax deduction in any tax year not to exceed 60% of Adjusted Gross Income (also called AGI).  This is an increase from prior law that allowed charitable deductions not to exceed 50% of AGI.

The new tax law wants to encourage taxpayers to make as many charitable deductions as possible.

How this works: to most of us, this may not make much sense.  If, for example, your family earns $100,000 per year, your maximum charitable deduction is only $60,000.  $60,000!  Like I said, this new provision in tax law makes no sense to most of us.

It is, nevertheless, an important change in the law. 

I see a trend in tax law that is encouraging.  When people move up from a middle class income to an upper middle class or higher income, the level of charitable giving, as a percentage of income goes up; often it goes up very fast. This is a cultural trend that I find encouraging.  Warren Buffett, Bill Gates and others are giving up to 90% of their income to charity; they are leaders in this cultural trend.

We are fortunate to have some very generous clients; some who give 60, 70 or even 80% of their income to charity.  As a rule, they are “well-to-do” financially; other than that, they are no different than anyone else.  Often you would not know who they are; they live in modest homes, drive modest cars and are basically nice friends and neighbors.  Typically, these generous givers do not give 60, 70 or 80% of their income away every year; most years they may give 10 to 20% of their income away.  Every so often, every fifth, eighth or tenth year, they will make substantial donations.  These generous givers are different from other historical charitable giving norms; they are very careful, deliberate givers.  These charitable givers research and plan their giving with care to maximize the impact of their donations.

It is a joy and this is a growing trend in the not-for-profit industry.

Stories

I have many wonderful stories about how some of these very generous donors plan their charitable giving.  If you are interested, I may get permission to tell a story about a woman who put $5,000,000 on her American Express Card to move aid quickly to Indonesia the day of ‘The Great Tsunami’ and got that aid on the ground in less than 24 hours!

Congress moved the Charitable Deduction AGI limit from 50% to 60% in an attempt to encourage this charitable giving trend.  Getting more money into the hands of §501(c)(3) organization is a good thing.

The New Tax Law

The new tax law seeks to limit the tax value of SALT deductions (Remember that SALT is State and Local Taxes). Bummer.

Quite the opposite, the new law seeks to encourage more money to move into the hands of §501(c)(3) organizations. Good!

The “Alabama Accountability Act of 2013” is an outstanding tax tool that allows a person to plan around the $10,000 SALT deduction limitation and increase charitable giving substantially.  It is a VERY GOOD TOOL.

The “Alabama Accountability Act of 2013” is so good that it is proving to be an inspiration to California and New York.  If these two states are successful at implementing similar legislation, I think we will see an interesting national trend in state tax laws.

On a Separate but Related Issue!

Section 529 of the new tax law substantially expanded the use of §529 accounts; these funds are no longer limited to “higher education” alone.  The new §529 rules allow for these funds to be used for tuition at an elementary or secondary public, private, or religious school, up to a $10,000 limit per tax year.  It is my opinion that this applies to home schools too.

Once again, this time on a federal level, government is encouraging the private not-for-profit sector to shoulder more of the burden of educating our citizens.

The more I read the new tax law

This law is complicated. I’m doing my dead-level best to understand the new law but I have a lot to learn! As I learn more, I will keep you posted with newsletters and memos.

Thanks!  I love my job and, without you, I would not be able to do what I do.  Thank You!

Steve Richardson, CPA