High-tax blue states are scrambling to circumvent the new limit on deducting state and local taxes imposed by the Republican tax bill. Under the 2017 Tax Act, taxpayers may only deduct up to $10,000 in income, sales, or property taxes. The average deduction is $16,000 to $22,000 in some states.

Given the hyper-partisan nature of tax reform, Democrats are eager to stick it to Republicans by gutting a major revenue raiser in the new tax law. With the 2018 elections looming, lawmakers are raring to pen a fix that they can tout during campaign season. Democrats from California, New York, and New Jersey (i.e. high-tax blue states) have been considering a few creative options to work around the limit:

  1. Prepay property taxes in 2017, so they can still be deducted: The IRS issued a Dec. 27 advisory, stating that taxpayers may prepay and receive a deduction for property taxes assessed in 2017.
  2. Charitable contributions: States would set up charitable funds to pay for police, schools, and other services. In lieu of paying property taxes, residents would contribute to the charitable fund and take a deduction on their federal tax returns. No limits were placed on charitable deductions in the GOP tax bill.  According to some legal experts, many states already have similar programs. For example, Arizona has a “School Tax Credits for Individuals” program. Taxpayers making contributions to this program may take a federal charitable contribution deduction and receive a dollar-for-dollar credit against state income tax liability. Interestingly, according to the IRS, the dollar-for-dollar credit is not viewed as “quid pro quo” and does not reduce the deductible portion of the federal charitable contribution deduction. Of course, conservative outlets have pointed out that the IRS is unlikely to view these shenanigans favorably, given existing restrictions on charitable deductions to stop taxpayers from gaming the system.
  3. Tax swap – payroll for property: States may shift the tax burden from property to payroll taxes. This would require states to repeal property taxes, replace them with employer-side state payroll taxes, and offset the employee-side with fully refundable wage credits. Employer-side state payroll taxes are still deductible under federal law. Much like the charitable contribution workaround, the payroll tax proposal will be met by strong logistical headwinds. Several companies have already expressed concerns with regards to the mechanics of this proposal.

Reactions to the workarounds have been mixed – while some would like to see one of these solutions implemented, others are critical of state efforts, noting that instead of trying to circumvent the tax law, local governments should focus on spending cuts.