California Scheming: Playing Games with the Taxman

Joel Fox
Editor and Co-Publisher of Fox and Hounds Daily

Sacramento Democratic politicians are so concerned that taxpayers will have to pay more taxes to the federal government under the recently passed U.S. tax law that they have devised a scheme to help taxpayers avoid paying more federal taxes.

Wait! Aren’t these the same Democratic leaders like Gov. Jerry Brown and state senate president Kevin de León, who pushed for higher income taxes under Proposition 30, an extension of those taxes under Proposition 55, and new gas taxes with SB 1?

What they really want is to preserve California’s high taxes which could be put in jeopardy of a taxpayer backlash if the federal write offs are reduced.

The plan to substitute charitable donations—still a write off against federal taxes under the new law–in lieu of paying state taxes will face strong headwinds.

The new federal tax law limited the amount of state and local taxes that can be deducted from federal taxes to $10,000. The California Department of Finance says that the average write off from state taxpayers who deduct state and local taxes is around $22,000. Therefore many taxpayers will see an overall increase in their tax liabilities.

Far be it from me to oppose reduction in taxes, but the plan offered in Sen. President Kevin de León’s SB 227 creating the California Excellence Fund seems too clever by half. The plan allows for donations to the fund to receive tax credits to reduce the taxpayer’s tax obligation. Charitable donations are voluntary. If a taxpayer chooses not to make a donation then they have to pay the tax. That hardly seems voluntary.

The plan has other obstacles the Internal Revenue Service will likely flag about the proposal.

According to a report issued by the Tax Foundation discussing the California proposal, “To be deductible, charitable contributions must have a genuinely charitable aspect, and cannot primarily benefit the contributor or involve a quid pro quo. Payments which function as taxes may be classified as taxes even if states choose to call them something else.”

The IRS declares that deductible charitable contributions are ones in which the taxpayer does not benefit. The report offered the following example:

For instance, if one purchases a $250 ticket to a benefit dinner, and the fair market value of the dinner is $50, then $200 can be deducted—not $250. Arguably, the benefit of, say, a $20,000 “contribution” to one’s state, which yields a $20,000 credit against state tax liability is, in fact, $20,000, completely wiping out deductibility. The contributor actually receives two benefits: one, the benefit of government services, and two, the benefit of a reduction in overall tax liability.

Proponents of the measure clearly state the goal of the California Excellence Fund is to offer tax credits to offset the donations. The old duck principle applies: If it looks like a tax and acts like a tax, the IRS and the courts could very well say that it is a tax.

The argument that current tax credits applied to charitable donations will apply to the California Excellence Fund is also problematic. Donations to private charities do not equate to donations to the state. Another difference under the California Excellence Fund proposal is that the tax credits are intended to make the state treasury whole where tax credits for some state sponsored functions come at a cost to the state treasury.

The main question for the IRS will come down to: Is the charitable donation to the California Excellent Fund really a tax in disguise?

Sen. de León’s classifies his bill as a majority vote measure that takes effect immediately upon the signature of the governor. Tax bills as well as urgency bills that take effect immediately require a two-thirds vote. To avoid a two-thirds vote, de Leon is relying on Article IV, Section 8c paragraph 3 of the California Constitution, which contains the clause: “statutes providing for tax levies or appropriations for the usual current expenses of the State” shall go into effect immediately.

The bill is creating a way to collect money for the state, not appropriate money. Whether that is accomplished via a tax levy or a donation, the IRS will take note.

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