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Federal Tax, State Law and Deductions

One of the tax related topics receiving a great deal of attention currently is the impact of the newest tax law on taxpayers’ ability to deduct state taxes. The new law basically limits taxpayers to deducting no more than $10,000 of state and local taxes paid when calculating the federal income tax they owe.  Not surprisingly, this change has proved upsetting to higher income taxpayers with large deductions for state and local taxes, particularly in states with higher tax rates.
One approach, discussing in a previous post, involves taxpayers making a “charitable” donation to a state or state operated entity in return for tax credits to defray some of those state and local taxes. The IRS has released a statement suggesting that this approach will be subject to scrutiny under current law and regulations, with the likely result that such techniques will be unsuccessful.
However, leaving this discussion aside, it is interesting to look at some aspects of the new law in context. There is nothing really new about the cap – any taxpayer who has been subject to the AMT is well aware of the fact that state and local taxes are NOT AT ALL deductible when figuring tax under the AMT. No complaints from the states in the decades that this tax has been a part of the federal income tax process. Clearly, disallowing the deductions entirely is well within the power of the federal government since they get to decide what we all have to pay and how it is to be determined.
It seems to be clear, at least to this writer, that it is within the power of the federal government to decide whether to allow any deductions when figuring income tax and that it is not within the power of the states to dictate to the federal government how that taxing system is to work. When you next add in the fact that the federal government has completely barred deductions for these types of taxes when determining taxpayer liability for AMT, without any opposition from the states that now complain, any challenge to the federal law seems doomed from the outset.

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