Tax Scheme Places Residents at Risk

The following letter was published in this week’s issue of the Gazette.

To the Editor:
Political activism is an American tradition as old as the founding of our nation. But there is a big difference between personal activism and a municipal corporation engaging in activism which places its residents at risk.

When our Village trustees pass activist resolutions and send letters of protest to Albany or Washington, such action is harmless, albeit ineffectual. When we participate in a “Hey hey, ho ho, [insert cause] has got to go” march, we are getting some exercise and our neighbors are no worse off.

But when our state and local officials encourage residents to break the law to make a political statement, that is not acceptable.

 Image courtesy of www.401kcalculator.org/

Image courtesy of www.401kcalculator.org/

Along with other municipalities in New York, New Jersey, and California, the Village of Croton-on-Hudson is considering pitching a tax avoidance scheme which is both illegal and creates liability for residents and the municipality itself. 

Trustee Murtaugh tells us this is a “workaround” and Trustee Gallelli says that the “devil is in the details.” The devil is not in the details but rather it is in the fraudulent premise. For that reason, it is not a “workaround” but tax evasion.

The Village proposes to set up “charitable” foundations to accept “donations” in the amount of your property taxes. You would then get a receipt and be able to use that for a 95 percent credit against your Croton property tax bill, and you would tell the IRS that your property taxes are charitable contributions.

If this sounds to you like a harebrained scheme that the IRS will not accept, then you have grasped the essence of the Village proposal. 

Even if it were legal, this scheme has no benefit unless you own your home and itemize your federal tax deductions. It would have little to no benefit to someone with an older mortgage because the interest portion of your mortgage payment declines each month. And if you are wealthy and subject to the AMT, this would not be of use to you. There is a specific group of Croton residents who might want to take the risk of this tax avoidance scheme, but even there the benefit would be far outweighed by the risks.

As an example, imagine a married Croton couple in the 22% marginal bracket. They have $30,000 in itemized deductions of which $14,000 is property tax.

The couple would make a “charitable donation” of $14,000 to the foundation established by the Village. They would then be given a piece of paper (the wording of which shall become important) showing the receipt of $14,000. They would take this to the Village and get a credit of $13,300 against their property taxes, and tender a check for the balance of $700. On their federal tax return, they would claim $14,000 as a “charitable contribution.”

For 2018, the couple’s standard deduction is $24,000. By itemizing, the couple would shield an additional $6,000 from tax and thereby save $1,320. But since they paid an additional $700 in taxes, their actual savings is $620.

Most people would not even itemize for such a small savings, because the additional accounting fees and increased risk of audit are not worth it. The Treasury Secretary has already said that claiming property taxes as a “charitable contribution” is not going to fly with the IRS. 

Back in the 1970s thru the 1990s there were tax avoidance schemes which relied on elevation of form over substance. The IRS aggressively pursued taxpayers who participated in such schemes. They even went after the promoters, CPAs, and attorneys involved. After the collapse of Jenkins & Gilchrist most legal and tax professionals became much more wary of tax schemes which did not pass the smell test.

The Village Attorney says that the Village is not going to be in trouble because it is making no representation that the “charitable contribution” is tax deductible, and that the Village will simply give the “donor” a piece of paper stating the amount “donated” to the “charity.”

By setting up a “charitable” foundation and then taking “donations”, the Village is making a representation. And the Village Attorney is being disingenuous about the receipt which the Village will issue to “donors.”

Albany has not yet issued a sample of the receipt. Let us assume that the receipt does indeed only show the amount “donated.” The problem is that Governor Cuomo cannot defy federal law any more than Gov. Wallace or Gov. Faubus. In recent years we have come to believe that state governments can pick and choose which federal law to follow, and the “charitable gifts reserve fund” law passed in Albany is the most recent episode in the political struggle. The IRS is not going to let New York win this round.

The concern regarding liability which neither the Village Attorney nor the Village trustees will discuss is that the IRS can take legal action against the Village (and any officers of the “charitable foundations” set up by the Village) if they issue such a receipt.

There are actually 2 different types of receipts for charitable donations. If you give $500 to a local food bank, you get a piece of paper saying you gave $500. But if you give $500 to the food bank and attend their Annual Dinner, you will get a piece of paper saying that you gave $500 and that you got a meal valued at $125. The meal is called a “quid pro quo” (QPQ) and you can only deduct $375 as a charitable contribution.

IRS rules on QPQ contributions are explicit, they are federal, and they trump (sorry about that pun) whatever Mr. Cuomo or the Village Attorney wants to write on the receipt. The rules apply any time the QPQ is valued at more than $75, so any Croton property tax bill of more than $78.94 is going to fall under the rules involving QPQ donation receipts.

When our state and local officials encourage residents to break the law to make a political statement, that is not acceptable.

There are 2 requirements: first, the charity must tell the donor that tax deductibility is limited to the amount donated in excess of the QPQ and secondly, the charity must give a “good faith estimate” of the value of the QPQ. Contrary to what the Village Attorney and certain members of the Village Board are implying, “caveat emptor” is not permitted under the IRS rules.

The supporting materials on the Croton Board of Trustees website don’t provide any discussion of what the Board is going to determine as the value of the QPQ, but if the Village really is going to claim that there is no QPQ then the ramifications of this need to be fully disclosed to the taxpayers of Croton who are going to be on the hook for any litigation costs.

In our times, even provisions of the Internal Revenue Code are subjective depending on political viewpoint.
 
The argument for those claiming no QPQ is primarily expounded in left-leaning political circles and relies on IRS guidance relating to charitable tax credit programs established by various states. Those charities involved such things as education foundations, nature preservation groups, and domestic violence shelters. Most of the credits were about 25% (one was 50%). But in every single one of those cases, the charity was for a bona fide charitable purpose and the beneficiary of the donation was not the municipal tax coffers.

The only remotely plausible “no QPQ” support in the context of donations to a government entity comes from an October 27, 2010 advice memorandum (201105010, for those Gazette readers who are tax geeks). It is risky for a taxpayer to rely on such an IRS document, particularly where the facts are not sufficiently detailed to indicate congruence with your situation. 

Yet even in this flimsy support for the “no QPQ” position, the IRS discusses “charitable intent” as a key aspect. Do any Croton officials or the Village Attorney seriously believe that someone giving to the proposed Village “charity” has charitable intent? If you can’t make that case without laughing, then it would be foolish to think that the IRS will buy that argument.

The 2010 memorandum concludes by stating that “there may be unusual circumstances in which it would be appropriate to recharacterize a payment of cash or property that was, in form, a charitable contribution as, in substance, a satisfaction of tax liability.”

In 2018, Croton is proposing to accept “charitable contributions” explicitly for the satisfaction of tax liability. That is the sole purpose of the scheme, and the Village states it right there in black and white in both proposed Local Law 5 and also in the Board Resolution.

All of the “no QPQ” arguments rely on pre-2018 court rulings and IRS guidance. Those determinations were issued when SALT and charitable contributions were both fully deductible. Now that the IRS is going to apply the statutory language of the 2018 tax law, guidance given under the old tax law may be irrelevant.

The Village has not discussed what will happen when this scheme implodes. That may be this year, but if it is resolved through taxpayer audits that could take many years. Croton residents will make their “charitable contribution” in 2018 and file their return in 2019, but any audits may not be finished till 2021 or later. So taxpayer litigation against the Village may not even commence till 2022 or later.

It is important to remember that the 5% tax surcharge cannot not be refunded. Due to timing issues, some people may need to pay twice and apply for a refund. But that is questionable, since the “charity” is not going to give a refund and money paid to the municipality and school district as taxes is a bit dicey to refund and would be a direct QPQ. 

It is not clear as to whether the Village insurance policy will even cover acts taken by the “charitable foundations” nor how officers of the foundations will get D&O coverage since the whole purpose of the foundation is to assist people in an illegal tax avoidance scheme.

I am sympathetic to the need for Croton to make a statement opposing the evil GOP tax plan, but enticing Croton residents to commit tax evasion is not the way to make a statement. 

New Yorkers can be justly proud of our rank as #1 for the heaviest state tax burden. Our property taxes are the envy of lesser states: according to the most recent data from Bloomberg, 9 of the top 10 counties are in New York. 

We in Westchester have the honor of having the highest property taxes of any county in the entire nation. Many of us feared losing our #1 ranking during the years of tax freezes, but George Latimer understands the importance of keeping our property taxes the highest in the nation and Westchester residents can now rest assured.

It is entirely proper—one might even say charitable—to give the rest of the country an opportunity to share in some of that honor by means of subsidizing New Yorkers by fully deductible SALT. Unfortunately the Congress does not appreciate our point of view and changed the federal tax law. 

Quite probably in November the political power in Congress will shift and we will once again be able to share our tax burden. In the meantime, we should embrace our record property taxes as a true badge of wokeness.

Village officials may join Mr. Latimer in celebrating our nationally-renowned property tax burden and seek to keep Westchester’s position intact. But Village officials should not promote a tax avoidance scheme in which residents pay a 5% property tax surcharge and incur IRS penalties simply in order to protest the new federal tax code.

Paul Steinberg
Croton-on-Hudson

After this letter was written, the Board on Monday 5/22 pulled the proposed resolution and proposed Local Law from the agenda. The Village Attorney stated that the State will be holding a meeting in White Plains on June 8 to further explain the program. In addition, Trustee Attias has said that she does not support the proposed resolution.

On Wednesday 5/23, the IRS issued Notice 2018-54 stating that it will be issuing specific rules about programs, and stated “The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment” of programs such as the one proposed here in Croton.