Exploiting tax loopholes is a sport associated with rich people and their fancy accountants. State governments may have to start getting fancy, too.

Republican Senate and House negotiators in Washington agreed last week on a $10,000 cap on state and local tax deductions, or SALT. In high-tax states, that’s bad news. Personal taxes are poised to rise for 13 percent of New Yorkers and 11 percent of California and New Jersey residents, according to an analysis by left-leaning Institute on Taxation and Economic Policy, conducted after the bill’s final details were announced.

Financial planners and law professors to the rescue. It’s possible, they say, to concoct workarounds, like replacing income tax with payroll tax, and turning state tax into charitable donations. Far-fetched? Perhaps. But tax experts are already formulating ways to stop the feds from grabbing more take-home pay from Californians, New Yorkers and New Jerseyans while folks across America buy boats with the money they save.

“There are many hundreds of billions of dollars on the table over the next decade,” said David Kamin, a New York University School of Law professor. “There’s a lot of incentive for states to shift into forms of taxation that remain deductible.”

State Capitals

SALT opponents say the deduction encourages states to increase taxes because of the indirect subsidy by Washington. Those who oppose the new cap argue that states like New York and New Jersey pay more in federal taxes than they get back in federal spending, and that putting federal taxes in front of state and local levies violates states’ constitutional rights.

For now, not much is brewing in affected state capitals except discussion, but then again, the Republican tax proposals aren’t yet law. State legislators will have a lot of decisions to make about how their tax codes will change, so a stratagem to offset the loss of the SALT deduction could be part of bigger overhauls, said Darien Shanske, professor at the University of California-Davis School of Law.

“No one likes paying more in taxes,” Shanske said. “It’s likely to be especially aggravating to pay more in taxes when others are paying less.”

Charitable Gifts

One tactic: Allow residents to make charitable gifts to the state instead of paying income tax.

That would involve legislators encouraging residents to donate to, say, New Jersey (insert quip here), instead of paying income taxes. The self-interested philanthropists who took up the state on the offer would receive a state income-tax credit for the full amount of their gift, which would qualify for a federal deduction.

Wealthy taxpayers already use a similar ploy in 18 states that offer at least partial tax credits in return for donations to nonprofits that grant tuition vouchers to private and religious schools. It especially appeals to affluent filers who pay the alternative minimum tax, which doesn’t allow them to claim deductions for state and local levies.

Similar Strategy

In a memo released in 2011, the Internal Revenue Service gave its blessing for taxpayers to claim federal deductions on those gifts. The combination of a 100 percent state-tax credit and a federal deduction actually makes the gifts profitable for some donors, said Carl Davis, research director for the Institute on Taxation and Economic Policy.

“It’s really just a mechanism in state law that lets people launder state income-tax payments and convert them into charitable contributions,” Davis said.

Alas, it would involve a loophole that’s easy to close, he said.

“Under the current rules, it’s workable,’’ he said. “But I don’t see Congress or the IRS letting a state get away with it very long.”

The charitable-gift gambit isn’t the only potential loophole. States could quit relying on income tax, paid by individuals, and switch to payroll taxes, levied on employers, according to a Dec. 7 report, “The Games People Play,” by a group of tax experts that includes Kamin and Shanske.

If employers pay the payroll tax and reduce employees’ salaries by the same amount, workers wouldn’t have to deduct anything and would wind up being paid the same amount. That would allow states to collect the same revenue while preserving individuals’ deductions on federal returns.

Incentive to Deduct

Channeling collections into payroll taxes would also allow both itemizers and non-itemizers to benefit, and states would keep more money within their borders.

States with progressive income-tax rates would need to devise a system of tax credits to make payroll taxes hit the right rates. Union contracts guaranteeing certain wage levels could be a challenge, as would explaining the changes so they don’t read as a tax hike when workers get their pay stubs.

The complexity of such tactics would probably be the main deterrent. Whether states respond may depend on whether residents complain loudly enough. As the new tax law takes effect, working to circumvent the SALT cap could be good politics in the blue states hit hardest by the change. 

The tactics amount to a zero-sum game between state and federal governments. To the degree that statehouses succeed in clawing back part or all of their SALT deductions, federal tax collectors would miss out on revenue they’re depending on to fund the corporate tax cuts at the center of the overhaul plan.

“The question is,’’ Davis said, “how far are the states going to push the envelope?”

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