The Democrats, including freshman Gov. Phil Murphy, think they’ve found a giant loophole in the new tax code, H.R. 1 (115), and want to leverage it. | AP Photo New Jersey leads blue-state defiance of Trump tax law SALT deduction The state may lead others in testing whether property taxes can be counted as charitable contributions.

Democrats in New Jersey are moving at a lightning speed to institute one of the boldest workarounds of the new Republican tax law, potentially setting up the first tax showdown between high-cost states from coast to coast and the Trump administration.

The Democrats, including freshman Gov. Phil Murphy, think they’ve found a giant loophole in the new tax code, H.R. 1 (115), and want to leverage it to allow homeowners across the state to keep deducting their property taxes by labeling the payments “charitable deductions.” Their approach, which has some Republican support in Trenton, could skirt a new $10,000 federal cap on such write-offs and deliver a benefit to some taxpayers who hadn’t been able to use the deduction previously.


New Jersey, which is said to have the highest property taxes in the nation, is just one of the high-cost states plotting ways around the new tax law. The restoration of the so-called SALT deduction has been a top priority in blues states from New York to California. Some governors, including Murphy and Democrat Andrew Cuomo of New York, have already hatched plans to file a legal challenge to the law, which passed Congress in December and was signed into law by President Donald Trump just before the new year. It applies to 2018 taxes and beyond.

Murphy, who at the same time wants to raise taxes on millionaires and corporations, has called the new tax code a “gut punch” to the middle class in New Jersey.

“The federal government threw us a screwball in the form of the new tax law,” Murphy said in a speech this month to mayors from across the state. “Now we are left with the dual problems of not only high property taxes but also the limited ability to deduct them from federal liabilities.”

Even as a few tax experts and the Internal Revenue Service question the legality of the approach, state officials in New Jersey insist they’re going to charge ahead and are prepared to defend their proposal in federal court if it comes to that. They’re quick to note similar programs exist in 30 other states, including some under Republican rule, though they concede nothing quite like this has been tried before.

“I’m not aware of anything of this magnitude or scale,” state Sen. Paul Sarlo, the chairman of the budget committee and the primary sponsor of the legislation, said in an interview. “But we’re not going to sit around and let the federal government kick us in the teeth. We’re New Jersey.”

Sarlo introduced his legislation Thursday, dropping a bill, NJ S 1893 (18R), that would allow local governments to create charitable funds that could be used as a primary revenue source. The local governments could give tax credits to residents who contribute to the fund, allowing them to offset a large portion of their property tax bill — likely around 90 percent — and take a write-off on their federal income taxes.

Lawmakers wasted no time in moving the legislation forward, calling a vote to advance it out of committee before the public had even seen a copy of the bill. Just one of the 11 state senators present voted against the measure, even though some worried they could be leading the state’s residents down a dangerous path if the workaround doesn’t withstand legal scrutiny.

“Obviously we agree on the fact that we should be able to deduct the taxes,” Republican state Sen. Steve Oroho said at the hearing. “But let me say, this is a workaround that creates a bigger risk.”

The approach was developed by Rep. Josh Gottheimer (D-N.J.) and has been championed in recent weeks by Murphy, a liberal who took over the governor’s office last month after the departure of Republican Chris Christie. Local officials who run numerous municipal governments across the state have already endorsed the approach and are working to set up charitable funds in their communities.

A $10,000 cap on write-offs for local taxes is of little consequence to millions of Americans. But it could have an outsize impact in states like New Jersey, where 41 percent of those who filed 2015 tax returns used the SALT deduction to reduce their total tax bill, according to the Tax Policy Center. Those people wrote off a combined $32.2 billion, with the average return claiming nearly $18,000 in deductions from SALT.

Some Republicans, notably Rep. Tom MacArthur, the only member of the state’s congressional delegation to vote for the new tax code, insist most in the state will see an overall benefit under the changes. Democrats, however, continue to use the loss of SALT as a rally cry against the tax laws, and few others in the state’s GOP have dared defend the new cap.

The charitable loophole envisioned in New Jersey remains legally dubious. Treasury Secretary Steven Mnuchin has slammed that and other supposed workarounds, calling them “ridiculous.”

“I hope that the states are more focused on cutting their budgets and giving tax cuts to their people in their states than they are in trying to evade the law,” he said last month.

Acting IRS Commissioner David Kautter, testifying before Congress, said Feb. 14 that charitable contributions qualify for tax deductions only if they're given for truly charitable purposes.

"Under the general principles for charitable contribution, the primary purpose of the contribution is donative, which is a disinterested and detached interest of generosity," Kautter said in congressional testimony.

But the Murphy administration and other supporters believe the practice would withstand legal scrutiny.

Gottheimer, a freshman congressman from high-tax Bergen County, met with Kautter on Thursday and pressed the issue. The Democrat notes there are 100 similar programs in 30 different states that use charitable deductions to offset property taxes. He says it would be hard for the IRS to distinguish between what New Jersey wants to do and what happens in those other states, some of which are under Republican rule. The congressman said he left his meeting with the IRS chief still comfortable with the approach.

“He did not say, ‘No way, no how,’” Gottheimer said Friday in an interview. “So I think they’re going to have to consider this, along with other programs in other states.”

The governor’s office in New Jersey also thinks it would be difficult for the IRS to change its existing guidance on charitable contributions to target its effort without hurting programs in other states, some of which are used to offset tuition paid to private schools, a Murphy administration official said.

“They’re in a bit of box and there’s strong legal precedent here, because these programs have been around for a long time,” the official said, speaking on condition of anonymity to describe their internal discussion about the issue. “This isn’t just something we just threw together. We think we’d have a strong case if there was a challenge."

To be sure, a confrontation could be inevitable. A disagreement between states and the IRS could certainly land in the courts, said Nicole Kaeding, director of special projects at the Tax Foundation. She thinks the IRS seems likely to rule against New Jersey because contributions to a state for property taxes would go to a major revenue stream, not a smaller, focused program for something like educational purposes.

In addition, she said making donations in return for government services could conflict with charitable giving limits in quid pro quo situations, which means individuals can’t receive a substantial benefit from their contributions.

Gottheimer disagrees with that argument and says he’s spoken with a number of tax experts who believe it would pass muster. But without any clarity from the IRS on the issue to date, a final outcome isn’t immediately apparent.

No guidance on the issue is expected in the near term.

“What we’re doing at this point is monitoring what the states are doing, and at the appropriate point we’ll issue some guidance,” Kautter said after the hearing. “But at this point it’s too early in the process to try and issue anything.”

Aaron Lorenzo contributed to this report.