A recent court decision limiting New York, New Jersey, and Connecticut’s ability to bypass the federal cap on state and local tax deductions is a warning to taxpayers to be wary of tax planning strategies that seem too good to be true.
For philanthropic taxpayers, Village of Scarsdale v. IRS means that the state and local charitable fund concept may be done for in its current form.
As the decision noted, New York’s charitable fund, which provides a state income tax credit equal to 85% of a taxpayers’ donation, received $78.7 million prior to the publication of Treas. Reg. Section 1.170A-1(h)(3)(i). While New Jersey and Connecticut intended to implement similar programs, none had yet materialized.
Going forward, a taxpayer donating to a state-run charitable fund can’t deduct the full donation on their federal taxes. And states wishing to maintain a state charitable fund have to scale back the credit to 15% or less if taxpayers want to deduct the full amount on their federal taxes.
Even with the lower threshold, though, the state fund provides additional benefits over other charitable donations, serving as an adequate incentive.
States and localities still wishing to make the most of the new credit limitations should consider establishing specific funds directed toward causes that otherwise attract private donations but that also consume tax dollars. This can include support for vulnerable populations, research for disease cures, and animal care, for example.
States also should consider the possibility of co-funding arrangements with public charities or other nonprofit foundations to help support projects that otherwise might not be feasible due to lack of tax revenue.
Taxpayers who contributed to New York’s charitable funds are likely to bear the economic costs of this decision, which said that “the same New York taxpayer who contributes $200,000 to that state’s designated fund and receives a corresponding state-tax credit worth $170,000 may claim only a $30,000 charitable-contribution deduction on her federal income-tax return.”
And unfortunately, neither New York’s statutes nor Scarsdale’s ordinance governing the funds appears to provide for refunds if the donations become nondeductible for federal tax purposes. State and local governments were the plans’ primary proponents, which makes this outcome perhaps even more frustrating.
The IRS will continue to use its regulatory power to police attempts to circumvent the SALT cap under Section 164 of the tax code. In its notice of proposed rulemanking related to the regulation, the IRS’s stated benefit of the regulation is to “substantially diminish this incentive to engage in socially wasteful tax-avoidance behavior.”
In addition to the effect this decision has on New York and the tri-state area, the case serves as a warning to other states and local governments trying to formulate SALT cap circumvention tactics—especially if they lack explicit IRS buy-in (passthrough entity taxes being an example of such buy-in).
Taxpayers can use lessons learned from this case to avoid the fate of New Yorkers who can’t claw back on charitable donations that have lost the bulk of their tax-credit impact. They should speak with their tax adviser or legal counsel to review their current charitable donations implemented as a tax-savings strategy.
They also should consider what donations might lose tax credit incentives if their state or local governments’ tax credits are limited in a similar matter in the near future. Based on those findings, it is up to the individual taxpayer to determine what donation programs they are comfortable supporting in light of the IRS’s intentions to limit the circumventing of SALT caps.
The case is Village of Scarsdale v. IRS, 2d Cir., No. 24-1499-cv(L), 8/13/25.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Michael Puzyk is tax partner at McCarter & English, focusing on domestic and international businesses, organizations, and individuals in state and local taxation, with emphasis on New Jersey tax matters.
Paul Buonaguro is an associate at McCarter & English and a member of the firm’s tax and employee benefits group.
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