Nov 18 2012

Tax Deductibility and the Proposed New School Tax

Will the State Turn a Blind Eye over the Next 8 Years?

Many California residents take their entire County property tax bill as a tax deduction, ignoring the question of whether some parcel taxes and assessments may be non-deductible.  But in the future this could lead to Piedmont residents receiving a “Notice of Additional Tax Due”.

While Piedmont School Bond assessments are clearly tax deductible, the proposed new 8-year Piedmont school tax and other city parcel taxes may not be:  they potentially fail the IRS “like rate” requirement for tax deductibility.  A recent IRS opinion letter states:

“Assessments on real property owners, based other than on the assessed value of the property, may be deductible if they are levied for the general public welfare by a proper taxing authority at a like rate on owners of all properties in the taxing authority’s jurisdiction, and if the assessments are not for local benefits (unless for maintenance or interest charges).”

The California State Franchise Tax Board (FTB) currently tends to overlook errors in property tax deductions for unaudited returns, but may take a more aggressive posture to limit deductibility as the State searches for new sources of revenue.

In 2011, the FTB posted strict new tax guidance on its website and planned to include 3 new lines on 2012 returns:  require California residents to identify their parcel number, “deductible” property taxes, and “non-deductible”property taxes.  While this new guidance was abruptly withdrawn after receipt of an IRS opinion letter rejecting the FTB’s overly narrow construction of deductibility, the FTB website indicates future limits are still on the table:

We have removed material from our website that limits the deductibility of real property taxes to taxes imposed on an ad valorem basis. Once the IRS forms and instructions are revised, we will provide revised California forms and instructions that are consistent with the revisions made by the IRS.”

The FTB stopped short of telling everyone they can deduct their entire property tax bill and at some point intends to halt the improper deduction of all property taxes in order to capture an estimated $200 million in new tax revenues.

An aggressive stance by the FTB could not only impact the deductibility of Piedmont’s proposed 8-year school parcel tax of $2,000 to $3,500, but other city parcel taxes that are also based on parcel size (see below).

The State has a strong pecuniary interest to interpret the term “like rate” as narrowly as possible.  Residents could eventually end up with an automatically generated Notice of Additional Tax Due (based on their property location and jurisdiction) for deducting parcel taxes improperly.  This would increase the effective cost of Piedmont’s non-deductible parcel taxes substantially.

PIEDMONT TAXES                                 AMOUNT                  INCREASES            TAX DEDUCTIBLE?

  • school bonds                               up to $146 per $100,000               0%                           YES
  • school parcel tax                                $2,021 to $3,678                      5%                                ?
  • city parcel tax*                                       $342 to $576                   CPI up to 4%                    ?
  • sewer parcel tax*                                   $471 to 849                      CPI w/o limit                   ?
  • private undergrounding                             $2,000+                           0%                            NO

*May be tax deductible in whole or in part, depending on the extent to which revenues can be shown to be expended on repairs, maintenance or related interest expense.  Property taxes that cannot be deducted may be added to the basis of the property, if they tend to increase the value of the property.  Future school bonds are anticipated up to $146 per $100,000. The exact amount has not yet been determined. The legal limit is ~$146-$155 per $100,000 of assessed value.

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