The United States Treasury threw cold water on attempts to work around the cap on state and local tax deductions Thursday.
The cap was one of the most controversial parts of the federal tax overhaul. It puts a $10,000 limit on how much taxpayers can deduct from their federal bill for what they pay in state and local taxes, known as SALT.
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Many high-tax states say the cap on what was once an unlimited deduction disproportionately hurts their residents.
New York, New Jersey, and Connecticut passed legislation to help taxpayers get around the cap and other states are considering similar policies.
Generally, the workarounds would allow taxpayers to make charitable contributions to their state in exchange for a tax credit.
But Treasury proposed a long-awaited rule Thursday that would prevent charitable contributions from being used to circumvent the new cap.
"Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families," said Secretary Steven Mnuchin in a statement.
"The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions," he said.
The rule is mechanically simple, said Steve Wlodychak, principle, Indirect Tax at Ernst and Young.
If you are getting a state tax credit benefit in exchange for the charitable contribution you have to reduce the value, dollar-for-dollar, for the purposes of the federal tax bill, he said.
The rule will also have an impact on other state tax credit programs that were established before the tax overhaul to promote charitable giving. Some, for example, are specifically for school choice initiatives.
These charitable tax programs were not spared by the proposed rule, said Steve Rosenthal, a senior fellow at the Tax Policy Center.
They may still offer a state tax advantage, but will not reduce you federal tax bill.
New York, New Jersey, Connecticut and Maryland, sued the Treasury and IRS last month, claiming the new tax law violates the constitution by unfairly targeting Democratic states.
New York Governor Andrew Cuomo said he would fight the guidance from Treasury.
"We are confident that the recently enacted opportunities for charitable contributions to New York state and local governments are consistent with federal law and follow well-established precedent," he said in a statement.
Officials for New Jersey and Connecticut could not immediately be reached for comment.