On August 23rd, the Internal Revenue Service and U.S. Treasury Department released proposed regulations regarding the use of charitable contributions made to state-controlled funds or agencies as a means to get around the new limitations on State and Local Tax (SALT) deductions under the Tax Cuts and Jobs Act of 2017 (TCJA).
The TCJA imposed limits on SALT deductions of $10,000 ($5,000 if married filing separately) that would result in a significant loss of deductions for many taxpayers, especially those in high tax states such as New York, New Jersey and California. In response to the new SALT limits, some states developed programs whereby they would allow a dollar-for-dollar state tax credit for contributions made to certain state-controlled agencies. In this way, the donor would theoretically obtain a charitable contribution deduction on their Federal tax return for an amount that would be credited against their state tax liability. Because charitable contributions are not subject to the $10,000 limit, the donor could effectively get a full tax deduction for what would otherwise have been limited as a state income and property tax deduction. The IRS has previously stated in a tax notice their position that Federal tax law would control the characterization of such payments, but had not yet issued any additional guidance or regulations, until now.
Under the proposed regulations: If a taxpayer makes a payment (or transfers property) to a charitable organization described in Internal Revenue Code Section 170(c), the amount of the taxpayer’s charitable contribution deduction is reduced by the amount of any state or local tax credit the taxpayer receives, or expects to receive, related to that payment or transfer. For example, if a state grants a 70 percent tax credit and a taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer charitable contribution deduction is reduced by the $700 state tax credit, leaving an allowable contribution deduction of $300. If the state tax credit were 100%, then 100% of the amount of the payment would be disallowed as a charitable contribution. In addition to the charitable contribution deduction under Section 170(c), the new rules also extend to contribution deductions by estates and trusts under Section 642(c).
The proposed regulations do provide a de minimis exception: A taxpayer may disregard up to 15% of the payment or transfer to the charitable organization. For example, if a taxpayer makes a charitable contribution of $1,000, he or she is not required to reduce the charitable contribution by $1,000 if the state tax credit is no more than $150. The proposed regulations also contain special rules for certain taxpayers (including those subject to Alternative Minimum Tax) as well as numerous examples. Finally, the new rules are intended to apply to all these types of tax credit programs, not just those created in response to TCJA.
The Treasury Department and IRS are seeking public comments on the proposed regulations, which are effective for amounts paid or property transferred by a taxpayer after August 27, 2018.
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If you have questions about how these new rules may apply to your situation, please contact your Elliott Davis tax advisor.