Treasury Proposes Amendments to Regulations to Prevent States from Circumventing the Deduction Limitation on State and Local Taxes
The IRS released proposed amendments that provide rules governing the availability of charitable contribution deductions under Internal Revenue Code Section 170 when a taxpayer receives or expects to receive a corresponding state or local tax credit. (REG-112176-18) (83 FR 43563; https://www.federalregister.gov/d/2018-18377)
Limitation on State and Local Tax Deductions. The Tax Cuts and Jobs Act, enacted into law in December 2017, limits an individual’s deduction for state and local taxes paid during the calendar year to $10,000 (or $5,000 for a married individual filing a separate return). This limitation is also applicable to estates and trusts.
No Quid Pro Quo. The U.S. Supreme Court held that “a charitable contribution is a transfer of money or property without adequate consideration.” United States v. American Bar Endowment, 477 U.S. 105, 116-118 (1986). A “payment of money generally cannot constitute a charitable contribution if the contributor expects a substantial benefit in return.” Id. at 116.
A number of states are creating government sponsored charitable contribution funds in which states and localities provide state or local tax credits in return for contributions by taxpayers to these “charitable” entities. The creation of these government sponsored charitable contribution funds is presumably to alleviate the effects of the $10,000 annual limitation on the federal state and local tax deduction noted above.
New York Legislation. Earlier this year, New York established a “charitable gifts trust fund,” which will have two separate and distinct accounts: a “health charitable account” and a “elementary and secondary education charitable account.” (See 2018 N.Y. S.B 7509C Part LL, amending N.Y. Fin. Law Section 92-gg; adding N.Y. Tax Law Section 606(iii)); http://assembly.state.ny.us/leg/?term=2017&bn=S07509).
The NY legislation also adds new Section 606(iii) to the N.Y. Tax Law. Section 606 provides, for taxable years beginning on or after January 1, 2019, that an individual taxpayer is allowed a tax credit against his or her personal income tax, in an amount equal to 85% of the amount contributed by the taxpayer during the immediately preceding tax year to any or all of the “charitable gift trust funds.” The legislation also created a credit for contributions made to Health Research, Inc., the State University of New York Impact Foundation, or the Research Foundation of the City University of New York.
The idea here is that for those whose state and local tax deduction is limited under the new Tax Act, by making a contribution to one of the new “charitable gifts trust funds,” the donor will be able to take a federal charitable contribution deduction, which is not limited.
Proposed Regulation. The Treasury Department and the IRS believe that when a taxpayer receives or expects to receive a state or local tax credit in return for a payment or transfer to an entity listed in section 170(c) (e.g., the New York charitable gifts trust fund), the receipt of this tax benefit constitutes a quid pro quo to the taxpayer and reduces his or her charitable contribution deduction.
Under the proposed regulations, a taxpayer who makes payments or transfers property to an entity eligible to receive tax deductible contributions must reduce their charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive.
For example, if a state grants a 70% state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer must reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s federal income tax return.
De Minimis Exception. The proposed regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred. A taxpayer who makes a $1,000 contribution to an eligible entity is not required to reduce the $1,000 deduction on the taxpayer’s federal income tax return if the state or local tax credit received or expected to be received is no more than $150.
Proposed Applicability Date. The amendments to these regulations are proposed to apply to contributions after August 27, 2018.
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