The US Treasury Department and the IRS have released new proposed regulations which seek to enforce the cap placed on federal deductions for state and local tax (“SALT”) payments that many states have sought to circumvent. Under the Tax Cuts and Jobs Act (TCJA), a taxpayer is limited to a maximum deduction of $10,000 for all state and local income, sales tax, and real estate taxes. By limiting those deductions, many taxpayers in high-tax states may face a higher federal tax liability in 2018 and forward. To combat this, many states set up programs where the taxpayer could make charitable donations to programs set up by the state where they would receive a state income tax credit in addition to the deduction for the charitable contribution. In June of 2018, the IRS alerted taxpayers and their advisors that regulations would be forthcoming that would address the rather public and aggressive programs being put into place in states such as New York and New Jersey.
Under the proposed regulations issued on August 23, 2018, 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. The IRS cited long standing policy and case law where charitable contribution deductions are reduced for any quid pro quo – benefits received by a donor in connection with a contribution. For example, if a state grants a 60 percent state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $600 state tax credit. The taxpayer must reduce the $1,000 contribution by the $600 state tax credit, leaving an allowable contribution deduction of $400 on the taxpayer’s federal (and likely their state) income tax return.
The proposed regulations do not apply to state tax deductions, only to tax credits that the state would issue in addition to the deduction. The proposed regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15% of the payment amount or of the fair market value of the property transferred. Therefore, 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.
Many fear that these new regulations could cause a decrease in donations to charities since taxpayers would have less incentive to donate without getting a corresponding deduction and credit combination – as they have been able to do under longstanding state tax credit charitable programs. Commentators believe these new regulations will likely be challenged in court by one or more high-tax states in the near term, in addition to the litigation already commenced by several of those states. The regulations would be effective for contributions made after August 27, 2018. The IRS will hold a hearing and accept comments over the next 6 weeks.
SC&H Group’s tax team will provide updates as additional information is published. If you have any questions about these tax implications, please contact us.