IRS Final Regulations Nullify $10,000 Annual SALT Limitation Workaround Attempts by States and Political Subdivisions
On June 11, 2019, the Treasury Department and the Internal Revenue Service issued final regulations (TD 9864, 6/11/2019) in response to legislation enacted by a number of states and their political subdivisions aimed at allowing their residents to avoid the $10,000 annual limitation on the deductibility of state and local tax (SALT) payments brought about under newly enacted Section 164(b)(6) under the Tax Cuts and Jobs Act. These legislative acts seek to allow taxpayers to claim a federal income tax charitable deduction for contributions to certain charitable organizations while permitting a credit against state or local income, real estate or other taxes otherwise imposed by such state or local tax governments in return for the contributions.
Some view this as an attempt by state and local governments to merely recast SALT payments as charitable contributions by providing state and local tax credits up to the full amount of the contributions, in effect providing an end-around the $10,000 annual deduction limitation on SALT payments that doesn’t apply to charitable contributions. The issuance of the final regulations follows proposed regulations that were published on August 27, 2018, as well as IRS Notice 2018-54, which was released on May 23, 2018, in what essentially was a warning to taxpayers that such legislation wouldn’t accomplish its intended purpose and taxpayers choosing this route might ultimately find themselves ultimately facing negative tax consequences.
Consistent with Notice 2018-54 and the proposed regulations, and effectively nullifying the SALT limitation legislative workaround attempts, the final regulations retain the general rule that if a taxpayer makes a payment or transfers property to or for the use of an entity described in Section 170(c) and the taxpayer receives or expects to receive a state or local tax credit in return for such payment, the tax credit constitutes a return benefit to the taxpayer, or a quid pro quo, reducing the taxpayer’s charitable contribution deduction for federal income tax purposes. The final regulations retain the de minimis exception provided in the proposed regulations, whereby a state or local tax credit that doesn’t exceed 15 percent of the amount of the contribution isn’t treated as a quid pro quo benefit and, therefore, doesn’t reduce the taxpayer’s charitable income tax deduction. However, the final regulations clarify that this 15 percent exception applies only if the sum of the taxpayer’s state and local tax credits received, or expected to be received, does not exceed 15 percent of the taxpayer’s payment or 15 percent of the fair market value of the property transferred by the taxpayer. Finally, the final regulations retain the provision in the proposed regulations, whereby the quid pro quo rules contained in the final regulations apply to payments made by a trust or a decedent’s estate in determining its charitable contribution deduction under Section 642(c).
Like the proposed regulations, while the final regulations clearly target recently enacted state and local legislative efforts seeking to circumvent the new annual $10,000 SALT limitation, their application also extends to longstanding programs across the country in which state and local tax credits have been provided for donations to certain community organizations and private schools where, with the apparent blessing of the IRS, taxpayers have for years been claiming charitable contribution deductions notwithstanding the tax credits provided in return. Therefore, although the impetus for their issuance was recent legislative efforts to avoid the SALT cap, the purview of the final regulations extends to preexisting tax credit programs (including those offered in many states for contributions of conservation easements described in Section 170(h)) aimed at encouraging donations to various charitable and educational institutions that have come to rely on such programs for support and that now may be in jeopardy because of the elimination of the charitable deduction that historically has been available in this context.
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