The IRS has issued guidance (Rev. Proc. 2019-12
) providing safe harbors for C corporations and “specified pass-through entities” to deduct payments made to state charitable programs when the entity receives or expects to receive certain state or local tax credits for an entity-level tax. Businesses meeting the safe harbor requirements may treat the payments as an ordinary and necessary business expense for the purposes of Section 162(a) to the extent of the credit received or expected to be received.
The safe harbor offers welcome clarification for questions arising after the IRS issued proposed regulations that require taxpayers to reduce their charitable deductions by the amount of any state tax credits received in exchange for payments. The safe harbor, however, does not provide guidance on the amount of payments that exceeds state tax credits received, or for payments that pass-through entities make in exchange for credits for an individual owner’s taxes.
The Tax Cuts and Jobs Act (TCJA) generally caps the individual itemized deduction for state and local taxes at $10,000. However, many states have charitable funds that finance state services to which taxpayers can contribute in exchange for state tax credits. Some of these programs were in effect before TCJA, while others were created afterward in an attempt to allow individuals to convert a state tax payment into a charitable payment that would allow for an unlimited charitable deduction. In response, the IRS released proposed regulations in August requiring taxpayers to reduce charitable deductions by the amount of state and local tax credits received in return.
The IRS later posted an FAQ indicating that the proposed regulations were not meant to affect businesses that make payments to state programs in exchange for state tax credits and deduct the payments as business expenses rather than charitable gifts. However, many taxpayers requested additional guidance on when a business’s payments to a charitable entity under Section 170(c) can be deductible as a business expenses under Section 162.
Rev. Proc. 2019-12 provides a safe harbor allowing C corporations and “specified pass-through entities” to deduct payments made to or for the use of an organization described in Section 170(c) equal to the amount of any state tax credits received or expected to be received. The deductibility of any additional payments in excess of state tax credits depends on the facts and circumstances.
A pass-through entity must meet the following four requirements to be a “specified pass-through entity” and qualify for the safe harbor:
- The pass-through must be organized as business entity other than a C corporation that is regarded for all federal income tax purposes as separate from its owners under Treas. Reg. Sec. 301.7701-3.
- The entity must operates a trade or business within the meaning of Section 162.
- The entity must be subject to a state or local tax incurred in carrying on its trade or business that is imposed directly on the entity.
- The entity must receive or expect to receive a state or local tax credit that the entity applies or expects to apply to offset a state or local tax described above, other than a state or local income tax.
The safe harbor will not apply to any payments made by a pass-through entity in exchange for any tax credits used by individual owners against taxes incurred at the individual level.
The guidance provides two examples for a C corporation to illustrate the application of the safe harbor. In the first example, a corporation makes a payment of $1,000 to a Section 170(c) organization for a dollar-for-dollar state tax credit to be applied to the corporation’s state income tax liability. The example concludes that the corporation may treat the $1,000 payment as a Section 162 expense. In the second example, a corporation makes a payment of $1,000 to a Section 170(c) organization in return for a credit in the amount of $800 to be applied to the corporation’s real property tax liability. The example concludes that the corporation may treat $800 of the payment as meeting the requirements of Section 162, and the treatment of the remaining $200 will depend upon the facts and circumstances and is not affected by the guidance.
The guidance also provides two examples for a “specified pass-through entity” to illustrate the application of the safe harbor. In the first example, a pass-through entity makes a payment of $1,000 to a Section 170(c) organization in return for a dollar-for-dollar credit to be applied to the entity’s state excise tax liability. The example concludes that the pass-through entity may treat the $1,000 payment as a Section 162 expense. In the second example, a pass-through entity makes a payment of $1,000 to a Section 170(c) organization in return for a credit in the amount of $800 to be applied to the entity’s real property tax liability. The example concludes that the entity may treat $800 of the payment as meeting the requirements of Section 162, and the treatment of the remaining $200 will depend upon the facts and circumstances and is not affected by the guidance.
The guidance applies retroactively to amounts paid on or after Jan. 1, 2018, so taxpayers can rely on the safe harbor for payments made last year and in their planning for payments this year. The guidance also provides that nothing in the revenue procedure may be construed as permitting an entity to treat the amount of any payment as deductible under more than one provision of the Tax Code or Treasury regulations.
For more information, contact:
Washington National Tax Office
Grant Thornton LLP
+1 202 521 1515
Washington National Tax Office
Grant Thornton LLP
+1 202 861 4144
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