The IRS finalized regulations (TD 9907
) on Aug. 7 that provide guidance on the treatment of charitable contributions made in exchange for state and local tax (SALT) credits and other forms of consideration. The final regulations largely adopt proposed regulations
issued in December 2019, including two safe harbors, with some clarifications.
The Tax Cuts and Jobs (TCJA) capped the itemized deduction for state and local taxes applicable to individuals at $10,000 for the 2018-2025 tax years. However, with a potentially higher limit on the charitable deduction, taxpayers in several states could contribute to charitable funds for state services in exchange for state tax credits. These programs allowed taxpayers to replace a state tax payment with a charitable contribution and convert a state tax deduction into a charitable deduction, circumventing the $10,000 cap. The IRS issued final regulations
in June 2019 that effectively shut down such workarounds, requiring taxpayers to reduce their charitable deduction by any state tax credits received in exchange for contributing to a state’s charitable fund, unless the credits do not exceed 15% of the contribution.
The new final regulations retain the proposed conforming amendments to rules under Sections 162, 164 and 170, including guidance and an example allowing partnerships to continue to deduct contributions that come with a reasonable expectation of financial return commensurate with the amount given. However, the regulations do not address new workarounds adopted by several states that allow pass-through entities to shift the income tax burden from the individual to the entity level through an election.
Most notably, the final regulations retain two safe harbors first issued through Rev. Proc. 2019-20 and Notice 2019-20 and later incorporated in the proposed regulations under Sections 162 and 164 respectively.
Under the Section 162 safe harbor, C corporations and certain pass-through entities engaged in a trade or business are allowed to treat the portion of a charitable contribution commensurate with the credit received or expected to be received as an ordinary and necessary business expense under Section 162, but only if the contribution is made in cash or cash equivalents. Pass-throughs are ineligible for the safe harbor if the credit received or expected to be received reduces a state or local income tax.
The Section 164 safe harbor allows individuals who itemize their deductions to treat the portion of a contribution that yields a credit, which would otherwise reduce their charitable deduction under the 2019 final regulations, as a deductible state and local tax payment up to the $10,000 cap. Credits received in excess of state and local tax liability may be carried forward to subsequent years and treated in the same manner. The safe harbor does not apply to contributions of property.
The final regulations also provide additional clarifications under the Section 170 rules. They define “goods and services” to mean “cash, property, services, benefits and privileges.” They also provide that a taxpayer receives goods and services “in consideration for” their payment or transfer to a Section 170(c) entity if they receive or expect to receive goods or services from that entity or any other party in return at the time the payment is made.
The applicability dates for the final rules vary. Amendments made to the Section 162, including the safe harbor, apply to payments or transfers made on or after Dec. 17, 2019, but may be applied to payments or transfers made on or after Jan. 1, 2018. The Section 174 safe harbor applies to payments on or after June 11, 2019, but taxpayers may choose to apply it to payments made after Aug. 27, 2018. Changes to the rules under Section 170 apply to amounts paid or property transferred on or after Dec. 17, 2019.
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