IRS Proposes Regulations in Response to SALT Workarounds Adopted by Some States
The Tax Cuts and Jobs Act limits the itemized deduction for state and local taxes (SALT) to $10,000 annually for taxpayers with a filing status of married filing jointly. In response to the Act, some high-tax states have created workarounds that attempt to re-characterize payment of SALT as a charitable deduction by providing substantial tax credits for “donations” to certain “charities”. The IRS has responded with proposed regulations.
In a previous article (please click here to read) we discussed the Act’s change in the itemized deduction for SALT and some of the workaround strategies being adopted by states including schemes to re-characterize payments of SALT to charitable deductions
Prior to the Act, the IRS had not adopted official guidance with respect to the various state programs that offered substantial tax credits for certain contributions. Common among these were conservation easement contributions and contributions to certain child care organizations. Prior to the SALT deduction limitation, the IRS believed (for the most part) that a taxpayer’s federal tax liability would not change based on whether a payment was characterized as a charitable contribution or a payment of a SALT liability. With the Act’s new limitation on the amount of SALT deductions, the characterization of the payment will most likely have an impact on the taxpayer’s federal tax liability. The IRS now believes the issue deserves official guidance that will apply equally to existing tax credit programs and new ones being adopted in response to the Act.
The Proposed Regulations
In drafting the proposed regulations, the IRS has fallen back on an old and non-controversial principle that if a taxpayer makes charitable contribution, but receives something in return, the deductible portion is the difference between the amount of the payment (or transfer) made and the fair value of the property received. As an example, if a taxpayer made a $1,000 contribution to the local public television station, and received a $100 gift card to a local wine shop, the deductible portion of the of the payment would be $900.
The new proposed regulations generally provide that if a taxpayer makes a payment or transfers property to or for the use of an organization eligible to receive deductible charitable contributions, and the taxpayer receives or expects to receive a state or local credit in return for such payment, the tax credit constitutes a return benefit, or quid pro quo, to the taxpayer and reduces the charitable contribution deduction.
The proposed regulation also establishes a de minimis exception under which a taxpayer may disregard a state or local tax credit if such credit does not exceed 15 percent of the taxpayer’s payment or transfer. In addition, the proposed regulations are proposed to apply to contributions after August 27, 2018.
While these are proposed regulations, it is hard to imagine there will be substantial changes made after the comment period.
As a final item, it is important to note that this article applies only to itemized SALT deductions for individual taxpayers. Businesses can continue to deduct SALT payments without limitation as they have in the past.