The Treasury Department and Internal Revenue Service have issued proposed regulations under Section 170 of the Internal Revenue Code (the “Code”) containing significant limitations on the availability of the charitable contribution deduction in situations where taxpayers receive state or local tax credits in exchange for a contribution to a state or local government.
By way of background, the Tax Cuts and Jobs Act of 2017 (the “Act”) made sweeping changes to the federal income tax laws. For example, the Act amended Section 164 of the Code in a manner so that the itemized deduction for state and local income and property taxes (the “SALT Deduction”) is limited to $10,000 in aggregate for tax periods 2018 through 2025. Unlike the limitation cap placed on the SALT Deduction, the Act did nothing to minimize the deduction for charitable contributions.
Certain states with high property taxes quickly realized that their residents may benefit much more if a portion of their property tax payments were recharacterized in the form a contribution to a state or local government, which is generally included as a charitable contribution under Section 170(c)(1) of the Code. New Jersey is one state where legislation has been enacted permitting residents to receive property tax credits in exchange for contributions made to special accounts established by municipal, county and school districts that will help pay for public services.
The Treasury Department and the Internal Revenue Service view the state legislation as an attempt to circumvent the new limitations placed on the SALT Deduction, and, in response, issued the proposed regulations under Section 170 to address the availability of the charitable contribution deduction when individual taxpayers, trusts and estates participate in these types of tax credit programs.
Under the proposed regulations, taxpayers who receive a significant amount of state or local tax credits in exchange for their charitable contribution will not be allowed a full deduction for such contribution as the amount otherwise deductible as a charitable contribution must generally be reduced by the amount of the tax credits received or expected to be received; however, there is a de minimis exception for situations where the amount of tax credits received is less than or equal to 15% of the amount contributed.
The proposed regulations also apply to estates and trusts.
Although the proposed regulations are merely suggestions made for public comment and are not binding on taxpayers unless and until they become final, it is important to note that the proposed regulations are consistent with longstanding tax principles which provide that payment of money generally cannot constitute a charitable contribution if the contributor expects a substantial benefit in return, such as in the case of a quid pro quo.
On September 5, 2018, the Internal Revenue Service issued a News Release to clarify its position that, despite the proposed regulations, business taxpayers who make business-related payments to charities or government entities for which the taxpayers receive state or local tax credits can generally deduct the payments as business expenses.