Proposed Regulations Clarify Tax Treatment of Charitable Donations in Return for SALT Credits
On December 13, 2019, the Internal Revenue Service (IRS) released proposed regulations which provide guidance for businesses and individuals regarding the tax treatment of charitable fund donations made in exchange for state and local tax (SALT) credits. Additionally, the proposed regulations provided guidance regarding the application of the “quid pro quo” principle to benefits received or expected to be received by the donor from a third party. This guidance is particularly welcome considering the lingering confusion around the highly unpopular SALT caps created by the Tax Cuts and Jobs Act of 2017.[1]
Background
An itemized deduction is generally permitted for any charitable contribution paid within the taxable year.[2]Per Internal Revenue Code (IRC) §170(c) a charitable contribution is defined as a “contribution or gift to or for the use of” an entity described in IRC §170(c).
However, deductions for IRC §170(c) charitable contributions are subject to certain limitations if the taxpayer in turn receives a state tax deduction or credit. For instance, a taxpayer must offset a federal charitable contribution deduction by the amount of any state or local tax credit received, or expected to be received, in return for that payment.[3]
1. Business Entities:Payments Made in Exchange for State/Local Tax Credits
As the proposed regulations point out:
transfers of property to an organization described in section 170(c) that bear a direct relationship to the taxpayer’s trade or business and that are made with a reasonable expectation of financial return commensurate with the amount of the transfer may constitute allowable deductions as trade or business expenses rather than as charitable contributions.[4]
Under IRC §162(a) a deduction is permitted for the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business; however, IRC §162(b) and existing Regs. §1.162-15(a)(1) do not permit a deduction under IRC §162(a) for an individual’s or corporation’s contribution if any part of it is deductible under IRC §170. The proposed regulations provide the following example of this:
if a taxpayer makes a contribution of $5,000 and only $4,000 of this amount is deductible under section 170(a) (whether because of the percentage limitation under either section 170(b)(1) or (2), the requirement as to time of payment, or both), no deduction is allowable under section 162(a) for the remaining $1,000.
Rev. Proc. 2019-12, issued in December of 2018, offers a safe harbor under IRC §162 for business entity (C corporations or certain passthroughs) payments to a IRC §170(c) organization if the entity receives or expects to receive state or local tax credits in return. Specifically, Rev. Proc. 2019-12 indicates that, to the extent that a C corporation receives or expects to receive a state or local tax credit as consideration for a payment to IRC §170(c) organization:
it is reasonable to conclude that there is a direct benefit to the C corporation’s business in the form of a reduction in the state or local taxes the C corporation would otherwise have to pay and, therefore, to the extent of the amount of the credit received or expected to be received, there is a reasonable expectation of financial return to the C corporation commensurate with the amount of the transfer.
2. Individuals:Payments Made in Exchange for State/Local Tax Credits
Under IRC §164, four categories of taxes are deductible whether or not a trade or business or for-profit activity exists. These taxes are as follows:
- State and local and foreign real property taxes;
- State and local personal property taxes;
- State and local, and foreign, income, war profits, and excess profits taxes; and
- The generation-skipping transfer tax imposed on income distributions.
However, beginning in 2018, the aggregate amount of the following categories of taxes able to be deducted was capped at $10,000 ($5,000 for married taxpayers filing separate returns):
- State and local real property taxes (not paid or accrued in carrying on a IRC §162 trade or business or in a IRC §212 activity);
- State and local personal property taxes (not paid or accrued in carrying on a IRC §162 trade or business or in a IRC §212 activity);
- State and local income, war profits, and excess profits taxes; and
- State and local general sales taxes.[5]
In June of 2019, the IRS issued Notice 2019-12, providing a safe harbor under IRC §164 intended to mitigate the consequences of the Regs. §1.170A-1(h)(3) limitations applicable to individuals who make a payment to or for the use of a IRC §170(c) entity in return for a state or local tax credit. Specifically, the Notice provides that:
an individual who itemizes deductions and who makes a payment to a section 170(c) entity in return for a state or local tax credit may treat as a payment of state or local tax for purposes of section 164 the portion of such payment for which a charitable contribution deduction under section 170 is or will be disallowed under final regulations.
3.Quid Pro Quo
Per Regs. §1.170A-1(h)(1), a taxpayer’s payment to a IRC §170(c) entity that is in consideration for goods or services is only deductible to the extent the payment exceeds the fair market value of the goods or services.
The Proposed Changes
Significantly, regarding business entities, the proposed regulations would amend Reg. §1.162-15(a) to incorporate the safe harbor provided by Rev. Proc. 2019-12. Specifically, the proposed regulations would revise Reg. §1.162-15(a) so that it more clearly reflects that:
If the taxpayer’s payment or transfer bears a direct relationship to its trade or business, and the payment is made with a reasonable expectation of commensurate financial return, the payment or transfer to the section 170(c) entity may constitute an allowable deduction as a trade or business expense under section 162, rather than a charitable contribution under section 170.[6]
The proposed regulations §1.162-15(a)(1), §1.162-15(a)(2), and §1.170A1(c)(5), regarding the application of IRC §162, are proposed to apply to payments on or after December 17, 2019. However, taxpayers are permitted to rely on the proposed regulations for payments made on or after January 1, 2018 and before the final regulations are published in the Federal Register.[7]
Proposed regulation §1.162-15(a)(3), regarding safe harbors for business entities is proposed to apply to payments on or after December 17, 2019. However, taxpayers are permitted to use Rev. Proc. 2019-12, which applies to payments made on or after January 1, 2018, for payments made before December 17, 2019.[8]
On the individual side, the proposed regulations considered the safe harbor in Notice 2019-12 to be “fair, reasonable, and legally sound,” and as such the proposed regulations would add this safe harbor as new Regs. §1.164-3(j). Thus, under the proposed regulations:
an individual who itemizes deductions and who makes a payment to a section 170(c) entity in exchange for a state or local tax credit may treat as a payment of state or local tax for purposes of section 164 the portion of such payment for which a charitable contribution deduction under section 170 is or will be disallowed under §1.170A-1(h)(3). This treatment is allowed in the taxable year in which the payment is made, but only to the extent that the resulting credit is applied pursuant to applicable state or local law to offset the individual’s state or local tax liability for such taxable year or the preceding taxable year. Any unused credit permitted to be carried forward may be treated as a payment of state or local tax under section 164 in the taxable year or years for which the carryover credit is applied in accordance with state or local law. The safe harbor for individuals applies only to payments of cash and cash equivalents.
Proposed regulations §1.164-3(j) and §1.170A-1(h)(3)(ix), pertaining to the safe harbor for payments by certain individuals are proposed to apply to payments made on or after June 11, 2019. However, individuals are permitted to rely on the proposed regulations for payments made after August 27, 2018, the applicability date of the final regs, and before the regs finalizing these proposed regs are published in the Federal Register.[9]
Finally, the proposed regulations would amend Regs. §1.170A-1(h) to clarify that if a payment to a §170(c) entity results in a return benefit, then that results in a “quid pro quo” situation-whether or not the party providing the quid pro quo is the donee or a third party. The donor’s payment is not considered a charitable contribution to the extent the donor expects to receive a substantial benefit in return.
The proposed regulations regarding the quid pro quo guidance are proposed to apply to payments or transfers on or after December 17, 2019.[10]
Conclusion
Taxpayers, entities and individuals, may now expect regulatory clarity regarding the tax treatment of charitable fund donations made in exchange for SALT credits. However, taxpayers should note that the rules are still complicated, and they are well-advised to consult a tax professional when accounting for charitable deductions in exchange for SALT credits.
If you have questions or concerns regarding charitable donations and SALT credits, contact Frost Law today at 410-497-5947.
[1]Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97. [2]IRC §170(a)(1). [3]Regs. §1.170A-1(h)(3)(i), T.D. 9864, 84 Fed. Reg. 27,513 (June 13, 2019). [4]REG- 107431- 19, 84 Fed. Reg. 68,833 (Dec. 17, 2019),citingRegs. §1.170A-1(c)(5). [5]IRC §164(b)(6), added by the Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97, §11042. [6]Seepreamble to REG-107431-19, 84 Fed. Reg. 68,833 (Dec. 17, 2019). [7]Prop. Regs. §1.162-15(a)(4). [8]Id. [9]Prop. Regs. §1.164-3(j)(7). [10]Prop. Regs. §1.170A-1(h)(4)(iii).
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