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IRS Issues Proposed Regulations on Charitable Contributions and State and Local Tax Credits

The IRS recently released proposed regulations addressing the state and local itemized tax deduction, available to individual taxpayers on their Federal tax returns.  The regulations also apply to trusts and decendents’ estates.

Under the Tax Cuts and Jobs Act, the state and local tax deduction (consisting primarily of income, real estate and other property, and certain sales taxes) is capped at $10,000 annually, beginning in 2018.  Several states have implemented or plan to implement a workaround to this limit by setting up charitable funds.  Donations made to such funds allow the taxpayer a full or partial credit towards their state and local tax obligations, such as property tax and state income taxes. With the limit on the charitable contribution deduction being much higher (generally up to 60% of adjusted gross income), many taxpayers would stand to benefit from the ability to deduct the full amount of their state and local taxes if they were recast as charitable donations.

The proposed regulations severely limit taxpayers’ ability to take advantage of such a strategy, by limiting charitable deductions when a state or local tax credit is received.  The general rule would disallow the deduction, dollar for dollar, for any state or local tax credit received.  For example, if a taxpayer had already maxed out their $10,000 state and local tax deduction and paid $1,000 to a state charitable fund in exchange for a $1,000 credit on his/her real estate tax bill, the federal charitable deduction would be zero.  With the same fact pattern, if the taxpayer instead received only a $700 credit on his/her real estate tax bill, he/she would be able to deduct the $300 difference as a charitable deduction.

The above result is in line with the existing rules for charitable donations, which require charitable organizations to indicate the amount of benefit received by the donor. This is commonly seen with respect to donor acknowledgement letters that state the value of a meal provided to a donor at a charitable dinner. In essence, the proposed regulations are applying a similar standard with regard to the issuance of state tax credits in exchange for a charitable donation.

For any charitable contributions that result in a state and local tax deduction on the taxpayers’ state tax return, no reduction to the Federal charitable contribution is required.  The proposed regulations include a limited exception for state tax credits received, allowing taxpayers a charitable deduction for the full contribution, as long as the value of the credit does not exceed 15% of the payment made.  For example, a taxpayer who makes a $1,000 payment and receives a $150 state tax credit could deduct the full $1,000 on his/her Federal return. The intent of the 15% rule is to smooth out differences between states that may or may not allow a deduction for charitable contributions.  Since the highest combined state and local income tax rate is about 15%, a deduction of $1,000 could potentially yield $150 in tax savings.

Given that the IRS is currently accepting comments on the proposed regulations, which have not been finalized, it remains to be seen where the potential tax minimization opportunities exist.

AAFCPAs’ Tax Practice will continue to monitor the IRS’s deliberations closely. As always, we will keep you informed and provide further updates as they become available.

If you have any questions on how these proposed regulations may impact you, please contact: Richard Weiner, CPA, MST at 774.512.4078, rweiner@nullaafcpa.com; or Daniel Cahill, CPA, at 774.512.4028, dcahill@nullaafcpa.com; or your AAFCPAs Partner.

About the Authors

Daniel Cahill
Dan has extensive experience in federal, state and multistate corporate taxation.  He delivers compliance and tax planning solutions for a variety of sophisticated privately-held C Corporations, S Corporations, and Partnerships, as well as high-net-worth individuals. Dan specializes in multistate taxation, including: state and local tax (SALT) analysis, sales and use taxes, determining nexus, accounting for income taxes (ASC 740), and negotiating voluntary disclosure agreements.  He also advises clients in partnership compliance, including analysis of partner allocations, taxability of distributions and deductibility of pass-through losses. Dan’s depth of expertise ensures that the firm’s emerging and growth-stage clients are fully compliant with multistate tax laws and regulations while optimizing tax strategies. He has been serving AAFCPAs clients since 2012.
Richard Weiner CPA
Rich has over 30 years of broad tax experience with a specialty in tax planning and consulting for private and publicly-held businesses. Rich has specific expertise in the Software, Bio-Technology, Medical Device, Life Science, Manufacturing, Retail, Professional Service and Publishing industries, as well as U.S. aspects of international taxation. He works extensively with European companies expanding into the U.S. market. Additional areas of focus include companies and stockholders in transition, including structuring of and planning for Mergers & Acquisitions, planning for changes in ownership and management, and adoption of tax methodologies with a view toward the long term. He is well known in his field and is a frequent speaker on a variety of tax related topics.