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September 11, 2018 -- Effective January 1, 2018, under the Tax Cuts and Job Acts (TCJA), state and local tax deductions (SALT) are limited to $10,000 ($5,000 if married filing separately). Some states have existing programs and other states have attempted to implement programs to work around this new limit by offering state tax credits that may be characterized as charitable contributions.
In response to state workarounds, the IRS has issued proposed regulations to apply to contributions after August 27, 2018, clarifying the relationship between SALT credits and the federal tax rules for charitable contribution deductions, thereby eliminating an individual taxpayer's ability to take advantage of such programs. Under the proposed regulations, a taxpayer who makes payments in satisfaction of a SALT liability to an entity eligible to receive a charitable contribution deduction must reduce their charitable contribution by the amount of the SALT credit that the taxpayer receives. An example of an eligible entity is a charitable gift trust fund created by a state, which may benefit health care or education.
The IRS posits that if the taxpayer receives any benefit when making any donation to an organization, the value of what they receive in return should not be included in their federal charitable contribution deduction. Accordingly, the IRS advises if a taxpayer receives a SALT credit for payments to an eligible entity after August 27, 2018, they cannot claim it as a charitable contribution for federal tax purposes.
The IRS does provide a de minimis exception for dollar-to-dollar state tax deductions and for tax credits of no more than 15 percent of the payment.
The IRS provides the following example – "A taxpayer who makes a $1,000 contribution to an eligible entity is not required to reduce the $1,000 deduction on the taxpayer’s federal income tax return if the state or local tax credit received or expected to be received is no more than $150." In other words, a SALT credit that does not exceed 15 percent of a payment will not reduce a taxpayer's federal charitable contribution deduction.
After the release of the proposed regulations, the IRS has released guidance that the regulation does not apply to pass-through entities that purchase state tax credits. The entity may take the charitable deduction and pass it through to the owners. Unfortunately, most of the available credits of this type do not allow for a transfer, such as the transfer from the pass-through entity to the owner.
This is certainly not the end of what we will hear about the SALT limitation as some of the regulations remain unclear. For instance, the IRS considered whether a taxpayer may decline the anticipated receipt of a SALT credit. However, the IRS has not concluded as to whether a decline would allow a full charitable contribution deduction. Thus, we will have to wait and see once the IRS response to state workarounds are adopted as final.
For updates on this and other Tax Cuts and Jobs Act updates, please stay tuned to our blog. Call today 503-697-4118 to connect with your Delap Advisor or our State & Local Tax team if the IRS response to state workarounds impacts your financial forecast.