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One of the more controversial provisions of the Tax Cuts and Jobs Act is the $10,000 itemized deduction limitation for state and local taxes (SALT). While the limit impacts all individual taxpayers, it places disproportionate pressure on taxpayers who file returns in high income tax and property tax states. Some states including New York, New Jersey and Connecticut, quickly enacted legislation permitting local governments to establish charitable funds to accept donations that the taxpayer would then receive a tax credit against SALT owed equal to all or some of the donation made. The thinking was that if a taxpayer made a $1,000 donation and received an 85 percent credit on their SALT bill, the taxpayer would also receive a $1,000 charitable contribution deduction on their federal tax return.
Responding to this state workaround, the Internal Revenue Service issued a notice announcing proposed regulations will be issued addressing the treatment of transfers to state controlled funds at the federal income tax level. The notice also reminded taxpayers that federal law controls the proper characterization of payments for federal income tax purposes and to proceed with caution in establishing and/or contributing to these charitable funds.
The long-awaited proposed regulations were issued providing rules on the availability of charitable contribution deductions when the taxpayer receives or expects to receive a corresponding SALT credit. According to the regulations, which are effective August 27, 2018, if an individual receives a credit of 15 percent or less of the charitable contribution, a full deduction is permitted for the charitable contribution on their federal tax return. If the credit received is greater than 15 percent, the amount of the charitable deduction is reduced by the amount of the credit received.
For example, if an individual makes a charitable contribution to one of these funds in the amount of $1,000 and receives a 70 percent credit on their SALT, the amount of the charitable deduction permitted federally would be $300. The deduction would be calculated in the following manner: $1,000 donation minus 70 percent credit of $700 equals an allowable federal charitable deduction of $300.
If the taxpayer makes a $1,000 charitable contribution to an eligible entity and receives a 15 percent credit, the entire $1,000 would be permitted as a charitable deduction under the Internal Revenue Service regulations.
The basis of the regulations is the old “quid pro quo” legal doctrine, which is when a taxpayer makes a charitable contribution and receives a valuable benefit in return, the taxpayer can only deduct the difference between the contribution and the benefit received. The regulations apply to pre-existing and new programs enacted since federal tax reform in 2017.
As workarounds and further guidance related to state and local tax deductions unfold, taxpayers should be aware of what their state’s approach will be and what federal guidance has to say about the treatment of deductible payments for federal tax purposes. Please contact your Marvin and Company representative for further details and updates.