When the Tax Cuts and Jobs Act (“TCJA”) was passed in late 2017, the standard deduction was increased and certain itemized deductions were eliminated or capped as an offset. One of the most noteworthy is the State And Local Tax (“SALT”) deduction, which allows taxpayers to deduct for Federal tax, what they pay in state/city income tax and property taxes on their residences. For many mid-upper income taxpayers in high-tax states, these deductions were already limited by the Alternative Minimum Tax (“AMT”) under prior law. Under the TCJA, SALT deductions are now limited to $10k per year for both single and married taxpayers. To give a real world example, if you make $150k and live in a state with a 6% effective tax rate, you’re $9k of state income taxes are still deductible, but only $1k of property taxes would be deductible on top of that.
Some states have taken action to try to circumvent the SALT limits by enacting laws that allow the creation of charitable funds to which taxpayers can donate money and receive a state income or property tax credit offsetting the amount “donated”. CT, NY, and NJ have passed laws that do this, while CA, IL, and RI had pending legislation as of June. Others are definitely looking into it. In late May, the IRS released a statement that they would be proposing regulations that would emphasize “substance over form” in these types of arrangements, essentially reminding everyone that a charitable contribution for which you get a tax credit is just really a tax paid and not a charitable contribution. Yesterday, the IRS released new regulations as promised. They also released a summary statement (below), which captures the essence of the regulations. That is, if you make a contribution to one of these charitable funds and receive a tax credit in return, the amount of the credit has to be subtracted from the contribution to determine your deductible amount. In other words, the work around created by these states won’t help.
The regulations go into effect on 8/27/2018, though the IRS points out that they’re not really a change of prior law (one was always required to subtract the benefit received from a charitable contribution to arrive at the deduction), but just a clarification. Technically though, you could make the argument that the law was previously unclear and that if one made a contribution pre-8/27 to one of these funds, it should be treated as a charitable contribution. The odds of audit increase in doing so, and there’s a decent chance that the IRS would nix the contribution, but for those who want to take a shot, that shot is probably available. Of course before doing so, you should of course check with a CPA, EA, or tax attorney to get a qualified tax opinion on the matter. The point is moot in most locations, because most states haven’t enacted laws that allow these types of funds to be set up. Even NJ and CT, who have enacted laws, have not, to my knowledge, set up the funds administratively. Why some municipalities in NY may have set them up (Scarsdale being one), most don’t seem to be available there either. If you have the option of making a contribution to one of these charitable funds in your state (meaning they passed legislation allowing the funds and the state or municipality actually set one up to receive money already), AND you’re comfortable making the claim that the limits imposed by the IRS regulations are new rather than clarifying existing law, then it would benefit you to make the contribution before 8/27. For all others, I don’t believe there’s any action to take on this.
You should also be aware that NY, NJ, MD, and CT have sued the Federal government over the SALT deduction caps as being unconstitutional. A few states have also threated that they will fight any IRS regulations that attempt to limit workarounds (e.g. the regulations that were released yesterday). I’m definitely not a legal expert, but it feels like this one is going to drag on for a very long time until we have a firm answer. With that said, the law of the land as of 8/27 (and probably before) is that if you make a charitable contribution and receive a tax credit in return, your Federal deduction is limited to the difference (in most cases, see below for details).
Lastly, existing programs that allow contributions to education or medical charitable funds in exchange for tax credits (e.g. GA’s GOAL program) are also impacted by this. The IRS has stated that it previously let those go because if the charitable contribution wasn’t made, then the state income tax paid would be higher and that was previously deductible for most tax payers (except those in AMT) anyway. You can still contribute to those funds and get a state tax credit for doing so, but the Federal charitable deduction is no longer available, at least starting 8/27.
From the IRS:
Treasury, IRS issue proposed regulations on charitable contributions and state and local tax credits
WASHINGTON — Today the U.S. Department of the Treasury and the Internal Revenue Service issued proposed regulations providing rules on the availability of charitable contribution deductions when the taxpayer receives or expects to receive a corresponding state or local tax credit.
The proposed regulations issued today are designed to clarify the relationship between state and local tax credits and the federal tax rules for charitable contribution deductions. The proposed regulations are available in the Federal Register.
Under the proposed regulations, a taxpayer who makes payments or transfers property to an entity eligible to receive tax deductible contributions must reduce their charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive.
For example, if a state grants a 70 percent state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer must reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s federal income tax return. The proposed regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their contribution deduction.
The proposed regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred. 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.
Treasury and IRS welcome public comments on these proposed regulations. For details on submitting comments, see the proposed regulations.
Updates on the implementation of the TCJA can be found on the Tax Reform page of IRS.gov.
Thanks for the much needed clarification of the clarification.