IRS Response to SALT Workarounds

| 8/30/2018
On Aug. 23, the IRS issued proposed regulations that are intended to shut down a perceived abuse of the recently enacted $10,000 statutory limitation on deductions for state and local taxes paid (the SALT cap).

The Tax Cuts and Jobs Act (TCJA) limited to $10,000 the itemized deduction for state and local taxes allowed for individuals. In response, several states have proposed or passed legislation to mitigate the effect of the SALT cap. New York, New Jersey, and other states enacted laws that allow taxpayers to receive a credit against state income taxes equal to a significant portion of a contribution made to a designated state charitable fund. For example, under New York’s law, a taxpayer who makes a contribution to a charitable fund designated by the state of New York receives an 85 percent tax credit against his or her New York income tax liability. The effect of the state credit programs is to effectively convert an otherwise nondeductible state income tax payment in excess of $10,000 into a deductible charitable contribution, defeating the purpose of the SALT cap.

Prior to the TCJA, if a taxpayer made a charitable contribution and received state credits in return, the full amount of the contribution generally was allowed as a charitable deduction even though the taxpayer received state income tax credits. In response to the actions of New York and other states, the proposed regulations would require taxpayers to reduce the value of their charitable contribution by the value of the state income tax credit. This change is consistent with the approach generally taken for charitable contributions in which the deductible contribution is reduced by the value of goods and services received in return.

For instance, assume an individual makes a $20,000 charitable contribution to a state-sponsored charitable fund after Aug. 27, 2018, and receives a $15,000 state income tax credit. Prior to the proposed regulations, it generally was accepted that the individual would get a $20,000 charitable contribution deduction. Under the proposed regulations, the taxpayer would get a charitable contribution deduction of $5,000 ($20,000 contribution less $15,000 credit).

The proposed regulations also adopt a de minimis rule. Under the de minimis rule, if the state income tax credit is 15 percent or less of the amount of the charitable contribution, the contribution is not reduced by the amount of the credit.

Many states have offered income tax credits for contributions to charities that target a specific population or societal issue. Although these programs were not created to escape the SALT cap, it appears the proposed regulations will apply equally to them unless they qualify for the de minimis threshold.

If enacted, the regulations would be effective for contributions after Aug. 27, 2018.

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Howard Wagner - social
Howard Wagner
Partner, Washington National Tax