Limitation on Charitable Contribution Deduction

The U.S Department of the Treasury and the IRS on June 11, 2019, finalized regulations that govern the availability of charitable contribution deductions under IRC Section 170. The regulations aim to end state tax workarounds that attempt to circumvent the $10,000 limit on an individual’s, trust’s, or estate’s state and local tax deductions.

The Tax Cuts and Jobs Act created Section 164(b)(6), which limits to $10,000 ($5,000 if married filing separately) an individual’s deduction for the aggregate amount of state and local taxes paid during the calendar year. The limitation applies to all state and local taxes paid, including income and property taxes. It particularly affects taxpayers in high-tax states by potentially reducing the deduction for state and local taxes previously available. In an attempt to circumvent the limitation, many state and local governments have implemented tax credit programs under which taxpayers may receive tax credits in return for certain charitable contributions. The IRS addressed the wave of state workarounds in June 2018 in Notice 2018-54 and in proposed regulations issued on Aug. 27, 2018.

The final regulations generally follow the proposed regulations and require taxpayers to reduce the charitable contribution by the amount of the state tax credit received. However, Notice 2019-12 issued concurrently with the final regulations grants relief to individuals whose deduction for state and local taxes is less than $10,000 and who made a charitable contribution in exchange for a tax credit in lieu of paying tax to the state or local government. The safe harbor allows a state income tax deduction for the disallowed contribution as affected taxpayers would have been able to deduct the amount of the tax credit received had the charitable contribution not been made.

The following chart illustrates the impact of the safe harbor:
exhibit 1
The regulations also retain the de minimis rule of the proposed regulations, under which the charitable contribution deduction is not reduced if the state income tax credit received in exchange for the contribution does not exceed 15% of the contribution.

The final regulations retain a separate rule with respect to state and local tax deductions, under which taxpayers are required to reduce their charitable contribution deduction only if the taxpayer receives or expects to receive state and local tax deductions in excess of its contribution to the charity.

Many states have offered income tax credits for contributions to public or private schools or to charities that target a specific population or societal issue. Although these programs were not created to avoid the state and local tax cap, the preamble to the final regulations makes it clear that contributions to these organizations are subject to the rules unless they qualify for the de minimis threshold.

Other states offer credits in return for conservation easements. Although many of the comments received suggested that conservation easements should be excluded from the regulations or given a delayed effective date, Treasury declined to provide such exceptions.

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Andrew Eisinger
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Howard Wagner
Partner, National Tax Services