SALT Blawg – State and Local Tax Blog
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The Internal Revenue Service is scheduled to publish its final regulations addressing attempts to end-run the 2017 Tax Cuts and Jobs Act’s cap on state and local tax deductions.
As readers will recall, prior to the TCJA’s amendment to Section 164 in December 2017, taxpayers were able to deduct the full amount of their state and local taxes (mostly property taxes and income taxes), subject to the limitation on itemized deduction. The TCJA added Section 164(b)(6) which limits the aggregate deduction of these taxes to $10,000 (less if not filing a joint return).
This little provision in a juggernaut piece of tax legislation quickly became a political lightning rod. Several states with high state and local tax burdens cried foul. There were accusations that the burden of the $10,000 cap fell disproportionately on Blue states. Whether Section 164(b)(6) was part of a political conspiracy against certain states or a dusted-off revenue offset to fund a massive tax cut package, you be the judge.
In response to the cap, several states enacted a workaround designed to convert state and local taxes into charitable deductions. Essentially, these workaround programs offered taxpayers the opportunity to donate to state and local government-run funds, which funds would be used to pay for government services that otherwise would be funded through taxes, and then the contributors would receive tax credits to apply against their state and local tax liabilities. The taxpayer’s cash out of pocket would thus not change, they would merely redirect the amount they would otherwise pay in state and local taxes into the government-run fund. But the kicker for the plan to work as intended was that the contributors would then claim a Section 170 deduction on their federal income tax returns, which are not subject to the $10,000 cap.
Were these workarounds too cute? Could you really get a charitable deduction when you receive a benefit from the contribution in the form of a credit against your state and local tax liabilities? Well, according to the IRS, the answer is unequivocally, “no.” In the final regulations set to be published this week, the IRS reinforces its position that charitable deductions under Section 170 are not available when there is a quid pro quo. So, according to the final regulations, the charitable deduction workaround does not work.
But the IRS did give taxpayer an “A” for effort. Taxpayers that had unwittingly attempted the workaround might have been exposed to a whipsaw situation where their contributions did not count towards even the $10,000 cap and because the taxpayers had received a quid pro quo they also might not qualify for a charitable deduction. Ouch. Well, the IRS provided relief to these taxpayers, confirming in the final regulations that to the extent the payment into the state and local charitable fund reduces state and local taxes, the taxpayer may treat the donations as taxes paid and include the amounts in the Section 164 deduction for state and local taxes, and further that any excess may be eligible for a Section 170 charitable deduction.
No doubt there will be interested parties not satisfied with this solution. Several states including New York, New Jersey and Connecticut have filed suit against the IRS and Treasury Department to challenge an earlier set of regulations addressing the SALT deduction cap, and it’s unlikely the final regulations will entirely calm the storm. In any event, the final regulations are worth a read. They cover state and local tax deduction issues beyond the charitable deduction workaround programs, including several safeharbors and assurances for businesses to deduct their state and local taxes which had not been addressed in the June 2019 regulation package.
The final regulations are attached to this link. Attorneys at Chamberlain are ready to assist clients with these and other federal and state and local tax issues.
Peter A. Lowy, a shareholder in Chamberlain Hrdlicka’s Houston office, is best known for his tax controversy work and deep experience in the energy sector. He also advises corporations and other taxpayers in a broad spectrum of ...