By Laurie Smith, CPA
In response to the SALT (state and local tax) deduction limit contained in the Tax Cuts and Jobs Act (TCJA), some states and local governments created workaround charitable funds which allowed individuals to receive a state credit in exchange for contributions to these funds. These SALT deduction limit workaround programs offered taxpayers a choice of paying tax to the state or local government (with that deduction on their Federal tax return possibly being limited) or making a payment to an entity which meets the definition of a charity and receiving a state or local tax credit in addition to a charitable contribution deduction on their Federal tax return.
In fact, one of the biggest changes to come out of the TCJA was the limitation of a taxpayer’s itemized SALT deduction. Under the TCJA, an individual’s SALT deduction limit is $10,000 ($5,000 if married filing separately).
There’s been much discussion around the SALT deduction limit workaround. Final regulations regarding the deduction as it relates to charitable contribution workarounds, issued this week by the IRS, shed more light on how taxpayers must treat the contribution and its impact on the SALT deduction limit.
These final regulations require taxpayers to reduce the amount of a charitable contribution deduction by the amount of any state or local tax credit they receive or expect to receive in return. The receipt of a SALT credit for a charitable contribution is the receipt of a return benefit, or quid pro quo benefit.
To illustrate, if you contribute $100 to a charitable organization during the tax year and, in exchange for that donation you receive tickets to an event valued at $75, your charitable contribution deduction for that organization is $25. The same logic applies here. If a taxpayer contributes to a certain charitable fund and, in return, they’re to receive a credit on their state income tax return, their charitable deduction must be reduced by the amount of the credit received or expected to be received. These rules are aimed at preventing taxpayers from getting around the SALT deduction limits.
Also included in the final regulations is a de minimis exception which states that a taxpayer doesn’t need to reduce their charitable contribution deduction if the state and local tax credits received as a benefit don’t exceed 15% of the taxpayer’s charitable payment.
Additionally, the IRS will be issuing proposed regs which will provide a safe harbor for individuals. Under the safe harbor, any disallowed portion of the charitable contribution deduction may be treated as the payment of state and local taxes.
The Treasury Department and the IRS explained that these regulations “will leave charitable giving incentives entirely unchanged for the vast majority of taxpayers.” However, both organizations did acknowledge that a small fraction of taxpayers could see a reduction in their incentive to donate to a state and local tax credit program.
The final regulations and safe harbor for individuals apply to charitable contribution payments made after August 27, 2018.
If you have any questions on how the IRS’s final regulations on charitable contribution credits may impact the SALT deduction limit workaround in your situation, please contact an Untracht Early Advisor.