IRS Provides Safe Harbor for Charitable Donations Made In Exchange for SALT Credits

(Parker Tax Publishing June 2019)

The IRS announced that it intends to publish a proposed regulation under Code Sec. 164 providing a safe harbor for certain individuals who make a payment to, or for the use of, an entity described in Code Sec. 170(c) in return for a state or local tax credit. Under the safe harbor, an individual may treat as a payment of state or local tax for purposes of Code Sec. 164 the portion of a payment for which a charitable contribution deduction under Code Sec. 170 is, or will be, disallowed under Reg. Sec. 1.170A-1(h)(3). Notice 2019-12.

Background

Code Sec. 170(a) allows an individual to claim an itemized deduction for charitable contributions made to certain qualified organizations during the tax year. Under Code Sec. 170(c), qualified organizations include a state, a possession of the United States, or any political subdivision of the foregoing, including the District of Columbia, as well as certain corporations, trusts, and other entities organized and operated exclusively for charitable purposes. Code Sec. 164(a) allows a deduction for the payment of certain state and local taxes (SALT). Code Sec. 164(b)(6), as added by the Tax Cuts and Jobs Act of 2017 (TCJA), generally limits an individual's annual SALT deduction to $10,000 ($5,000 in the case of a married individual filing a separate return). This limitation applies to tax years beginning after December 31, 2017, and before January 1, 2026.

Due to the potential for taxpayers to use SALT credit programs to avoid the limitation in Code Sec. 164(b)(6), the IRS has issued guidance on the federal income tax treatment of transfers to entities described in Code Sec. 170(c) when the taxpayer receives, or expects to receive, a SALT credit in return. Proposed regulations under Code Sec. 170, published on August 27, 2018, generally state that if a taxpayer makes a payment or transfers property to an entity described in Code Sec. 170(c) and receives a SALT credit in return, the tax credit constitutes a return benefit, or quid pro quo, to the taxpayer and reduces the taxpayer's charitable contribution deduction under Code Sec. 170(a). On June 11, 2019, the IRS published final regulations in T.D. 9864, providing rules governing the availability of charitable contribution deductions under Code Sec. 170 when a taxpayer receives or expects to receive a corresponding SALT credit.

In the Special Analyses section of the proposed regulations, the IRS explained that the proposed regulations would leave charitable giving incentives entirely unchanged for the vast majority of taxpayers. The IRS acknowledged, however, that a small fraction of taxpayers could see a reduction in their financial incentives to donate to SALT credit programs compared to their pre-TCJA incentives and requested comments on this consideration. Practitioners argued that the proposed regulations would create unfair consequences for certain individuals who receive SALT credits in return for payments to Code Sec. 170(c) entities. Specifically, donors to such tax credit programs who itemize deductions for federal income tax purposes and have total SALT liability for the year under $10,000 would be precluded from taking charitable contribution deductions for payments to Code Sec. 170(c) entities to the extent the donors receive SALT credits, even though the donors would have been able to deduct equivalent payments of SALT offset by such credits. As a result of the proposed regulations, if these individuals chose to make a payment to a Code Sec. 170(c) entity instead of paying tax to the state or local government, they would lose a deduction to which they would otherwise have been entitled.

These state tax credit programs effectively offer taxpayers a choice of paying tax to the state or local government or making a payment to a Code Sec. 170(c) entity and receiving a tax credit that offsets the taxpayer's SALT liability. This situation can be analogized to situations in which a party entitled to receive a payment from a second party directs or permits the second party to satisfy its payment obligation by making a payment to a third party. In such situations, the payment may be treated, for federal income tax purposes, as a payment by the payor to the party entitled to receive payment. In reaching this conclusion, the IRS cited the conclusions reached in Rev. Rul. 74-75 and Rev. Rul. 86-14.

Safe Harbor for Individuals

In conjunction with the final regulations issued in T.D. 9864, the IRS issued Notice 2019-12. In that notice, the IRS said that it takes seriously the concern that regulations could create unfair consequences for individuals who (1) itemize deductions for federal income tax purposes, (2) make a payment to a Code Sec. 170(c) entity in return for a SALT credit, and (3) would have been able to deduct a payment of tax to the state or local government in the amount of the credit absent regulations denying such treatment. Accordingly, in Notice 2019-12, the IRS concludes that a safe harbor is appropriate to mitigate the consequences in such situations.

As a result, the IRS states in Notice 2019-12 that it intends to publish a proposed regulation amending Reg. Sec. 1.164-3 to provide a safe harbor for certain individuals who make a payment to, or for the use of, an entity described in Code Sec. 170(c) in return for a SALT credit. Under this safe harbor, an individual who itemizes deductions and who makes a payment to a Code Sec. 170(c) entity in return for a SALT credit may treat as a payment of SALT, for purposes of Code Sec. 164, the portion of such payment for which a charitable contribution deduction under Code Sec. 170 is, or will be, disallowed under final regulations. This treatment as a payment of SALT under Code Sec. 164 is allowed in the tax year in which the payment is made to the extent the resulting credit is applied, consistent with applicable state or local law, to offset the individual's SALT liability for such tax year or the preceding tax year. To the extent the resulting credit is not applied to offset the individual's SALT liability for the tax year of the payment or the preceding tax year, any excess credit permitted to be carried forward may be treated as a SALT payment under Code Sec. 164 in the tax year or years for which the carryover credit is applied, consistent with applicable state or local law, to offset the individual's SALT liability. The safe harbor in Notice 2019-12 does not apply to a transfer of property.

Notice 2019-12 does not permit a taxpayer who applies this safe harbor to treat the amount of any payment as deductible under more than one provision of the Code or regulations. Notice 2019-12 also does not permit a taxpayer who applies the safe harbor to avoid the limitations of Code Sec. 164(b)(6) for any amount paid as a tax or treated under the notice as a payment of tax.

Examples

Example 1: In 2019, Amy makes a payment of $500 to an entity described in Code Sec. 170(c). In return for the payment, Amy receives a dollar-for-dollar state income tax credit. Prior to application of the credit, Amy's state income tax liability for 2019 was $500 or more. Amy applies the $500 credit to her 2019 state income tax liability. Under the safe harbor of Notice 2019-12, Amy treats the $500 payment as a payment of state income tax in 2019 for purposes of Code Sec. 164. To determine her deduction, Amy must apply the provisions of Code Sec. 164 applicable to payments of state and local taxes, including the limitation under Code Sec. 164(b)(6).

Example 2: In 2019, Bob makes a payment of $7,000 to an entity described in Code Sec. 170(c). In return for the payment, Bob receives a dollar-for-dollar state income tax credit, which under state law may be carried forward for three tax years. Prior to application of the credit, Bob's state income tax liability for 2019 was $5,000. Bob applies $5,000 of the $7,000 credit to his 2019 state income tax liability. Under the safe harbor of Notice 2019-12, Bob treats $5,000 of the $7,000 payment as a payment of state income tax in 2019 for purposes of Code Sec. 164. Before applying the remaining credit, Bob's state income tax liability for 2020 exceeds $2,000. Bob applies the excess credit of $2,000 to his 2020 state income tax liability. For 2020, Bob treats the $2,000 as a payment of state income tax for purposes of Code Sec. 164. To determine Bob's deduction amounts in 2019 and 2020, Bob must apply the provisions of Code Sec. 164 applicable to payments of state and local taxes, including the limitation under Code Sec. 164(b)(6).

Example 3: In 2019, Carla makes a payment of $7,000 to an entity described in Code Sec. 170(c). In return for the payment, Carla receives a local real property tax credit equal to 25 percent of the amount of this payment ($1,750). Prior to application of the credit, Carla's local real property tax liability in 2019 was $3,500. Carla applies the $1,750 credit to her 2019 local real property tax liability. Under the safe harbor of Notice 2019-12, Carla treats $1,750 as a payment of local real property tax for purposes of Code Sec. 164. To determine Carla's deduction amount, Carla must apply the provisions of Code Sec. 164 applicable to payments of state and local taxes, including the limitation under Code Sec. 164(b)(6).

Applicability Date

The proposed regulation setting forth the safe harbor described in Notice 2019-12 will apply to payments made to Code Sec. 170(c) entities after August 27, 2018. Before the issuance of that proposed regulation, taxpayers may rely on the provisions of Notice 2019-12 with respect to such payments.

For a discussion of the deductibility of state and local taxes, see Parker Tax ¶83,125.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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