In recently published correspondence (2018–0030) to a Section 501(c)(3) taxpayer, the IRS states that proposed regulations (REG-112176-18) on the federal deductibility of charitable contributions for which a taxpayer received a state or local tax (SALT) benefit do not affect business taxpayers' payments to a state tax credit program that are deductible under a code section other than Section 170.

Background

The taxpayer is a state-approved scholarship funding organization that solicits businesses to fund K-12 scholarships for disadvantaged children by contributing to the Florida Tax Credit Scholarship Program and the Florida Sales Tax Credit Scholarship Program. In return, the businesses receive dollar-for-dollar tax credits, available with regard to tax liabilities for the: alcohol beverage excise tax; business rent tax; corporate income tax; direct pay sales and use tax; insurance premium tax; and oil and gas production tax.

The proposed regulations, released in late-August 2018, were largely aimed at curbing work-arounds that various states had devised following the imposition of a $10,000 limit on SALT deductions under the Tax Cuts and Jobs Act of 2017. (For details, see Tax Alert 2018-1714.) In early September 2018, the IRS announced in a press release (IR-2018-178) and a new "State and Local Income Tax FAQ" that the regulations do not affect business taxpayers' ability to claim business expense deductions for certain payments to charities or government entities for which taxpayers receive SALT credits.

(For details, see Tax Alert 2018-1778.)

IRS correspondence

The IRS correspondence notes that the taxpayer had requested information regarding the potential effect of the proposed regulations on the tax credits that corporations receive when contributing to the scholarship programs the taxpayer organizes. In a brief synopsis, the correspondence explains that, under the proposed regulations, a taxpayer making a payment or transfering property to an entity described in Section 170(c) "must reduce its charitable contribution deduction by the amount of a state or local tax credit the taxpayer receives or expects to receive."

Because the proposed regulations address only "whether certain amounts may be deducted as charitable contributions under Section 170 (or Section 642, if the payments are made by a trust or decedent's estate) and [its regulations] and does not propose to change existing tax treatment under any other provisions of the Code or the Treasury Regulations," any payments that businesses make as part of the state tax credit program at issue that are not deductible as charitable contributions are not affected by the proposed regulations, the IRS advised.

Implications

Although the IRS correspondence does not specifically identify the Florida state plan, or the taxpayer's status as an eligible nonprofit scholarship-funding organization (SFO) under Florida law, the opening paragraph does refer to "state tax credit program in your state." EY has learned that the correspondence was addressed to a charity located in the state of Florida, and deduced that it implicitly refers to the Florida Tax Credit Scholarship Program (TCSP) and Florida Sales Tax Credit Scholarship Program (STCSP). This implicit reference likely was intentional to enable other state funds to align themselves with the nature of the correspondence, without having to align their program specifically to the TCSP and STCSP.

The opening paragraph of the correspondence also specifically mention credits that are available for use by business taxpayers against the state: (a) insurance premium tax, (b) direct pay sales and use tax, (c) corporate income tax, (d) alcoholic beverage excise tax, (e) oil and/or gas production tax, and (f) state sales tax due on rent or license fee payments. The taxes described in (a)-(e) are the same taxes covered by the TCSP under Florida Statute Section 1002.395, and the state sales tax due on rent or license fee payments in (f) is the tax covered by the STCSP under Florida Statute Section 212.099.

The third paragraph of the IRS correspondence is the most important — both for what it says and what it doesn't say. The paragraph concludes that a business taxpayer making payments to the taxpayer under the TCSP or STCSP will continue to deduct those payments in the same way after the regulations as they did before the regulations. There are several elements to this conclusion that could have been more expressly stated, but were not.

First, the reference to "business taxpayer" is not limited to corporations. The phrase "business taxpayer" captures any business that might incur one of the six taxes covered by the TCSP or STCSP, regardless of whether they are organized as a corporation, partnership, S corporation, or sole proprietorship.¹ This same position is also present in the following FAQ statement: "The rules permitting an ordinary and necessary business expense deduction under Section 162 apply to a taxpayer engaged in carrying on a trade or business regardless of the form of the business." Additionally, the term "business taxpayer" distinguishes operating businesses that participate in TCSP or STCSP from non-operating businesses that could participate in credit programs of other states — such as individuals who could contribute to state credit plans to offset their personal tax liabilities.

Second, the portion of the sentence that provides "your state's tax credit program described above" links to the opening paragraph. The reference to "your state's tax credit program" identified the State of Florida. Additionally, the phrase "tax credit program described above" specifically refers to the six credits available under the TCSP or STCSP listed in the opening paragraph.²

The end of the last sentence — "that are deductible under a Code section other than Section 170" — is cryptic. It is important to recall that the IRS concluded in a 2006 information letter issued to a Florida tax-exempt organization that was associated with the Florida Corporate Income Tax Credit Scholarship program that, "if credit is viewed as a quid pro quo benefit, that eliminates the necessary charitable intent for federal tax purposes." It went on to state that "arguably the taxpayer's transfer of the credit to the state to satisfy the taxpayer's state tax liability should be viewed as a payment of state tax for purposes of the federal deduction for tax payments in [Section] 164 or for [Section] 162."

Although the Florida Corporate Income Tax Credit Scholarship program has been rolled into the TCSP since the issuance of the 2006 letter, the same rationale continues to apply. The conclusion from the 2006 letter that remains key to interpreting the latest correspondence is that the receipt of a dollar-for-dollar credit eliminates the necessary charitable intent for federal tax purposes. The IRS correspondence should be read to mean that the federal income tax consequences of a credit received under the TCSP or STCSP is the same as a credit received under the Florida Corporate Income Tax Credit Scholarship. Thus, a taxpayer's transfer of the credit to the state should be viewed as a payment of state tax for purposes of the federal deduction for tax payments in Section 164 or for Section 162. We believe that the rationale behind not simply repeating the conclusion in the 2006 letter was a heightened awareness by the IRS that it was possible, at least theoretically, that some taxpayer-donors have been treating payments to the taxpayer as charitable contributions described in Section 170 based on their own analysis of the historical interaction between Sections 162, 164, and 170. For the large majority of business taxpayers that have followed the logic in the 2006 letter, their current practice of deducting payments to the taxpayer under Section 162 or Section 164 remains unchanged.

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ENDNOTES

¹ For a point of clarity, partnerships, S corporations, and sole proprietorships are not subject to the Florida corporate income tax, so only five of the six taxes would apply to them.

² Florida tax credits available under TCSP and STCSP include: (a) insurance premium tax, (b) direct pay sales and use tax, (c) corporate income tax, (d) alcoholic beverage excise tax, (e) oil and/or gas production tax, and (f) state sales tax due on rent or license fee payments.