August 13, 2020
IRS issues final regulations on donations to charities in exchange for SALT credits
The IRS issued final regulations (TD 9907) under IRC Sections 162, 164 and 170 regarding limitations on the deductibility of charitable contributions made in exchange for state or local tax credits.
For the most part, the final regulations adopt proposed regulations issued in December 2019 (REG-107431-19; see Tax Alert 2020-0054) with some clarifications in response to the comments and testimony the IRS received.
The final regulations: (1) adopt the safe harbor under IRC Section 162 for businesses that make payments to IRC Section 170(c) entities; (2) adopt the safe harbor under IRC Section 164 for individuals who make payments to IRC Section 170(c) entities if the individuals itemize deductions and receive, or expect to receive, a state or local tax credit in return; and (3) update the IRC Section 170 regulations to address how the quid pro quo principle applies to donors who receive benefits from a third-party in exchange for contributions.
An itemized deduction is generally allowed under IRC Section 170(a)(1) for any charitable contribution paid within a tax year. Taxpayers can qualify for such a deduction if the charitable contributions are made to a state, US possession, political subdivision or the District of Columbia, in addition to certain corporations, trusts, community chests, funds or foundations organized and operated exclusively for religious, charitable, scientific, literary or educational purposes, or to foster amateur sports competition, or to prevent cruelty to children or animals. A taxpayer that (1) transfers to an IRC Section 170(c) entity with a direct relationship to the taxpayer's trade or business and (2) reasonably expects to receive a commensurate financial return, may be entitled to deduct the contributed amount as a trade or business expense deduction under IRC Section 162, rather than as a charitable contribution deduction. IRC Section 164 permits taxpayers to claim deductions for the payment of certain taxes, including state and local property taxes.
Added to the code under the Tax Cuts and Jobs Act (TCJA), IRC Section 164(b)(6) provides that, in the case of an individual, the deduction for aggregated state and local tax (SALT) (e.g., income tax, sales tax, real property tax, personal property tax) paid during the tax year is capped at $10,000 (or $5,000 for married couples filing separately) for tax years beginning in calendar years 2018 through 2025 (SALT deduction limit).
Various state and local governments created programs aimed at helping taxpayers mitigate the effect of the SALT deduction limit, including SALT credit programs under which taxpayers who contribute to IRC Section 170(c) entities created and promoted by state and local governments received a corresponding tax credit against their respective SALT liabilities in return.
In response to these programs, the IRS and Treasury issued several pieces of formal and informal guidance. In August 2018, new regulations (REG-112176-18; see Tax Alert 2018-1714) were proposed that would amend regulations under IRC Section 170 to generally provide that if a taxpayer makes a payment or transfers property to or for the use of an IRC Section 170(c) entity and receives or expects to receive a SALT credit in return, the taxpayer must reduce its charitable contribution deduction by the amount of the tax credit, because it is considered a return benefit (quid pro quo principle).
In June 2019, the IRS and Treasury issued final regulations (TD 9864; Tax Alert 2019-1150) that largely retained the rules described in the 2018 proposed regulations. Concurrent with the 2019 final regulations, the IRS issued Revenue Procedure 2019-12 and Notice 2019-12, containing safe harbors that generally allow businesses and individuals who itemize deductions to treat would-be charitable contribution deductions that are disallowed under the final regulations as state or local taxes for federal income tax purposes.
The proposed regulations issued in December 2019 included the safe harbors provided under Revenue Procedure 2019-12 and Notice 2019-12, updating regulations under IRC Section 162 to reflect current law regarding how IRC Section 162 applies to a taxpayer that makes a payment or transfer to an IRC Section 170(c) entity for a business purpose and clarifying how the quid pro quo principle applies under IRC Section 170 to benefits received or expected to be received from third parties.
Confirms business expense deduction
The final regulations retain the proposed amendments to Treas. Reg Section 1.162-15(a), which provide that if a taxpayer's payment or transfer has a direct relationship to its trade or business and is made with a reasonable expectation of receiving commensurate financial return, the payment or transfer to an IRC Section 170(c) entity may be claimed as a business expense under IRC Section 162 instead of as a charitable contribution under IRC Section 170.
Safe harbors under IRC Section 162 for businesses
The final regulations retain the safe harbors under IRC Section 162 for payments (of cash or cash equivalents) by C corporations or specified passthrough entities to IRC Section 170(c) organizations if those corporations or entities receive or expect to receive state or local tax credits in return. The safe harbor for specified passthrough entities does not apply if the credit received or expected to be received reduces a state or local income tax.
Safe harbors under IRC Section 164 for individuals
Treas. Reg. Section 1.164-3(j) retains the safe harbors under IRC Section 164 for payments (of cash or cash equivalents) to IRC Section 170(c) organizations by individuals who itemize deductions and receive or expect to receive a SALT credit in return. Taxpayers can deduct the portion of the payment that is a charitable contribution deduction under IRC Section 170 or will be disallowed under Treas. Reg. Section 1.170A-1(h)(3). The safe harbor may be applied in the tax year in which the payment is made but only to the extent that the SALT credit is applied under applicable state or local law to offset the taxpayer's SALT liability for that tax year or the preceding tax year. An unused credit may be carried forward and treated as a SALT payment under IRC Section 164.
Under the final regulations, individuals who apply these safe harbors to make deductions under IRC Section 164 may not also deduct the same payments under any other IRC section.
Quid pro quo clarification
The final regulations retain the amendments to the IRC Section 170 regulations regarding the application of the quid pro quo principle to a donor who receives or expects to receive benefits from a third party. The final regulations clarify that the quid pro quo principle applies regardless of whether the party providing the quid pro quo is the donee or a third party.
Specifically, the final regulations define "in consideration for" and "goods and services" for purposes of applying Treas. Reg. Section 1.170A-1(h): "a taxpayer will be treated as receiving goods and services in consideration for a taxpayer's payment or transfer to an entity described in [IRC S]ection 170(c) if, at the time the taxpayer makes the payment or transfer, the taxpayer receives or expects to receive goods or services in return." The final regulations further clarify that the fair market value of goods and services includes the value of goods and services provided by parties other than the donee.
The amendments to Treas. Reg. Section 1.162-15 apply to payments or transfers made on or after December 17, 2019. However, taxpayers may choose to apply the amendments to payments or transfers made on or after January 1, 2018. Treas. Reg. Section 1.164-3(j) applies to payments made to IRC Section 170(c) entities on or after June 11, 2019. But, taxpayers may choose to apply paragraph (j) to payments made after August 27, 2018. The definitions provided in Treas. Reg. Section 1.170A-1(h)(4) are applicable to amounts paid or property transferred on or after December 17, 2019.
The final regulations largely reduce to regulation form the existing views of Treasury and the IRS on the state tax credit systems relating to charitable contributions. Although TD 9907 is a tax regulation, it was largely a joint undertaking between the Department of Treasury and Department of Education to provide clarity on the state tax credit systems that involve contributions made to support education.
IRC Section 170(c) donee organizations may want to review their procedures regarding the contemporaneous written acknowledgement of charitable contributions in order to accommodate the clarification to the quid pro quo principle.
The final regulations are a virtual carbon copy of the proposed regulations. Treasury and the IRS received more than 40 comments responding to the proposed regulations and did not adopt any of these comments, except for a few clarifications that have little impact on the effect of the regulations.
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