The IRS has recently issued proposed regulations here which clarify that the IRS is utilizing a substance over form approach for all states that are attempting to circumvent the $10,000 state and local deduction cap under the Tax Cuts and Jobs Act (TCJA) through charitable giving strategies.
Under the TCJA taxpayers are limited in their Schedule A deductions for all state and local income, sales, and property taxes such that these cannot exceed $10,000 ($5,000 for married filing separately). Prior to the TCJA there was no limitation on the amount of state and local taxes you could claim.
New York, New Jersey, Maryland and Connecticut in an attempt to fight the new $10,000 cap on state and local tax deductions, have legislation in place in an attempt to bypass this limitation. The suggested workaround for many of these states involved variations on a state and local charitable fund that taxpayers could make payments to in satisfaction of their state and local liabilities. These payments would then be re-characterized as a fully deductible charitable contribution completely bypassing the $10,000 cap on state and local deductions under the TCJA.
The IRS has now issued new rules that will block states’ attempts at circumventing this deduction cap. The IRS warned taxpayers back in May that they would be looking into state-approved maneuvers to avoid these new federal limits, especially those that involved charitable organizations and charitable giving. The proposed regulations state that whenever a charitable gift is given, if the taxpayer receives anything in return the Fair Market Value (FMV) of what you receive must not be included in your total charitable deduction. This is a well-established principal that the IRS is now applying in the context of state work around charitable funds. When a taxpayer makes a contribution to one of these workaround charitable funds, they are expecting a benefit in return, the state or local tax credit in return for their contribution. The IRS will now be looking at the receipt of these benefits as quid pro quo, and taxpayers will not be permitted to claim the full value of the deduction. The proposed regulations state that the amount that would otherwise be a deductible charitable contribution must be reduced by the amount of state or local tax credit received or expected.
If a taxpayer contributes $20,000 to a state charitable fund in lieu of paying their state property taxes, and receives a $13,000 state credit for that donation, for federal income tax purposes that taxpayer would only be permitted to deduct $7,000 as a charitable deduction. The remaining quid pro quo $13,000 is disregarded.
Additionally, if you were to receive or expect to receive a state or local tax deduction that exceeds the amount of your FMV contribution, your charitable contribution deduction must be reduced. The proposed regulations also include a de minimis provision that allows a taxpayer to disregard the value of their state or local tax credit if that credit does not exceed 15% of their payment or 15% of the FMV of the transferred property.
The IRS has also proposed that these regulations apply to all contributions made after August 27, 2018. This means the IRS may challenge contributions made before today.
If there are any questions on this or any other tax matters please contact a member of TAG.