IRS short-circuits SALT deduction charitable workarounds to new tax law, but leaves others open for now
The Internal Revenue Service and the Treasury Department are following up on their threat to forestall attempts by states to get around the $10,000 limit in the Tax Cuts and Jobs Act on deductions of state and local taxes by setting up state-run charitable contribution funds.
Last Thursday, the IRS and the Treasury Department issued proposed regulations aimed at stopping blue states like New York, New Jersey and Connecticut that have authorized such funds, and other high-tax states that have been considering them (see IRS moves to block New York, New Jersey plans to bypass SALT deduction cap). Under the proposed rules, the proposed regulations took effect on Monday, Aug. 27, giving taxpayers only a few days to make contributions to such funds, although for the most part they hadn’t yet been set up except in a few parts of New York State (see New York taxpayers have four-day window to try to beat SALT cap). The proposed regulations still allow for contributions to existing state-run charitable funds that benefit schools and some other nonprofits, but with some limits.
Under the proposal, the regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred. That means a taxpayer who makes a $1,000 contribution to an eligible entity isn’t required to reduce the $1,000 deduction on the taxpayer’s federal income tax return if the state or local tax credit received or expected to be received is no more than $150.
Even before the proposed regs were released, Treasury Secretary Steven Mnuchin put the states on notice that the IRS likely wouldn’t allow attempts to circumvent the SALT deduction limits. In response, New York, New Jersey, Connecticut and New Jersey filed a lawsuit (see States take feds to court with ‘creative’ arguments over the SALT cap).
The IRS and Treasury Department are still taking comments on the proposed regs, but Crowe LLP national tax services managing director Howard Wagner thinks the IRS is likely to prevail over the states’ attempts to get around the cap, at least through the state-run charitable funds. “I think they’re probably on good footing and it’s consistent with the rest of the charitable contribution regs,” he said. “By analogy, if I buy a ticket for a person at a charity dinner for $1,000 and they notify me that I received a meal valued at $100, I only get to deduct $900, not $1,000. This puts these programs on a similar footing with the rest of the charitable rules.”
With the IRS and Treasury Department threatening months ago not to allow the charitable deduction workaround, few taxpayers were taking their chances on sending money to any state-run fund that had been set up to get around the TCJA limits.
“I know that a lot of advisors were shying away from these because they weren’t sure of the treatment,” said Wagner. “If I put a hundred bucks in and only get a $85 credit, and I don’t get a charitable contribution deduction, I’ve lost 15 percent on the deal.”
He sees good reason for the 15 percent limit in the proposed regulations. “The 15 percent de minimis rule is to allow for making, let’s say, a contribution to my local school so they can buy supplies,” said Wagner. “The de minimis rule is there to protect some of those programs, and I’m saying that generically. Some of these little programs, which may be little, maybe not so little, which are very well intentioned, but if they don’t conform to the 15 percent de minimis rule, that can have an effect on giving to those funds.”
He sees good reason not to try to use the charitable funds to get around limits on deductions in the new federal tax law. But taxpayers and their preparers should try to weigh the advantages and disadvantages of the various deductions still allowed under the new tax law and how they interact with charitable contributions.
“Here’s how I’d phrase it,” said Wagner. “If I give a hundred bucks to the United Way, I get a $100 charitable contribution deduction. If I give a hundred bucks to one of these charitable contribution funds, and I get a $10 state credit, I’m coming out ahead. There’s still a benefit to that. If I have to reduce my charitable contribution deduction, then have I lost the advantage? Is that benefit gone?”
He summed it up this way: “You have to factor in the reduction in your charitable contribution deduction in your analysis of the tax benefit of the gift,” said Wagner. “You’ve got to do the math. That’s the bottom line.”
While the IRS and the Treasury seem to be closing off the charitable contribution fund workaround, they haven’t yet weighed in on another tactic that New York State is trying with an optional payroll tax system for employers, as well as one that Connecticut is doing with unincorporated business income for pass-through entities, also being considered by New York (see Some high-tax states aim to provide businesses workaround for SALT limits).
“I don’t think you should view these regulations as blessing those types of tax changes,” said Wagner. “It remains to be seen what’s going to happen with what the IRS’s response will be to those. It doesn’t mean you’re out of the woods yet. You’re going to have to wait and see how the IRS responds to those.”