Final Regulations Limit Federal Charitable Contribution Deductions in Connection with Receipt of State Tax Credits

Update: On September 20, a U.S. district court denied the legal challenge mounted by New York, New Jersey, Connecticut, and Maryland to block the SALT deduction cap.  It is uncertain at the time of this update whether the case will be appealed.

On June 13, 2019, the IRS and Treasury Department issued final regulations under Section 170, limiting federal charitable contribution deductions when taxpayers receive or expect to receive state or local tax (SALT) credits in return for charitable donations. Effective August 12, 2019, federal charitable contributions made after August 27, 2018, will have limited deductibility when a taxpayer’s corresponding SALT credits result in a return benefit, or a quid pro quo.  The limit is intended to prevent taxpayers from circumventing the $10,000 cap on state and local property and income tax deductions from their federal taxable income under the new laws of the 2017 tax reform.

The final regulations retain the proposed regulations issued in August 2018 , with a few clarifications and technical changes.  Namely, taxpayers must reduce their deduction for a charitable contribution by the amount of the SALT credit received where the credit constitutes a quid pro quo.  The de minimis exception was also kept, whereby the taxpayer’s charitable contribution deduction is not reduced when the sum of the SALT credits received or expected to be received by a taxpayer does not exceed 15 percent of the taxpayer’s charitable contributions. 

SALT Deductions vs. Credits

However, the final regulations treat SALT deductions differently than SALT credits.  Taxpayers are generally not required to reduce their charitable contribution deductions for the receipt of a SALT deduction—unless the taxpayer receives or expects to receive a SALT deduction in excess of the taxpayer’s payment or fair market value of property transferred.  The IRS and Treasury state that tax policy considerations and sound tax administration do not support the application of quid pro quo for dollar-for-dollar SALT deductions, as the risk of using SALT deductions to circumvent the SALT limit on federal taxable income is low, and accurate calculation of federal and state and local taxes would be difficult for both taxpayers and the IRS.

Additionally, the final regulations extend the rules and limits provided for charitable contributions made under Section 170 to charitable contributions made by trusts or decedents' estates under Section 642(c). 

Safe Harbor

On June 11, 2019, Treasury Department issued Notice 2019-12 , providing a safe harbor under Section 164 for taxpayers who itemize their deductions and make a payment to or for the use of an entity under Section 170. The portion of an individual’s charitable contribution payment that is or will be disallowed under the final regulation limits may be treated as a SALT payment for the purposes of Section 164, so long as the itemizing taxpayer has a state tax liability of less than $10,000.  Taxpayers may rely on the provisions in the notice until proposed regulations are issued. 

BDO Insight

The final guidance should come as no surprise to taxpayers, given what the IRS and Treasury Department have said on the matter in the proposed regulations and in Notice 2018-54 , which was issued in June 2018.