In 2018, in one of our previous Tax alerts, we had informed that the Treasury and the IRS was clamping down and preparing final regulations that would address the various state workarounds for state and local tax (SALT) deductions limitation mainly by setting up charitable entities. The Tax cut and Jobs Act passed in late 2017, limited the amount of state and local taxes, also known as the SALT deductions, which can be deducted on an individual’s federal taxes to $10,000 a year. This aggravated many high-tax states like New York, New Jersey and California, who were able to deduct much more than the $10,000 limit. Further, some states tried to bypass this by enabling taxpayers to donate to charity funds in return for tax credits against their state and local taxes. Taxpayers could then deduct their donations as charitable contributions on federal taxes, lessening their broader tax burden. Final regulations on charitable contributions and State and Local Tax credits was released by the Treasury and the IRS on Tuesday, June 11, 2019.
The final regulations, which apply to contributions made after Aug. 27, 2018, and are effective on Aug. 12, 2019, largely adopt the rules in the proposed regulations. Under the final regulations, a taxpayer making payments to an entity eligible to receive tax-deductible contributions must reduce the federal charitable contribution deduction by the amount of any state or local tax credit that the taxpayer receives or expects to receive in return. The regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their charitable contribution deductions.
For example, if a state grants a 70 percent state tax credit pursuant to a state tax credit program, and an itemizing taxpayer contributes $1,000 pursuant to that program, the taxpayer receives a $700 state tax credit. A taxpayer who itemizes deductions must reduce the $1,000 federal charitable contribution deduction by the $700 state tax credit, leaving a federal charitable contribution deduction of $300.
The regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the amount transferred. Thus, a taxpayer who receives a state tax deduction of $1,000 for a contribution of $1,000 is not required to reduce the federal charitable contribution deduction to take into account the state tax deduction; and a taxpayer who makes a $1,000 contribution is not required to reduce the $1,000 federal charitable contribution deduction if the state or local tax credit received or expected to be received is no more than $150.
The IRS also posted a notice (Notice 2019-12<https://www.irs.gov/pub/irs-drop/n-19-12.pdf>) providing a safe harbor that allows an individual who itemizes deductions to treat, in certain circumstances, payments that are or will be disallowed as charitable contribution deductions under the final regulations as state or local taxes for federal income tax purposes. Eligible taxpayers can use the safe harbor to determine their state and local tax (SALT) deduction on their tax-year 2018 return.
Those who have already filed may be able to claim a greater SALT deduction by filing an amended return, Form 1040X<https://www.irs.gov/forms-pubs/about-form-1040x>, if they have not already claimed the $10,000 maximum amount ($5,000 if married filing separately).
The Treasury Department and the IRS continue to consider issuing future guidance on a number of issues raised by commenters.
If you have any questions regarding this guidance in the new regulation, contact your DDK tax advisor.
