On Sept. 5, 2018, the IRS released guidance to explain that businesses can deduct payments for charitable contributions made in exchange for state or local tax credits as ordinary and necessary business expenses.
The IRS released IR-2018-178 and State and Local Income Tax FAQ to clarify that while businesses cannot take a charitable contribution deduction for these payments under recently issued proposed regulations (REG-112176-18), such payments may represent ordinary and necessary business expenses that are deductible under section 162.
Section 164(b)(6), as added by section 11042 of Pub. L. No. 115-97, 131 Stat. 2054 (commonly referred to as the “Tax Cuts and Jobs Act” or “TCJA”), limits an individual’s deduction under section 164 for the aggregate amount of state and local tax payments made during the calendar year to $10,000 (or $5,000 for those married filing separately).
On Aug. 23, 2018, the IRS and Treasury issued proposed regulations that negate certain state laws designed to circumvent the $10,000 cap. In light of the new $10,000 state and local tax deduction limit, IRS and Treasury believe that when a taxpayer receives or expects a state or local tax credit in return for a payment, the resulting federal tax benefit constitutes a quid pro quo that precludes a full deduction under section 170(a). Accordingly, the proposed regulations amend the regulations under section 170 to require a taxpayer to reduce his or her charitable deduction in the amount of any state and local tax credit received or expected in exchange for the donation.
IR-2018-178 and State and Local Income Tax FAQ
In a response to taxpayer inquiries, the new guidance under IR-2018-178 and the State and Local Income Tax FAQ clarifies that curtailment provisions in the proposed regulations under section 170 apply to business taxpayers. In addition, businesses may treat the payments to charities or government entities in exchange for state and local tax credits as deductible under section 162 for payments made with a business purpose. Thus, any business taxpayer may deduct such payments as business expenses as long as the amounts qualify as ordinary and necessary business expenses.
While businesses can no longer take deductions under section 170 for charitable contributions made in exchange for state tax credits, the new regulations do not prevent businesses from taking a business expense deduction under section 162. Taxpayers making such charitable contributions should consult their tax adviser to make sure they characterize payments properly to qualify for deductions.
Check RSM’s Tax Reform Resource Center for the latest analysis on this and other developments related to tax reform.