On Aug. 23, 2018, the IRS and Treasury issued proposed regulations (REG-112176-18) that negate certain state laws designed to circumvent the $10,000 cap on the deduction for state and local taxes (SALT) added by new section 164(b)(6).
Under the proposed regulations, in general, a taxpayer’s payment to certain designated charitable entities listed in section 170(c), in exchange for or with the expectation of, a SALT credit, constitutes a quid pro quo that may preclude a full charitable deduction under section 170. The proposed regulations apply to contributions made after Aug. 27, 2018 to a new SALT credit program or a preexisting one.
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 SALT payments made during the calendar year to $10,000 (or $5,000 for those married filing separately). The new limit applies to taxable years beginning after Dec. 31, 2017 and before Jan. 1, 2026.
In May 2018, IRS and Treasury issued Notice 2018-54, announcing their intent to propose regulations addressing payments made by taxpayers for which they receive a credit against their SALT liabilities. Notice 2018-54 specifically targeted programs designed by states to allow taxpayers to make transfers to the state or its designated transferees in exchange for credits against their SALT payments. These programs aim to allow taxpayers to characterize the transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy SALT liabilities.
The New Proposed Regulations
With the new $10,000 SALT deduction limit, IRS and Treasury believe that when a taxpayer receives or expects a SALT 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 SALT credit received or expected in exchange for the donation.
Dollar-for-dollar SALT deductions, however, do not receive the same treatment, and may be disregarded to the extent the taxpayer does not receive or expect to receive a SALT deduction that exceeds the amount of the taxpayer’s payment or the fair market value of the property transferred. In such cases, the taxpayer must reduce the charitable contribution deduction accordingly.
The proposed regulations also include a de minimis exception, under which a taxpayer may disregard a SALT credit if it does not exceed fifteen percent of the payment or 15 percent of the fair market value of the property transferred by the taxpayer. The Preamble to the proposed regulations indicates that the rule provides consistent treatment between SALT deductions and SALT credits providing a benefit equivalent to a deduction. The IRS and Treasury reason that the combined top marginal SALT rate currently does not exceed fifteen percent, and thus a SALT credit up to fifteen percent does not reduce the taxpayer’s federal deduction for a charitable contribution.
Because trusts and estates can also take advantage of the SALT limitation through charitable contributions under section 642, the proposed regulations amend Reg. section 1.642(c)-3 by also requiring a reduction of the charitable contribution when a trust or estate makes a donation to receive a SALT credit.
The proposed regulations curtail use of SALT deduction cap workaround programs, whether new or preexisting, based on charitable contributions. Taxpayers taking advantage of these programs should consult their tax adviser to make sure they remain in compliance with federal law.
Check RSM’s Tax Reform Resource Center for the latest analysis on this and other developments related to tax reform.