The Internal Revenue Service has issued its final regulations that require taxpayers to reduce charitable contribution deductions by the amount of any state or local tax credits they receive or expect to receive in return.
The notice also includes an IRS statement that taxpayers “may treat payments they make in exchange for these credits as state or local tax payments,” allowing some taxpayers to deduct certain such payments as taxes.
The guidance comes in Treasury Decision 9864, and finalizes proposed regulations published in August of 2018. The IRS says the final version applies to contributions made after Aug. 27, 2018, and are effective August 12, 2019.
“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 IRS release states. “The regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their charitable contribution deductions.”
The IRS uses this example to illustrate: if a state grants a 70 percent state tax credit as part of a state tax credit program and an itemizing taxpayer contributes $1,000 as part of that program, the taxpayer gets a $700 state tax credit. A taxpayer who itemizes deductions has to reduce the $1,000 federal charitable contribution deduction by the $700 state tax credit, which means the taxpayer only gets a federal charitable contribution deduction of $300.
The final regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the amount transferred.
A taxpayer who gets 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 the state tax deduction into account. In another example, a taxpayer who makes a $1,000 contribution isn’t required to reduce the $1,000 federal charitable contribution deduction if the state or local tax credit they receive (or expect to receive) is $150 or less.
The IRS also posted Notice 2019-12, which provides a safe harbor that allows - in certain circumstances - a taxpayer who itemizes deductions to treat disallowed charitable contribution deductions 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, if they have not already claimed the $10,000 maximum amount ($5,000 if married filing separately),” the IRS news release states.
Comment Period Ended
The final version of the regulations was issued after reviewing more than 7,700 written comments taken during its input phase and another 25 comments made at a public hearing in November of 2018. The IRS says about 70 percent of the overall comments were in favor of adopting the proposed regulations without any change.
The Treasury Department and the IRS say they are continuing to consider issuing future guidance, based on a number of other issues raised in the comments they’ve received.