By Tim Clancy, CPA
On June 11, 2019, the Internal Revenue Service issued final regulations regarding the federal tax treatment of donations to programs providing state or local tax credits in exchange for charitable contributions. On that same date, the IRS also published Notice 2019-12, which contains a safe harbor for individuals making such donations. Examples of programs providing tax credits in exchange for donations are the Georgia education expense credit, the Georgia rural hospital credit, and the South Carolina education credit programs.
In both the proposed and final regulations, the IRS applied a longstanding principle of tax law related to the deductibility of charitable contributions: If you receive a benefit in exchange for a donation to a charity, you may deduct only the amount of the donation exceeding the value of the benefit. The preamble to the final regulations contains a lengthy and detailed legal analysis of this quid pro quo principle.
IRS Final Regulations
The final regulations replace the proposed regulations which were effective as of August 27, 2018. In response to the proposed regulations, the IRS received more than 7,700 comments and 25 requests to speak at its public hearing. The IRS reported that about 70% of the comments were positive and urged the adoption of the proposed regulations with no changes. The final regulations retain the provisions of the proposed regulations, with some clarifications:
In general, if you donate to a state tax credit program, you must reduce your charitable contribution deduction by the value of the state tax credits you receive. For example, suppose that you donate $100 to a state tax credit program and receive a credit of $100 to offset your state tax liability. Under the regulations, your charitable contribution deduction is zero – $100 donated to the tax credit program less than $100 tax credit received. Prior to these regulations, you would have received a charitable contribution deduction of $100 in addition to a state tax credit of $100.
If you donate to a similar program and receive a state income tax deduction equal to or less than your donation instead of a tax credit, you do not need to reduce your charitable contribution deduction. The benefit of a state income tax deduction depends on your state marginal tax rate, while a credit decreases tax on a dollar-for-dollar basis. The IRS reasoned that the potential revenue loss from a deduction is relatively low.
A state or local tax credit does not impact your charitable contribution deduction if it does not exceed 15% of the amount of your contribution. Here, suppose that you donate $100 to a state tax credit program and receive a credit of $15 to offset your state tax liability. Under the regulations, your charitable contribution deduction is $100.
These rules also apply to payments made by a trust or a decedent’s estate.
Under the safe harbor in Notice 2019-12, you may treat a charitable donation disallowed under the final regulations discussed above as a payment of state or local income taxes. However, to obtain any benefit, you must be able to itemize deductions and have an actual state and local tax liability for the year of less than $10,000. The safe harbor is intended to help those individuals who would have been able to deduct their state taxes, had those taxes not been offset by a credit received in exchange for a donation.
Recall that, starting in 2018, the Tax Cuts and Jobs Act (TCJA) limited the total of an individual’s itemized deductions for state income and property taxes to $10,000. Individuals who pay high property taxes and/or individuals with high income often find their state and local tax deduction limited. Many believe that the IRS has issued these regulations to block attempts by high-tax states such as New York, New Jersey, and California to avoid the TCJA’s $10,000 limit on the deduction for state and local taxes. Several states have already indicated that they intend to pursue legal action against the regulations, and several more are continuing to develop other types of workarounds with benefits not addressed by the regulations. While the IRS may be primarily aiming at these other states, individuals who have donated to the Georgia education expense credit and the rural hospital tax credit programs, which existed before the enactment of the TCJA, are unfortunately impacted. Unless changes occur, Georgians who donate to these programs are doing so out of a sense of altruism and without much expectation of federal tax benefits.
Please contact your Windham Brannon tax advisor for more information.
State and Local Tax Practice Leader