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What the IRS Says About SALT Cap

What the IRS Says About SALT Cap

Additional guidance on state or local tax (SALT) cap workarounds are what The Internal Revenue Service (IRS) issued, and there are no real surprises. Following the Tax Cuts and Jobs Act (TJCA), the benefits of those workarounds aimed at mitigating the consequences of SALT caps is what the guidance largely puts an end to.

The amount that you may claim for Schedule A for all state and local sales, property and income taxes together may not exceed $10,000 (married taxpayers who are filing separately it will be $5,000) under the TCJA. For taxpayers in high-property tax states like Texas and California as well as those in high-income-tax states like New Jersey and New York, this cap was concerning for them. 

Variations on state and local charitable funds that accept payment from taxpayers in satisfaction of local and state tax liabilities are proposed by some of those states as a result. Those payments would be re-characterized as fully deductible charitable contributions under section 170(a)(1) for federal income tax purposes. 

A warning shot at taxpayers in those states via Notice 2018-54, advising that it intended to propose regulations to resolve the issue is being fired by the Treasury Department and the IRS last June. The agency warned that the proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers. 

You cannot repackage one thing like the deduction for state and local taxes, as another thins like a charitable deduction and pretend that it is the first thing. The economic reality of a transaction should be reflected in your tax returns and financial records and should not be an attempt to hide the real intent. 

In the Federal Register (83 FR 43563), those proposed regulations were published last August and they boiled down to the concept of quid pro quo. Partly for goods or services but it is a payment that a donor typically makes to a charity in exchange for something else. The proposed regulations made it very clear that if the taxpayer expects or receive a state or local tax credit in return after making a payment or transfer to or for the use of a government or charity, it is a quid pro quo-- and under section 170(a), the benefit to the taxpayer will reduce any charitable contribution. 

By the amount of any state or local tax credits they receive or expect to receive in return (the quid pro quo), the Treasury issued this month that they should reduce those charitable contribution deductions. Contributions made after August 27, 2018, will be affected by those final regulations which are effective on August 12, 2019. 

The proposed regulations are largely mirrored by the final regulations. As written, any federal contribution deduction must be reduced by the amount of any state or local tax credit that the taxpayer receives or expects to receive in return of the payment made by the taxpayer who is making payments to an entity eligible to receive tax-deductible contributions (a charity). The same rules apply to payments made by decedents’ estates or trusts. 

For tax credits that do not exceed 15% of the amount transferred and also for a dollar-for-dollar state tax deduction, there are some exceptions. That means that for a contribution of $1,000 that will receive a state tax deduction of $1,000, it is not required to reduce the federal charitable contribution deduction to account for the state tax deduction. Also, if the state or local tax credit received or expected to be received is no more than $150, a taxpayer who makes a $1,000 contribution is not required to reduce the $1,000 federal charitable contribution deduction. 

Not claiming the same amount twice under different sections of the Tax Code (section 164 applies to state and local tax payments and section 170 applies to charities 170) is the general idea to prevent double-dipping. However, there are some bright-line rules unintended consequences. A small fraction of taxpayers could see a reduction in their financial incentives to donate to state and local tax credit programs compared to their pre-Act incentives is what the Treasury and the IRS have acknowledged. Taxpayers are given an option either to pay tax to the local or state or local government or to make a payment to a charitable entity in exchange for a tax credit is what some existing tax credit programs -- including pre-TCJA programs offer to them. Taxpayers can still end up with a higher tax bill under the rules even if they don’t hit the SALT cap but are forced to reduce their charitable contribution deduction. 

Notice 2019-12 are simultaneously posted by the IRS to mitigate the issue. To provide a safe harbour for taxpayers who make a payment to or for the use of an entity under section 170(c) in return for a state or tax credit, the Treasury Department and the IRS announced in the Notice that they intend to publish a proposed regulation amending the regulations. 

Under the safe harbour, taxpayers may include the payment of state or local tax for purposes of section 164 as long as they itemize deductions and makes a payment to section 170(c) entity in return for a state or local tax credit. The portion of such payment for which a charitable contribution deduction under section 170 is or will be disallowed under final regulations. 

To the extent the resulting credit is applied, consistent with applicable state or local law, to offset the taxpayer’s local or state tax liability for such taxable year or the preceding taxable year is this treatment is allowed in the taxable year in which the payment is made. Payment of state or local tax in tax in a taxable year or years is how it will be treated when there is any excess credit permitted to be carried forward.

To a transfer of property, the safe harbor does not apply. 

Payments made after August 27, 2018, is where the proposed regulation for the safe harbor will apply. Affected taxpayers may be eligible for a larger SALT deduction but will need to file an amended return to claim the benefit but that’s only for those who have already filed their 2018 tax returns. 

By July 11, 2019, the Treasury Department and the IRS have requested comments on the safe harbor described in this notice. You can submit comments electronically via the Federal eRulemaking Portal at www.regulations.gov. And you can also submit your comments by mail or by private delivery. 

If you are hesitant to give your comment because they might not read it, then you should think again. Remember that in response to taxpayer comments to the August proposed regulations, this Notice and the resulting safe harbor came about. 

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