Since the passage of Tax Cuts and Jobs Act (“TCJA”), states with high tax rates have tried to establish workarounds to avoid the new limitations on the deductibility of state and local taxes. This past summer, the Administration issued guidance aimed at preventing some of these workarounds. The final regulations (T.D. 9864), and Notice 2019-12 address SALT deduction limitations, and certain cap workarounds enacted by states in response to TCJA. While the House of Representatives has tried to repeal the TCJA provision, the regulations will continue to apply to 2019 returns.
Under the IRS guidance, limits are placed on tax benefits for individuals’ charitable contributions where states allow state-level tax credits on those same contributions. The rules require individuals, who make payments to a charitable organization and thus receive a state tax credit in return, to reduce their federal charitable contribution deduction by the amount of the state or local tax credit. The regulations apply this rule to any new or preexisting state tax credit programs.
The regulations, in essence, prevent states from circumventing the Tax Cut and Jobs Act $10,000 limit on deductions for state and local taxes (SALT deduction). However, in an attempt to address the growing concerns arising from the effect these regulations will have on taxpayers who itemize deductions, the IRS has also proposed a safe harbor. Under the safe harbor, an individual who is under the $10,000 SALT deduction limit may elect to treat up to 15% of the charitable contribution amount as a state tax payment. Otherwise, the individual would be ineligible under the final regulations to take a duplicate federal charitable contribution deduction. This safe harbor attempts to ensure that taxpayers that are below the SALT deduction limit, are not adversely affected by the law and regulations as they stand.
Additionally, the notice specifies that the safe harbor election is allowed in the taxable year in which the payment is made, to the extent the resulting credit is applied to offset the individual’s state or local tax liability. In states or localities that permit an individual to carry forward an excess credit amount to a subsequent taxable year, an electing individual may treat the carryforward amount as a state or local tax payment for the taxable year or years to which the credit is applied to offset the state or local tax liability. However, it is important to note that while this safe harbor generally applies payments of charitable contributions as defined under IRC Section 164, it specifically excludes charitable contributions of non-cash property.
As noted above, since the issuance of the safe harbor, the House Ways and Means Committee passed the Restoring Tax Fairness for States and Localities Act (H.R. 5377) on December 19, 2019, to temporarily repeal the $10,000 cap on state and local deductions for tax years 2020 and 2021. The measure would retroactively double the $10,000 cap on income, property, and sales tax deductions to $20,000 for married couples, and increase the top individual tax rate to 39.6 percent from the current 37 percent. However, the measure prevents individuals who make more than $100 million from benefiting from the cap’s repeal. This provision is not likely to become law in the near term.
Taxpayers who itemize deductions in certain states may be able to take advantage of this safe harbor and thereby somewhat mitigate the effect of the SALT cap. Taxpayers should consider consulting with a Tax attorney to better understand the impact of the regulations on their federal charitable contribution deductions and SALT credits. If you have questions regarding this issue or other complex tax issues, please contact Steven Miller, alliantgroup, LP’s National Director of Tax, at Steven.Miller@alliantgroup.com.