On August 7, 2020, the IRS released final regulations (T.D. 9907) regarding the interaction of the $10,000/$5,000 cap on state and local tax (SALT) deduction and charitable contributions. Your SALT deduction includes real estate taxes, state income taxes (unemployment, disability, family leave, personal property taxes) and local taxes. For tax years after 2017, an individuals itemized deduction for SALT taxes is limited to $10,000 ($5,000 if married filing separately). States that have high tax rates such as New Jersey, New York and California tried to circumvent this SALT limitation by adopting laws allowing individuals to receive a state tax credit for contributions to certain charitable funds. These laws are aimed at getting around the SALT deduction limit by creating a charitable deduction for federal income tax purposes. We must remember that a charitable contribution is a voluntary contribution or gift of cash or property to a qualified charitable organization and it must be given without present or future expectations of any monetary or economic benefit to be derived from the contribution. With this in mind, the receipt of a SALT credit for a charitable contribution is the receipt of a return benefit (quid pro quo benefit). Thus, the taxpayer must reduce any contribution deduction by the amount of any SALT credit received or expected to receive in return. A de minimis exception is available to taxpayers if the tax credit they receive in return does not exceed 15 percent of their charitable contribution. This means no limitation applies. There is also a safe harbor for individuals who have a portion of a charitable deduction disallowed due to the receipt of a SALT credit. Any disallowed portion of a charitable contribution deduction may be treated as a payment of SALT taxes for the purposes of deducting taxes. The safe harbor is allowed in the tax year the charitable payment is made, but only to the extent that the credit is applied as provided under state or local law to offset the individual’s SALT liability for the current or preceding tax year. Any unused credit may be carried forward as provided under state and local law. The IRS’s objective with these final regulations is to prevent taxpayers from avoiding the SALT deduction cap. Below are some examples:
Example 1
“A” an individual, makes a payment of $2,000 to “X”, a nonprofit entity. In exchange for the payment, A receives or expects to receive a state tax credit of 70 percent of the amount of A’s payment to X. Since A will receive a benefit in exchange for his contribution, he must reduce his charitable contribution deduction by $1,400 (0.7 x $2,000). This reduction occurs regardless of whether A can claim the state tax credit in that year. Thus, A’s charitable contribution deduction for the $2,000 payment to X may not exceed $600.
Example 2
“B” an individual, transfers a painting to “Y”, a nonprofit entity. At the time of the transfer, the painting has a fair market value of $100,000. In exchange for the painting, B receives or expects to receive a state tax credit equal to 10 percent of the fair market value of the painting. As a result of the de minimis exception, B is not required to reduce his contribution because the amount of the tax credit received or expected to be received by B does not exceed 15 percent of the fair market value of the property transferred to Y. Accordingly, the amount of B’s charitable contribution deduction for the transfer of the painting is not reduced.
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