Following up on yesterday's post, IRS Warns Taxpayers That Regs Will Prevent States From Circumventing $10k S&L Tax Cap With 'Charitable' Contributions: Daniel Hemel (Chicago), Two Cheers for IRS Guidance on the New SALT Cap:
Yesterday’s notice by the Treasury Department and the IRS that they plan to propose regulations related to the state and local tax (SALT) and charitable contribution deductions has generated lots of news coverage. ...
Let’s start with what the notice did say. First, it revealed — and this is new news — that Treasury and the IRS “intend to propose regulations addressing the federal income tax treatment of certain payments made by taxpayers for which taxpayers receive a credit against their state and local taxes.” That’s apparently a reference to laws already enacted in New Jersey, New York, and Oregon that allow taxpayers to claim a state tax credit for charitable contributions to certain state-affiliated funds, as well as several similar proposals pending in other state legislatures. Interestingly, Treasury and the IRS signaled no intention to issue regulations addressing New York’s new “Employer Compensation Expense Program,” which allows employees to claim a state tax credit if their employer opts into a new payroll tax regime. Even those who are skeptical of the charitable credit arrangement acknowledge that the payroll tax shift “almost certainly” will pass muster under federal tax law, and nothing in yesterday’s notice suggests otherwise.
I think it’s good news that Treasury and the IRS will be coming out with regulations regarding state charitable credits (with the caveat that tax regulatory projects can sometimes take years and don’t always come to fruition). Thus far, states and taxpayers have been relying on a 2011 memorandum from the IRS’s Office of Chief Counsel stating that “[g]enerally,” donations to state programs are deductible for federal purposes as charitable contributions — notwithstanding the fact that the donor receives a state tax credit — provided that the other requirements of section 170 of the Internal Revenue Code are satisfied. The problem with relying on a chief counsel memorandum is that those memos specifically say they “may not be used or cited as precedent.” A clarifying regulation will help states plan their fiscal futures and will help taxpayers organize their financial lives. ...
Yesterday’s notice states that “federal law controls the proper characterization of payments for federal tax purposes” (well, of course it does) and that “substance-over-form principles” are relevant (well, of course they are). But as a number of other tax professors and I have argued, the best reading of existing federal law is that donations to state-designated charitable funds are deductible as charitable contributions as long as they meet the substantive and formal requirements for deductibility — whether or not the taxpayer receives a state tax benefit.
Consider, for example, the Bridget “Biddy” Mason Golden State Credit Program, passed this month by the California State Assembly’s Revenue and Taxation Committee (but not yet acted upon by the Assembly’s Appropriations Committee or the State Senate). Under that program, a taxpayer can give $100 to a K-12 public school district, community college, public university, or public charity active in California and receive 100 Golden State Credits. The school, community college, university, or charity can obtain those 100 Golden State Credits by transferring $90 to the state’s general fund. The 100 credits allow the taxpayer to offset $80 of state tax liability.
Under federal law, should the taxpayer’s $100 donation be treated as a $100 charitable contribution or a $100 state tax payment (or as something else entirely)? Well, section 170 of the Internal Revenue Code says that gifts to states and their subdivisions and to charities are deductible as charitable contributions, subject to a number of requirements related to substantiation and other matters that the Golden State Credit Program participants will surely meet. ...
Does anything in yesterday’s notice indicate that the regulations contemplated by Treasury and the IRS will disallow charitable contribution deductions for Golden State Credit Program participants? I’ve re-read the notice several times and I can’t find anything to that effect. Concededly, it’s possible that Treasury and the IRS will fashion a new federal tax law doctrine that distinguishes between Golden State Credit contributions and donations that have been deductible for decades. But that is certainly not what the Service said yesterday, and we do a disservice to state lawmakers and taxpayers if we tell them otherwise.
New Jersey Attroney General Press Release, AG Grewal to IRS: Stop “Playing Politics” with SALT Tax Guidance—or Face a Legal Challenge:
In a letter to IRS Commissioner David J. Kautter, Attorney General Grewal points out that the New Jersey tax credit law is similar to 100 laws enacted in more than 30 other states, and is consistent with longstanding IRS guidance and numerous court decisions that such contributions remain deductible. So “the IRS’s plan will upend over 100 state programs in a single rule—a nightmare for both states and the IRS.” Yet the IRS has given “no reason for [its] sudden about-face.”
“The IRS should not play politics. Instead, it must confirm its longstanding interpretation of federal law,” Grewal explains in his letter. “Should the IRS and Treasury Department continue down this path, New Jersey will have no choice but to challenge the new rule in court.” ...
The Attorney General contends that the IRS’s decision runs counter to the federal Tax Code, which makes plain that deductions are permissible for “any charitable contribution … payment of which is made within the taxable year.”
“The statute is explicit that such contributions include gifts given to state governments and their political subdivisions,” Grewal notes. “The only remaining issue is whether such gifts are deductible if the contributor gets a tax credit in return.” While the IRS has previously “answered that question resoundingly in favor of laws” like New Jersey’s, the latest guidance “suggests that the IRS plans to tell states and taxpayers alike the answer is no.”
“I ask you to think twice before going down that misguided road,” Grewal warns the IRS Commissioner. “The IRS’s longstanding approach, supported by precedent and policy, supports what New Jersey has done.”