TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, September 20, 2018

Grewal: When IRS Guidance Backfires

Andy Grewal (Iowa), When IRS Guidance Backfires, 36 Yale J. on Reg.: Notice & Comment (Sept. 7, 2018):

This week, the IRS tried to clarify how proposed regulations on state tax credit programs apply to Section 162(a) business deductions. But its attempted clarification has created only more problems.

Under the proposed regulations, a taxpayer who makes a transfer to a Section 170(c) organization must reduce her charitable contribution deduction by the amount of any state tax credits received. See Prop. Reg. § 1.170A-1(h)(3)(i). Some businesses contacted the IRS and presumably expressed concerns that transferred amounts might not be deductible at all. That is, if Section 170 deductions were denied for creditable transfers, then Section 162 deductions might be denied too.

In IR-2018-178 (Sept. 5, 2018), the IRS cryptically announced that “taxpayers who make business-related payments to charities or government entities for which the taxpayers receive state or local tax credits can generally deduct the payments as business expenses.” See also IRS State and Local Income Tax FAQ. The IRS did not provide any further guidance on when a transfer to a state tax credit program will qualify as “business related.”

Existing authorities suggest a high standard. Under Treas. Reg. § 1.170A-1(c)(5), transfers to Section 170(c) organizations may be deductible under Section 162 only when they “bear a direct relationship to the taxpayer’s trade or business” and “are made with a reasonable expectation of financial return commensurate with the amount of the transfer.” Thus, for example, when a company makes a transfer to a Section 170(c) hospital in exchange for “a binding obligation on the part of the hospital to provide hospital services and facilities for the company’s employees,” the company will enjoy a Section 162 deduction. See Treas. Reg. § 1.162-15(a)(2).

It is far from clear how this regulatory framework applies to state tax credit programs. And it may be challenging for a taxpayer to show why a creditable transfer to, for example, a school choice program bears a “direct relationship” to the taxpayer’s business. But Secretary Mnuchin assured taxpayers that recent statutory amendments had “no impact on federal tax benefits for business-related donations to school choice programs.” ...

My prior post noted that the proposed regulations suffer from gaps and conceptual flaws that will confuse taxpayers, and the IRS’s latest guidance makes things even worse. One hopes that the agency actively incorporates public feedback as it proceeds through the rulemaking process.

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