Irs Issues Final Regulations on the Deductibility of Charitable Contributions Which Generate State and Local Tax Credits

This week the IRS issued T.D 9864, the final regulations on the deductibility of charitable contributions which generate state and local tax credits.  Under a state and local tax credit program, some states give taxpayers a credit against their state and local taxes of some percentage or dollar amount of their donation to a specific charity.  These programs are prevalent in states with income taxes - they generally don’t apply to Washington residents with no activity outside the state.

For most individuals, prior to 2018, the deductibility of charitable contributions and state and local taxes were the same.  The issue of whether a charitable contribution which generates a state and local tax credit is considered A) a charitable contribution or B) a state and local tax payment received little attention.  The Tax Cut and Jobs Act (TCJA) introduced a $10,000 ($5,000 if married but filing separate returns) ceiling on the amount of state and local tax that individual taxpayers can deduct on their returns.  As the TCJA’s limitation affects many taxpayers, the need was created to more clearly define the deductibility of a contribution which generates state and local tax credits - as no such limit exists for charitable contributions.

The final regulations characterize the amount of a charitable contribution which generated a corresponding state and local tax credit as state and local taxes subject to the TCJA’s limitations.  Conceptually this is very similar to the rules regarding the deductibility of charitable contributions when you receive something in return.  If you were to buy an item at a charity auction for $100 whose value is $75, your charitable contribution is limited to $25 ($100 paid - $75 value).  Similarly, if you donate $100 to charity and receive a $75 state tax credit, your may deduct $25 as a charitable contribution.  However, unlike the charity auction purchase, the $75 is still deductible as it is characterized as a state and local tax payment.  Whether this $75 results in a tax reduction then depends on whether the taxpayer has already exceeded the TCJA’s limitation.  There is an exception from this rule if the tax credit doesn’t exceed 15% of the donation amount

Regardless of the Federal tax regulations, state and local tax credit programs do continue offer attractive state and local tax reduction opportunities through targeted charitable giving.  These final regulations simply clarified that these state and local tax credit programs do not provide a workaround for the TCJA’s state and local tax limitation. 

If you have questions either about the new regulations or whether state and local tax credit programs may be beneficial to your overall tax plan, please get in touch!