On June 11, 2019, Treasury and the IRS issued final regulations that prohibit taxpayers from avoiding the $10,000 cap on itemized deductions for state and local taxes that was imposed by the Tax Cuts and Jobs Act of 2017.
The IRS also issued a notice providing safe harbor relief for taxpayers that already engaged in one of the state-sponsored, charitable contribution workarounds that are now prohibited under the final regulations. Under the safe harbor, taxpayers that itemized deductions and made a charitable contribution to a state entity in return for state and local tax credits generally may treat the portion of such contribution that is disallowed under the final regulations as a payment of state or local taxes for purposes of section 164. The disallowed portion can be treated as a state or local tax payment when and to the extent a taxpayer applies the credit to offset its state or local tax liability.
The Tax Cuts and Jobs Act of 2017 generally imposes a $10,000 aggregate limit on taxpayer’s ability to deduct residential real estate taxes and state and local income taxes as part of their itemized deductions. In response to this change, which affects residents of high-tax states more than residents of low-tax states, some states enacted programs that allow taxpayers to make charitable contributions to state-owned entities in exchange for state and local tax credits equal to all or some portion of the amount of the charitable contribution. The goal of these programs was to change the nature of the payments from state and local tax payments, which are limited to $10,000 per year, to charitable contributions, which are not limited by the $10,000 cap. The IRS announced in the past that it did not approve of these programs, and these final regulations are its official response to prevent taxpayers from circumventing the $10,000 deduction limitation.
The final regulations were issued under section 170 of the Internal Revenue Code, which deals with charitable contributions. Thus, the regulations generally attack the problem by preventing taxpayers from receiving a deduction for charitable contributions if they receive or expect to receive a corresponding state or local tax credit in return for the contribution. Because the IRS’ approach could be viewed as overly harsh, it simultaneously published a notice that provides relief for certain taxpayers that contribute to one of the state-sponsored programs.
These final regulations do not affect the programs adopted in New York and Connecticut that contain workarounds other than through charitable contributions.
This summary is general in nature, and does not discuss every aspect of the final regulations, including the taxpayer-friendly 15-percent exception. For more information on this exception, or any other aspect of the final regulations or the safe harbor, please fill out the form below.
Author: Daniel Mayo, JD, LLM, Principal | [email protected]
State and Local Tax Services
How Can We Help?