Treasury Department Issues Final Regulations Limiting Charitable Deductions – Potential Impact on Alabama Donors?
By Bruce P. Ely and Brian T. Robbins, Bradley
Now that the dust has settled following the issuance of the final “SALT cap workaround” regulations by the Treasury Department, here’s a summary of those regulations, the IRS guidance issued in connection with the final regulations, and a set of proposed regulations that should be issued within the next two months. We have also provided some initial thoughts on the potential impact of these regulations on donors to qualified scholarship granting organizations (SGOs) operating in Alabama.
Unfortunately (in our opinion), the final regulations don’t differ materially from the proposed regulations. As David Thompson of the National Council of Non-Profits stated: “It blocks SALT workarounds, it limits the value of state tax credits, and even in stepping back from a very harsh draft proposal, it caused taxpayers during the last months of 2018 not to make donations to worthy … non-profits in communities throughout the country.” As did the proposed regulations, the final regs require individuals donating to a charitable organization and receiving a state or local tax credit to reduce their federal charitable deduction by the amount of that credit. Despite pleas from long-standing SGOs and similar organizations in 18 states, such as the non-profit Alabama Opportunity Scholarship Fund (AOSF), none of these organizations were grandfathered or carved-out. Thus, as a general rule, if an individual donor in Alabama makes a $1,000 contribution to an SGO, they would receive the $1,000 Alabama income tax credit but their federal charitable contribution deduction would be zero (with a couple of possible exceptions summarized below).
Simultaneously with the final regulations, the IRS issued Notice 2019-12, informal guidance offering a “safe harbor” for individual itemizers who have less than $10,000 of SALT to deduct and who donate to a qualified charity in the same year. In essence, individuals would receive a federal tax deduction for part of their donation, depending on the amount of their SALT deduction that year. Treasury and IRS also announced their plan to issue proposed regulations that combine the new notice with guidance issued in December 2018 (Revenue Procedure 2019-12) that allows “C” corporations and certain “specified passthrough entities” (PTEs) to continue to deduct donations to qualifying charities, even if the C corporation receives or expects to receive any sort of state or local tax credit (including a state income tax credit) or, in the case of PTEs, even if they receive a state or local tax credit that offsets an entity-level tax, such as a property or sales/excise tax. But the donation must qualifiy as an ordinary and necessary business expense under IRC § 162.
A number of tax practitioners and charitable organizations have requested that the scope of the upcoming proposed regs be expanded to include PTEs that receive a state or local income tax credit in return for their donation, provided the donation qualifies as a trade or business expense (e.g., promoting goodwill with a key customer or with the donor’s employees).
Two other aspects of the final regulations should be noted. First, they retained the rule that taxpayers aren’t required to reduce the amount of their federal charitable deduction if all they receive is a state tax deduction, rather than a tax credit. Additionally, the final regulations maintain the 15% de minimus exception for charitable contributions so that, for example, a $1,000 donation to a qualified SGO could generate a $150 state income tax credit and a $1000 federal (and state) charitable contribution deduction, provided that state law permits this.
In summary, there were likely winners and losers in the final regulations and related guidance:
|Most C corporation donors||
Most individual donors, post-2018
|Most PTEs receiving non-income tax credits in return for their donation (and perhaps PTEs that receive a state or local income tax credit, as described above)
|Potentially thousands of children from low-income families who rely on SGOs and similar non-profit organizations across the U.S. to provide scholarships, and those on lengthy waiting lists
|Individual taxpayers who have only moderate SALT deductions (less than the $10,000 cap for MFJ status)
|For 2018 only, individuals who made donations prior to the retroactive effective date of the final regulations(i.e., August 27, 2018)|
According to Lesley Searcy, executive director of our worthy client AOSF, “The final rules provide long awaited clarity to donors and financial professionals. The Alabama Opportunity Scholarship Fund has hundreds of students who need funding secured for the upcoming school year. We are depending on Alabama’s corporate and individual taxpayers to continue their support of low income students seeking better educational options. Without the donation of state income tax liability by taxpayers, our students will lose their opportunity to attend a school that works, feels safe, and where they have been thriving for years. More than $20 million in credits is available.” Thus, Ms. Searcy remains cautiously optimistic, but reminds us that the privilege and duty of funding these badly-needed scholarships for both existing and prospective students across the state now falls more heavily on C corporation and PTE donors (with the caveat above) than ever before. We continue to remind individuals, however, that donating to a qualified SGO in Alabama should continue to generate a dollar-for-dollar Alabama income tax credit (subject to certain limitations), even if in most cases donors won’t receive a federal tax deduction for the same payment any more.
Upcoming COST Southeast Regional State Tax Update
In cooperation with the influential Council On State Taxation (COST) in Washington, D.C., our firm and KPMG, LLP, are co-sponsoring the annual “COST Southeast Regional State Tax Update” in Birmingham on August 6, 2019. COST member-companies, as well as other companies in the region, should send their in-house tax officers and staff to this valuable seminar (sorry, tax practitioners may not attend).
The seminar will be held at the headquarters of Encompass Health Corporation in Liberty Park and will begin at 8:30 a.m. and adjourn no later than 4:00 p.m. In addition to “hot” SALT topics — including the impact of federal tax reform on the states, current SALT developments in the Southeastern states, state taxation after the Wayfair decision, and a review of state tax cases, issues and policy matters across the U.S. — Chief Judge Jeff Patterson of the Alabama Tax Tribunal will update us regarding the tribunal’s operations and recent decisions of potential interest.
For more information, please contact Tiffany Frazier at 202-484-5225 or tfrazier@COST.org.