IRS Issues Final Regulations on Contribution State Tax Credit Offsets

June 17, 2019 | Article

Last August, the IRS released proposed regulations on charitable contributions in exchange for state and local tax credits.

We described the proposed changes in our insight and noted, in particular, that the effective date provided an extremely short three day window of opportunity to make contributions that would not be subject to the newly issued rules.

On Tuesday, June 11, 2019, the U.S. Department of Treasury and the IRS finalized the proposed regulations issued last August.

By most measurements, the final version of these regulations follows the proposed version. The requirement to reduce a tax deductible charitable contribution made by a taxpayer, including trusts and decedent’s estates, by any state tax credit received for making the contribution, was retained in the final version.

In addition, the 15% de minimis exception was retained. This exception provides that if the state credit received for making a charitable contribution is not more than 15% of the amount contributed, then there is no requirement to make the reduction in the charitable contribution amount.

And, as we advised in our earlier insight, the final version of regulations retain the date of August 27, 2018, as the date to measure application of these new rules. Any contribution made after August 27, 2018, will be subject to the final regulations, which are effective on August 12, 2019, 60 days after the date they were published in the federal register. The Treasury and the IRS reasoned, in holding firm on the August 27, 2018 date, that to do otherwise would provide too much opportunity to plan around the changes being made in the regulations.

Expect more information to be forthcoming from the IRS on their decision process concerning the many comments they received on the proposed regulations suggesting changes or waivers be made or given.

For example, the new rules, according to information provided by the IRS last August, were introduced to offset actions that were being taken by many states to lessen the effect of the state tax deduction being limited to a maximum amount of $10,000. However, in making the new regulations change, there was no exception or waiver provided for state tax credit programs that were in full operation prior to the change in the Tax Cuts and Jobs Act reducing the allowable state tax deduction. This raised the question, how could they have been established to provide a means to offset the new limitation on state tax deduction?

Although many comments were received questioning the lack of a waiver or exception for pre-existing state tax credit programs, the IRS did not see the need to treat those programs differently, noting that the result for them, and the taxpayers giving to those pre-existing programs, will get the same tax results as a new state tax credit program specifically formed to offset the loss of state tax deductions. In light of the high comment level for this area of interest, anticipate the IRS providing more information on their decisions, but don’t anticipate them changing their mind.

However, there is something new in the final version of the regulations. A safe harbor position that was posted by the IRS in Notice 2019-12 has been incorporated into the final regulations. The safe harbor provides some relief, “in certain circumstances,” to itemizing taxpayers who have:

  • less than $10,000 in total state and local taxes for the year.
  • made a charitable contribution for which a state tax credit is received.

The benefits of this provision can be described as follows: An itemizing taxpayer contributes $1,000 to a charitable program that allows a 60% state tax credit for making the contribution. The charitable contribution would therefore, under the final regulations, be reduced to $400. But, if the taxpayer was only otherwise deducting $8,000 of state taxes, the disallowed charitable contribution would be available for deduction as state tax, increasing the taxpayer’s state tax deduction to $8,600. And, it is good to be reminded, the increase in state tax deductions by the disallowed charitable contributions remains subject to the $10,000 maximum limitation.

Finally, if you have filed a 2018 tax return that handles a charitable contribution and state tax credit or deduction differently than described in the final regulations, an amended return should be considered. The IRS has shown a lot of interest in this area of tax change and is most likely not going to reverse that position.

If you have any questions, please contact your Eide Bailly professional.

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