The Treasury Department recently issued proposed regulations addressing the availability of charitable deductions when taxpayers receive or expect to receive corresponding state or local tax credits for contributions. The proposed regulations require a taxpayer who makes a contribution to a charitable organization to reduce his charitable deduction by any state or local tax credit that he receives or expects to receive.
Taxpayers have traditionally been allowed itemized deductions for paying state and local taxes. The Tax Cuts and Jobs Act enacted last year, however, caped the deduction for payments of state and local taxes at $10,000. This cap hits taxpayers in high tax states like New York, New Jersey, and California hardest because many taxpayers in those states pay over $10,000 in state and local taxes. These states have attempted to circumvent the $10,000 cap by considering or passing new state and local tax credit programs. The programs give taxpayers who make charitable contributions to state or local tax credit programs state or local tax credits, while also being designed to create federal charitable deductions for the same contributions.
The proposed regulations put an end to this strategy by limiting any federal charitable deduction by the state or local tax credit a taxpayer receives or expects to receive. For example, suppose an individual pays a charitable organization $1,000. In exchange for the payment, the individual receives a 70% state tax credit. Under the proposed regulations, the individual’s charitable deduction is reduced by $700 (70% of $1,000) for federal tax purposes. He may only take a $300 charitable deduction on his federal return.
The proposed regulations are in line with the Supreme Court’s charitable contribution jurisprudence. The Supreme Court has held that a charitable contribution is a transfer of money or property without adequate consideration. As a result, a payment is not a charitable contribution if the contributor expects a substantial benefit for the payment. See United States v. American Bar Endowment, 477 U.S. 105, 116-118 (1986); see also Singer Co. v. United States, 449 F.2d 413, 422-423 (Ct. Cl. 1971). Taxpayers who receive state or local tax credits for contributions receive substantial benefits for their contributions, so they are not entitled to charitable deductions.
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