Proposed IRS Regulations & State and Local Tax Cap

September 20 2018 | by Christine Ryer, CPA

Fast Tax Facts2018 has been a year full of twists and turns when it comes to state and local tax (SALT). Most recently, the IRS issued proposed regulations on August 23, which address the endeavors by state and local governments to work around the new state and local tax deduction cap, issued under the Tax Cuts and Jobs Act (TCJA).

States Feel the Burn

The SALT deduction cap is one of the most controversial aspects of the Tax Reform Act. Beginning in 2018, an individual’s deduction of state and local tax is limited to $10,000 (or $5,000 if married filing separately). In particular, taxpayers in states with high property and income tax rates, such as CT, NJ, and NY, are facing a larger burden.

Several state governments have gotten creative and passed laws that attempt to circumvent the new SALT cap. For example, CT has enacted a new, mandatory pass-through entity tax and related credit, while NY has created an optional payroll tax. Another strategy states are utilizing is to allow individuals or businesses to receive a tax credit for charitable contributions deductions to funds controlled by state governments, or in exchange for donations to tuition programs.

Credit Where Credit is Due

The proposed IRS regulations indicate that a SALT credit taken for charitable contributions is considered the receipt of a “quid pro quo benefit.” Therefore, payments or transfers of property made to a Section 170 (c) entity (gift to the state made for public purposes) must reduce a charitable contribution deduction if a state and local tax credit is received in return. This would be effective for contributions made after August 27, 2018. Therefore, deductions under Section 170 are not permitted for charitable contributions to state government administered funds, to avoid the SALT deduction limits.

However, in response to taxpayer inquiries, on September 5, the IRS issued IR-2018-178, clarifying that while charitable contribution deductions are disallowed for individuals contributing to state-run funds in exchange for SALT credits under the proposed regulations, the expenses are able to be deducted by businesses, if classified as ordinary and necessary business expenses under Section 162. The business expense deduction is available to any business taxpayer including sole proprietors and partnerships.

This is good news for taxpayers. According to an article featured in Accounting Today, “The IRS clarification makes clear that the longstanding rule allowing businesses to deduct payments to charities as business expenses remains unchanged under the Tax Cuts and Jobs Act,” said Treasury Secretary Steven T. Mnuchin in a statement. “The recent proposed rule concerning the cap on state and local tax deductions has no impact on federal tax benefits for business-related donations to school choice programs.” Pennsylvania EITC credits would be deductible for federal purposes under the current issued guidance. The IRS is still accepting comments on the proposed regulations.

Next Steps

Keeping up with the ins and outs of state and local tax can be an uphill battle for many companies, so our SALT team continuously monitors the states’ methods of handling the SALT cap workarounds and the related federal guidance on the matter. To ensure business payments are characterized properly to qualify for deductions and review any applicable limitations, contact a member of our team for a SALT consultation. And for a deeper look at top of mind SALT issues, join us for our complimentary upcoming 30-minute State and Local Tax Update.

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