The federal Department of Treasury and Internal Revenue Service (IRS) released a final rule on June 13, 2019 regarding federal tax treatment of charitable giving when donations also generate state and local tax credits. The rule will take effect on August 12, 2019.
About the rule
Similar to the proposed regulation released in October of 2018, an individual taxpayer claiming the charitable deduction may not deduct the portion of a donation that generates a state or local tax credit.
Unlike the proposed regulation, there is a safe harbor provision. Individual taxpayers can deduct the value of the tax credit under the State and Local Taxes (SALT) deduction up to the $10,000 cap.
- A itemizing taxpayer who makes a $1,000 donation to a child care facility and claims the 50% Child Care Contribution Credit (CCCC) ($500) on Colorado taxes would only be able to claim $500 of the donation as part of the taxpayer's federal charitable deduction. However, the taxpayer could claim the remaining $500 as part of the taxpayer's SALT deduction if SALT liability is less than $10,000.
- A non-itemizing taxpayer who gives $1,000 and claims CCCC would still be able to claim this 50% credit on state taxes ($500) . Because the taxpayer claims the standard deduction, the taxpayer would not be able to deduct the contribution on federal taxes under the charitable deduction or SALT deduction.
Like the proposed rule, this does not apply to state or local tax deductions or state of local programs that generate tax credits of 15% or less.
The change will affect the 5 to 15 percent of taxpayers that make charitable contributions and continue to itemize despite the standard deduction increase in the Tax Cuts and Jobs Act.
According to a research paper entitled State Responses to Federal Tax Reform, the rule is expected to apply to at least 7 tax credits in Colorado including CCCC, the credit for contributions to Enterprise Zone projects, and the Gross Conservation Easement Credit.
How the rule affects giving
The National Council of Nonprofits indicates that the impact may be limited for nonprofits in low-tax states and those that usually receive donations from low to middle income taxpayers. However, the proposed regulation would have applied to contributions made after August 27, 2018. Taxpayers could have increased their donations prior to August 27, 2018 in anticipation of the new rule or held off making contributions while the rule was pending. Potentially, taxpayers who made contributions and claimed state tax credits after August 27, 2018 could file amended tax returns to take advantage of the safe harbor.
Our initial review of 2015 Colorado tax data suggests how this change might impact giving to nonprofits that benefit from these tax credits. The change would clearly impact taxpayers with incomes of $200,000 or more who deduct more than $10,000 in state and local taxes. These taxpayers represent only 16% of all taxpayers claiming the SALT deduction.
However, in looking at specific tax credits affected by the program, it appears that high income taxpayers claimed most of the dollar amount of credits offered through these programs despite being less than half of the number of donors in 2015. Because of their high incomes, these taxpayers will most likely still benefit from the federal charitable deduction for their gifts but how they give could be influenced by the more favorable approach for their taxes.
In other words, they may have to choose between taking a state tax credit and a reduced chairtable deduction versus taking the charitable deducton and forgoing state tax credit programs. Taxpayers who previously itemized could still give more via state tax credit programs to increase their state tax savings.
2018 Proposed IRS regulations
On October 11, 2018, the IRS concluded a comment period on regulations that reduce the charitable deduction for individual taxpayers who itemize their federal tax deductions and benefit from state or local tax credits for giving. The rule would apply to contributions made after August 27, 2018.
The proposed regulations are intended to address new laws in several other states to work around the new $10,000 limit on the federal itemized deduction for state and local taxes (SALT). Those laws would essentially allow taxpayers to make certain state and local tax payments in the form of charitable contributions to nonprofits formed by state and local governments. As a result, those taxpayers would be able to deduct state and local taxes in excess of $10,000 via the charitable deduction.
But the regulations not only affect these government agencies or government-formed charities, they require individuals who make payments, or transfer property to nonprofits, to reduce their federal charitable deduction by the amount of any state or local tax credits they claim for charitable giving.
The regulations propose treating the value of tax credits like other benefits donors may receive when making a gift - e,g. subtracting the value of the cost of a meal at a charity gala from the tax-deductible contribution.
Visit Leaffer Law Group, for a helpful article explaining the rationale for the proposed change.
Our comments on the proposed regulation
Colorado Nonprofit Association submitted written comments on the proposed regulation.