Tax Reform and Non-Profits
IRS Issues Final Regulations Invalidating SALT Workaround Frameworks in NJ, other high cost-of-living states; NJ, NY, CT File Suit to Challenge Rules
Safe harbors allow certain credits of up to $10,000, providing relief for certain programs in other states
Updated July 30, 2019
The IRS has issued final regulations that would effectively invalidate the use of so-called “SALT workarounds” like those passed in New Jersey and other high-cost-of-liivng states to mitigate the impact of the federal $10,000 deductibility limit on state and local taxes (SALT), while providing “safe harbors” for some other programs.
As summarized by the National Council of Nonprofits:
- The final rule limits the federal tax deduction for certain charitable giving programs encouraged by state and local governments via tax credits.
- Individual taxpayers may claim a charitable deduction for only the amount of their donation that exceeds the value of any state or local tax credit. For example, a $1,000 donation that allows the taxpayer to claim a state tax credit of $400 (40%) may only be counted as a $600 charitable contribution for federal tax purposes.
- It doesn’t matter whether the recipient of the donation is a nonprofit run by a governmental entity or one operated independent of government, as is the case with most charitable nonprofits. But, …
- A safe harbor provision, added after the initial draft was proposed, clarifies that individual taxpayers may still claim the value of the tax credit ($400 in the above example) as an itemized deduction for state and local taxes paid, up to the capped amount of $10,000. Taxpayers who pay state and local taxes higher than the cap get no federal tax benefit for the value of the tax credit and may question the utility of contributing to programs at nonprofits that generate tax credits. Here’s another example: if someone donates $30,000 to a charter school in a state that offers a 50 percent state tax credit, the donor could deduct half as a charitable donation ($15,000), but could claim no more than $10,000 as a state and local tax deduction (and probably much less).
- The final rule does have limitations. It does not apply to dollar-for-dollar state tax deductions for donations to nonprofits, nor to programs that generate a tax credit of 15 percent or less. The rule only applies to donations by individuals; it does not apply to corporate donations, which are treated more favorably (see IRS Rev. Proc. 2019-12).
In short, the new rules effectively invalidate New Jersey’s program since the “safe harbor” only applies up to $10,000, and because the tax credit-for-donation exchange is viewed by the IRS as a “quid pro quo,” which it has long held is not eligible for a deduction as a charitable contribution.
As a reminder, SALT deductions — like charitable contribution tax deductions and many others — are only available to taxpayers who itemize on their returns, so these regulations have no impact on non-itemizers.
Background
The federal tax law which took effect January 1, 2018, caps federal deductibility of state and local taxes to $10,000, an amount lower than many New Jersey taxpayers have actually claimed in prior years. Legislation designed to help New Jersey property owners by providing a mechanism to exceed the SALT cap was signed into law May 4, 2018, by Governor Murphy (P.L. 2018, c. 11). The state’s law would allow taxpayers to offset their property tax bills by “donating” to specific funds created by municipalities or school districts. The basic premise is that since the charitable giving tax deduction is not capped under the new tax law, taxpayers who itemize deductions on their federal returns would be able to circumvent the $10,000 SALT limits. Creation of these local funds by municipalities or school districts is optional and not mandatory under the state law.
While some hailed the measure as a way to provide relief to taxpayers hit hard by the federal tax law, there were questions about the framework that it would create. (Read our 2018 analysis of the SALT workaround legislation here.) The New Jersey Department of Community Affairs adopted regulations on September 21, 2018, to implement the state’s law, but towns have been reluctant to participate in light of the uncertainties regarding whether the framework would pass muster with the IRS.
The IRS’ regulations proposed last August would have not only prohibit New Jersey’s framework but would also have invalidated a wide array of differently-structured tax incentive programs in more than 30 other states. The final rules alleviate some – but not all – of those other states’ concerns, while leaving the prohibition against New Jersey’s framework unchanged.
On July 17, 2019, the Murphy Administration, which had vowed to mount a legal challenge if the IRS blocked the framework in its final regulations, filed suit in the U.S. District Court for the Southern District of New York, seeking to have the regulations invalidated. The states of New York and Connecticut also joined in the suit.
[Related: More background about the new federal tax law and New Jersey Non-Profits]
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