Businesses Entitled to Deduct Charitable Contributions Received in Exchange for SALT Credits

One of the more controversial provisions of the Tax Cuts and Jobs Act (TCJA) of 2017 was the addition of 26 U.S. Code § 164(b)(6), which capped the tax deduction for state and local taxes (SALT) paid by an individual to $10,000 per year ($5,000 for married taxpayers who file separately) beginning January 1, 2018.

Since then, taxpayers have sought ways to avoid that limitation.

In August 2018, the U.S. Treasury Department issued proposed regulations that effectively blocked state proposals aimed at circumventing the federal SALT cap by requiring that taxpayers reduce their charitable deduction by the amount of any state tax credit they received in exchange for their gift. This rule did not apply to SALT incurred in carrying on a trade or business.

Frequently asked questions and answers

In the months that followed, taxpayers and their advisers submitted questions regarding the application of these regulations (and the tax reform) to businesses that make contributions to charitable or government entities pursuant to state and local tax credit programs. They asked whether businesses were entitled to deduct these payments as ordinary and necessary business expenses under 26 U.S.C. § 162.

In response, on September 5, 2018, the IRS published an FAQ document that responded to these inquiries. That document clarified that any type of business may deduct payments made to a charity described in 26 U.S.C. § 170(c) as ordinary and necessary business expenses under Section 162 if the payment to that charity is made with a business purpose. Section 170 charities include both public charitable organizations and government entities.

Questions continued to come in regarding the application of the proposed regulations, Section 162, and Section 164. These were further addressed in Rev. Proc. 2019-12, which applies to payments made as of January 2018:

Safe harbors for C corporations and pass-through entities

Safe harbor provisions in laws and regulations shield taxpayers from liability or penalties if certain conditions are met. The safe harbor provisions that allow businesses to retain the state and local tax deduction for charitable contributions are specified in Rev. Proc. 2019-12 as follows:

A C-corporation may treat contributions made to Section 170(c) qualifying charities in exchange for SALT credits as ordinary and necessary business expenses under Section 162(a) to the extent of the credit received (or expected to be received).

A pass-through entity that is subject to state and local taxes in carrying out its trade or business may also treat payments to Section 170(c) charities as Section 162(a) ordinary and necessary business expenses to the extent of the credit received (or expected to be received). Deductions for pass-through entities is determined at the level of the individual owners and may be applied to property, franchise, and other local taxes, but not to state and local income tax payments.

Moskowitz, LLP Business Tax Group

The attorneys and accountants at Moskowitz, LLP’s Business Tax Group aim at developing strategies that minimize our client’s income tax liability on the federal, state and local levels. To learn more, contact our San Francisco offices today at (415) 394-7200.