The IRS remained largely silent during the first half of 2019 concerning the State and Local Tax (SALT) deduction issue, following the August 27, 2018 publication of its Proposed Rule concerning Contributions in Exchange for State or Local Tax Credits. Well, silent no more, the IRS on June 11, 2019 announced its follow through, issuing Final Regulations on the matter, published in the Federal Register June 13th. Several northeast states, infamous for disproportionately high property taxes, wasted no time in responding.
The final regulations, effective August 12, 2019, apply to contributions made after the August 27, 2018 publication of the proposed regulations. The final regulations largely adopt rules in the proposed regulations governing the availability of charitable contribution deductions when a taxpayer receives or expects to receive a corresponding state or local tax credit. The regulations, in both their proposed and final form, stifled the states’ 2018 legislative attempts to circumvent the new $10K SALT deduction cap implemented by the Tax Cuts and Jobs Act of 2017 (a/k/a The Federal Tax Reform Act).
While dozens of states have charitable fund programs providing for personal income tax credit in exchange for qualifying contributions, with most of those programs pre-existing last year’s federal tax code updates, only a few posed some concern from a mortgage servicing perspective. Namely, the 2018 legislative measures enacted in Connecticut, New Jersey and New York included provisions that effectively allowed for property tax credit in exchange for contributions to designated charitable funds; credits ranging anywhere from 70 to 95 percent of the taxpayer’s donation; credits potentially wreaking havoc with escrow administration.
And while the states still want to convince you that this is a viable solution to get around the SALT cap, the IRS has made it clear that it is not; its final regulations clarifying the application of quid pro quo and substance over form doctrines. Nonetheless, these three states have pushed back once again by filing suit against the IRS over the final regulation. The latest lawsuit was filed July 17, 2019 in U.S. District Court for the Southern District of New York; the same court hearing an earlier suit filed last year by these same three states, plus Maryland, challenging the new SALT cap itself.
Again, the final regulation in large part affirms and retains the proposed regulation’s assertion that a taxpayer making payments to an entity eligible to receive tax-deductible contributions must reduce the federal charitable contribution deduction by the amount of any state or local tax credit that the taxpayer receives or expects to receive in return and thereby renders the states’ workaround legislation ineffective in accomplishing the intended purpose of circumventing the SALT limits. In practical application, if a state grants a 90 percent state tax credit and the taxpayer “contributes” $10,000 to an eligible entity, the taxpayer receives a $9,000 state tax credit. Per the now finalized regulations, the taxpayer must then reduce the $10,000 contribution deduction by the $9,000 state tax credit, leaving an allowable contribution deduction of just $1,000 on the taxpayer’s federal income tax return. This effectively renders the Charitable Fund SALT workaround as pointless, having no effect in mitigating the SALT cap.
Given the verified lack of widespread local government and taxpayer engagement subsequent to the publication of IRS proposed regulations, despite the SALT workaround enabling legislation previously enacted in these three states, and given the fact that the 2018 federal tax filing deadline lapsed this past April with no known impact to escrow administration (i.e. no escrow-impacting property tax credits issued in exchange for donations), it is anticipated that the finalized regulations from the IRS should effectively deter local government and taxpayer appetite to further engage. Of course, that could change in the event of a favorable judgment arising from the related lawsuits now pending in federal court. However, the cases are expected to drag on for a while and, at least for now, the IRS final regulations disallow the state-legislated SALT workaround provisions.
Beyond the lawsuits, the IRS final regulations on this matter may very well stir up further creative efforts by the states to get around the SALT deduction cap. However, with all but a few state legislative sessions now adjourned or otherwise recessed for much of the remainder of 2019, we’ll have to wait until next year to see if there will be any further legislative pushback.
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