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Alliance of Arizona Nonprofits: Proposed Regulations on State & Local Charitable Tax Credits

The Alliance of Arizona Nonprofits released an advocacy alert:


"The U.S. Treasury Department and the Internal Revenue Service released draft regulations that change how the federal government will treat donations to charitable organizations that generate state or local government tax credits. The proposed tax regulations reportedly target new tax laws in Connecticut, New Jersey, and New York that seek to convert some state and local tax payments that are capped under the 2017 federal tax law into uncapped charitable deductions. As written, however, the draft would also apply to many programs in Arizona and other states that provide a state or local tax credit when a taxpayer makes a donation to certain nonprofits, such as school choice scholarship funds.
 
The proposal would require taxpayers to treat the value of tax credits like other benefits received when making a charitable donation, i.e., subtracting the value or cost of a meal at a charity gala from the charitable deduction. As explained in the Treasury Department news release pasted below, the value of a tax credit would have to be deducted from a taxpayer’s deduction. The proposal does not apply to state tax deductions for donations to charitable nonprofits, nor to programs that generate a tax credit of 15 percent or less. Notably, the proposed rule does not make a distinction between government-run nonprofits and public charities; donations to either that generate tax credits would have to be reduced by the value of the credit. This is a change from prior law that permitted full deduction of charitable donations that also allowed taxpayers to apply a tax credit based on that donation to reduce state taxes.
 
The proposed rule has a stated effective date of this coming Monday, August 27. Donations to nonprofits that currently generate Arizona tax credits would no longer be fully deductible as of that date. We understand that some CPAs are advising their clients to make donations to those Arizona nonprofits this weekend, before the tax treatment of the donations changes."


NOTICE FROM PRIMAVERA: Whether this proposal will affect our donors is contingent on their personal tax bracket, income, and other taxation facts. Therefore, we cannot predict whether this proposed change will affect any one individual donor. We do encourage you to reach out to your accountant, financial planner, or other tax advisor if you are concerned about your giving and its effect on tax planning.


DEPARTMENT OF TREASURY PRESS RELEASE
Treasury Issues Proposed Rule on Charitable Contributions and State and Local Tax Credits


Washington, D.C., August 23, 2018 - The U.S. Department of the Treasury today issued a proposed rule on the federal income tax treatment of payments and property transfers under state and local tax credit programs.  The proposed rule would prevent charitable contributions from being used to circumvent the new limitation on state and local tax deductions. 

The Tax Cuts and Jobs Act of 2017 (TCJA) limits the amount of state and local taxes (SALT) an individual can deduct to $10,000 a year. Several states have enacted or are considering enacting tax credit programs to circumvent the TCJA limit.

“Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families,” said Secretary Steven T. Mnuchin. “The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions. We appreciate the value of state tax credit programs, particularly school choice initiatives, and we believe the proposed rule will have no impact on federal tax benefits for donations to school choice programs for about 99 percent of taxpayers compared to prior law.”

The proposed rule is a straightforward application of a longstanding principle of tax law: When a taxpayer receives a valuable benefit in return for a donation to charity, the taxpayer can deduct only the net value of the donation as a charitable contribution. The rule applies that quid pro quo principle to state tax benefits provided to a donor in return for contributions. 

For instance, if a state grants a 50 percent credit and the taxpayer contributes $1,000, the allowable charitable contribution deduction may not exceed $500. The proposed rule provides an exception for dollar-for-dollar state and local tax deductions and tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred. These guidelines will apply to both new and existing tax credit programs.

Due to a major increase in the standard deduction, Treasury projects that 90 percent of taxpayers will not itemize under the new tax law. The proposed rule will not affect these taxpayers at all. Treasury estimates that approximately 5 percent of taxpayers will itemize and have state and local income tax deductions above the SALT cap. Those taxpayers will generally see no change in the level of federal tax benefits available to them before the TCJA, but will be unable to exploit the charitable deduction to avoid the SALT cap. 

Treasury expects that only about 1 percent of taxpayers will see an effect on tax benefits for donations to school choice tax credit programs.

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