Washington—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.