How IRS SALT rules could jeopardize other tax credits

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WASHINGTON – UCLA Law Professor Kirk Stark predicts the federal deductibility of state tax credits for private as well as public schools will be in jeopardy if the Internal Revenue Service proposes rules disallowing charitable contributions for workarounds of the new $10,000 limit on the federal household deduction for state and local taxes.

Stark told The Bond Buyer that he can’t imagine how the IRS could prevent households from making federally deductible contributions to public schools unless it also prevents deductions for contributions to private and charter schools.

“There is very little meaningful distinction between a state that uses a tax credit to help fund public schools and a state that uses a tax credit to help fund private schools,” he said.

The IRS last week announced it will issue regulations to “assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.”

The IRS announcement came in response to recently enacted state laws in New York, New Jersey and Connecticut providing workarounds of the $10,000 annual cap that began Jan. 1 under the Tax Cuts and Jobs Act.

All three states have created charitable funds into which taxpayers can make contributions to offset a high percentage of their state and local taxes, including school taxes.

The IRS has not yet issued its proposed regulations, but in the past the service has accepted the federal deductibility of numerous tax credits offered by states.

“I think they have found themselves in a box because there are programs in 18 states to fund school vouchers,” said Stark, who co-authored a scholarly paper published in January along with seven other law professors on 113 different tax credits offered by 33 states that are also federally deductible.

“If the regulations are simply taking a shot at one particular type of situation and not treating identical situations comparably, that makes it more likely a court will scrutinize them and regard them as arbitrary and capricious,” he said.

Georgia began offering a tax credit for donations to public schools in January in addition to the one it already provides for donations to scholarship organizations to pay for tuition at private schools.

‘It’s hard to imagine the service crafting regulations that would treat those two credits differently,” Stark said, referring to the Georgia tax credits. “I think that’s going to be one of the dimensions along which this is going to be a very hard nut to crack.”

At stake is the current balance – which Stark labeled it as “equipoise” – between the deductibility of charitable donations made to the private sector versus government entities.

“You can make a gift to the Treasury Department, to the federal government if you want,” Stark said. “People give gifts all the time to [Veterans Affairs] hospitals or to the National Parks. And the federal government itself is providing a tax subsidy for those gifts. There’s never been any suggestion anywhere in the 100 plus years that we’ve been dealing with this, that somehow the fact that the federal government is giving a deduction when you give a gift to the National Parks system that somehow that deduction should be limited in some way.”

In an interview last week, Jared Walczak, a senior policy analyst at the Tax Foundation, said the new state workarounds are different from the earlier charitable credits.

“For something to be considered genuinely a charitable contribution for the purposes of the deduction, it needs to both have some degree of charitable intent and it needs confer a charitable benefit,” Walczak said. “When a credit is provided by the state for a contribution to a third party, there is still a charitable benefit. When the state provides the credit and is the recipient, then there is no benefit or it is a very small one.”

Stark disagreed. “I know there are some people who for either ideological or political reasons would like to have that feature in the law, but there certainly is not that feature,” he said.

Internal Revenue Code Section 170(c) enumerates entities that are entitled to receive deductible charitable contributions, Stark said. Section 170(c)(1) specifically mentions states and their political subdivisions.

“They are either going to have to issue a regulation that is brazenly political or they are going to have to bite the bullet and go with what the law is,” he said.

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Tax reform Tax cuts Tax deductions State and local finance Government finance IRS Washington DC