IRS SALT regulation allows loophole for pass-through businesses

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A proposed Internal Revenue Service regulation may allow owners of pass-through businesses to turn a profit on donations to private school groups and avoid the $10,000 cap on state and local taxes.

Pass-through businesses would be able to profit on their donations by classifying their payments as deductible business expenses rather than charitable contributions.

The proposed regulation published Dec. 17 is a follow up by the IRS on a regulation it finalized last June to prevent charitable donations to be used a workarounds for the $10,000 SALT cap that was part of the December 2017 Tax Cuts and Jobs Act.

Last year’s regulation addressed state tax credits enacted by New York and New Jersey as workarounds for paying property taxes and state income taxes.

The June 2019 regulations limit a taxpayer who claims a state tax credit to claiming only the portion of their charitable donation not covered by the state.

The public comment period on the new regulation ended Friday with mostly parents of learning disabled children in South Carolina among the 42 letters that were received.

The proposal allows people who make donations to private schools to use the $10,000 SALT deduction even though those payments aren’t made to a state or local government.

However, concerns about another provision has raised concern about a loophole for pass-through businesses. Most US businesses are taxed as pass-through (or flow-through) entities that, unlike corporations, are not subject to the corporate income tax or any other entity-level tax, according to the Tax Policy Center.

Separate letters filed by the liberal-leaning Institute on Taxation and Economic Policy in Washington as well as Americans United for Separation of Church and State focused on that aspect of the proposed regulation.

A public hearing on the proposal is scheduled for Feb. 20 at IRS headquarters in Washington.

Carl Davis, research director for the Institute on Taxation and Economic Policy commended the overall IRS proposal as an attempt to “tie up some of the loose threads” that last year’s regulation did not cover.

“This is building on what was already finalized last year,” Davis said in an interview. “What was being dealt with last year was taxpayers getting a state tax credit and then still writing off their payment as a charitable donation. So the IRS changed the charitable regulations to deal with that.”

The new proposed regulation deals with a parallel issue involving pass through businesses that claim a state tax credit and also claim a federal business expense.

“They would be writing their SALT payments as business expenses,” said Davis.

The IRS published proposed Regulation 107431-19,“Treatment of Payments to Charitable Entities in Return for Consideration,” on Dec. 17.

Americans United for Separation of Church and State said in its letter “the language in this proposed rule could allow certain businesses to continue to turn a profit by donating to state tax credit voucher private school voucher programs.”

“We urge the department to revise the proposed regulation to ensure that no donor may receive tax benefits by donating to private school voucher programs,” the group said.

The $10,000 limit on the SALT deduction caused an estimated 10.88 million individual taxpayers to lose $323.1 billion in tax deductions for the 2018 tax year, the Treasury Inspector General for Tax Administration reported in February 2019.

The impact has been the greatest in high income, high tax states where many residents pay substantial property taxes and income taxes.

State laws that created tax credits of up to 100% for private school donations are a separate controversy that predated the SALT cap.

Only six states of the 18 that have these tax credits prohibit donors from simultaneously claiming a state tax credit and a federal charity deduction.

Two major banks — Ohio-based Fifth Third Bank and Wells Fargo — recently announced they are ending their financial support of Florida’s private school voucher program because of reports of discrimination against LGBTQ students.

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