Revenue Procedure 2019–12 Provides Taxpayer Guidance on Payments to a Section 170(c) Charity in Exchange for State and Local Tax Credits

The Internal Revenue Service (IRS) has issued guidance, Rev. Proc. 2019-12, that provides safe harbors for C-corporations and certain pass-through entities that make payments to a section 170(c) charity in exchange for state and local tax (“SALT) credits. The revenue procedure states that such payments may be treated as ordinary and necessary business expenses. Note: a section 170(c) charity is an organization for which a taxpayer receives a charitable contribution deduction if a donation is made to the organization. Section 170(c) charities include public charities and governmental entities.

The federal 2017 Tax Cuts and Jobs Act limits the amount an individual taxpayer may deduct for state and local taxes to $10,000 ($5,000 for individuals who file married filing separately).This limitation applies for tax years beginning after December 31, 2017, but it does not apply to taxes paid in conducting a trade or business that would be deductible under section 162 of the internal revenue code.

Since the enactment of this limitation, states have sought ways to enable taxpayers to avoid this limitation, one of which included the grant of a state income tax credit in return for a donation to a section 170(c) charity. In response, Treasury and the IRS issued initial guidance, providing that if a taxpayer makes a payment to a section 170(c) organization and expects to receive a SALT credit in return, then the amount of the charitable contribution deduction will be reduced by the amount of the credit.

After this guidance was released, Treasury and the IRS received many questions regarding the application of this rule to SALT credit programs, whereby a business taxpayer made payments to section 170(c) charities, received a SALT credit, and deducted the payment under section 162 as a business expense. Rev. Proc. 2019-12, which is effective for amounts paid on or after January 1, 2018, provides guidance on these questions in the form of safe harbors.

In general, the Rev. Proc. 2019-12 provides the following safe harbors:

• For C corporations: If a C corporation makes a payment to or for the use of an organization described in section 170(c) and receives or expects to receive a tax credit that reduces a state or local tax imposed on the C-corporation in return for such payment, the C corporation may treat such payment as meeting the requirements of an ordinary and necessary business expense for purposes of section 162(a), to the extent of the credit received or expected to be received.

• For a specified pass-through entity: A specified pass-through entity is an entity other than a C- corporation that operates a trade or business within the meaning of section 162, that is subject to a state or local tax incurred in carrying out its trade or business that is imposed directly on the entity, and in return for a payment to a section 170(c) charity, the entity expects to receive a credit that offsets said SALT. If a specified pass-through entity makes a payment to or for the use of an organization described in section 170(c) and receives or expects to receive a tax credit that the entity applies or expects to apply to offset a state or local tax other than a state or local income tax, the specified pass-through entity may treat such payment as meeting the requirements of an ordinary and necessary business expense for purposes of section 162(a) to the extent of the credit received or expected to be received.

Rev. Proc. 2019-12 specifically provides guidance to C corporations and pass-through entities that pay an entity-level state or local tax. It is important to note that for pass-through entities, the credit must be for a tax other than a state or local income tax. In other words, the credit must be for a property tax, a franchise tax, or any other tax that isn’t an income tax. Either way, the Rev. Proc. does provide important guidance and ensures that the many already existing SALT credit programs can still function as originally intended.

For more information, please contact Brian Newman, Tax Office Department Head, at Brian.Newman@CohnReznick.com or (959) 200-7009 or Stephen Gregory, Director, at Stephen.Gregory@CohnReznick.com  or (959) 200-7021.