SALT workarounds: Treasury provides safe harbors in latest regulations
Amid their efforts to curb workarounds to the $10,000 limit on state and local tax (SALT) deductions, the Department of the Treasury released final regulations (TD 9907) on Aug. 7, 2020, that largely adopt the proposed regulations issued in December 2019 and provide safe harbors for payments made to certain charitable organizations.
Read on for our overview of the final regulations, which are effective as of Aug. 11, 2020.
The Tax Cuts and Jobs Act (TCJA) limited the federal income tax deduction taxpayers can take on their SALT payments to $10,000. Numerous states have passed legislation to enable a workaround whereby taxpayer payments could be converted from SALT payments to charitable contributions.
Under these workarounds, taxpayers could contribute money to SALT-run funds used for state and local government purposes, and in exchange they would receive credits against their state and local taxes. The theory was for taxpayers to receive deductions for contributions made to these SALT funds for federal income tax purposes and then also receive a tax credit for their state and local tax obligations. In this way, state and local authorities sought to circumvent the $10,000 limit.
The Treasury Department and IRS moved quickly to curb such workarounds, proposing regulations in the summer of 2019 to quell this activity. The regulations only permit a deduction for federal income tax purposes for contributions in excess of SALT credits received by the taxpayer.
The finalized regulations released August 7 further clarify certain points and provide safe harbors for certain taxpayers.
Safe harbor for certain entities to treat payments as IRC Section 162 expenses
A safe harbor is provided for C corporations and specified pass-through entities that receive SALT credits in exchange for cash or cash equivalent payments made to certain charitable organizations. Should the entity satisfy the safe harbor, the portion of the payment equal to the amount of the credit may be treated by the entity as an ordinary deduction under Internal Revenue Code (IRC) Section 162, instead of as a charitable contribution. However, the safe harbor does not apply to specified pass-through entities if state or local income tax liability is reduced by the credit received. The safe harbor for specified pass-through entities only applies to entity-level taxes that a state may impose.
The safe harbor applies to payments or transfers made after Dec. 17, 2019, though it may be applied at the taxpayer’s choice to those made after Jan. 1, 2018.
Safe harbor for itemizing taxpayers with disallowed charitable deductions
The final regulations also clarify certain instances in which an itemizing taxpayer’s charitable contributions are disallowed. Should an itemizing taxpayer make a charitable contribution in exchange for SALT credits, but the contribution is or will be disallowed, the final regulations permit the taxpayer to treat the disallowed portion as a payment of state or local tax. Any unused credits carried forward may be treated as SALT payments under IRC Section 164 in accordance with state or local law.
The safe harbor applies to payments made on or after June 11, 2019, but at the taxpayer’s choice may be applied to payments made after Aug. 27, 2018.
Other items of note
These finalized regulations also clarify other points including:
- SALT payments are still subject to the limitations under IRC Section 164(b)(6).
- Payments deducted under the safe harbor in Treas. Reg. Section 1.164-3(j) (for itemizing individuals) as qualifying payments may not also be deducted under another IRC section.
- The quid pro quo principle under IRC Section 170 applies to either a donee or third party.
The Health and Economic Recovery Omnibus Emergency Solutions Act (HEROES Act), proposed legislation to intended to bolster recovery from COVID-19, contains a clause to repeal the $10,000 SALT deduction cap for the 2020 and 2021 taxable years.
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