August 27, 2020 10:31 pm

Charitable Contributions in Exchange for State and Local Tax Credits

Federal law limiting the itemized deduction for state and local taxes to $10,000 ($5,000 for married persons filing separately) prompted a number of states, including Connecticut, New Jersey, and New York, to create “workarounds.” These are designed to help certain residents maintain their write-offs. One such workaround involves making charitable contributions in exchange for state and local tax credits.

The IRS has limited the viability of this workaround. Final regulations (T.D. 9907, 8/7/20, T.D. 9864, 6/13/19) generally bar any charitable contribution where there is a quid pro quo (i.e., the receipt of state and local tax credits in exchange for making the contribution). Essentially, the charitable contribution deduction must be reduced by the amount of any credits received.

However, there is an exception that allows state and local tax credits to be disregarded (so the charitable contribution deduction is not reduced) if the sum of the credits expected to be received do not exceed 15% of the taxpayer’s payment or 15% of the fair market value of the property transferred.

Where the charitable contribution must be reduced by state and local tax credits, a safe harbor allows the taxpayer to treat the disallowed amount as a payment of state or local taxes for itemized deduction purposes, subject to the $10,000 limit on state and local taxes ($5,000 for married persons filing separately).

Tax Glossary

Capital gain or loss

The difference between amount realized and adjusted basis on the sale or exchange of capital assets. Long-term capital gains are taxed favorably. Capital losses are deducted first against capital gains, and then again up to $3,000 of other income.

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