August 24, 2018
Treasury Releases Guidance on Permissibility of State Legislation to
Circumvent SALT Deduction Cap
On Aug. 23, 2018, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued
proposed regulations under Section 170 of the Internal Revenue Code (Code) addressing the federal income tax
treatment and characterization of state legislation allowing certain charitable contribution payments made by
taxpayers in exchange for a corresponding credit against state and local taxes (SALT).
Section 164(b)(6) was amended by the Tax Cuts and Jobs Act (P.L. 115-97) to limit the deduction for the
aggregate amount of state and local taxes paid during the calendar year to $10,000 for individuals and $5,000 for
married individuals filing separately. Corporations and owners of passthrough entities may still fully deduct their
business-related SALT liability. Prior to the passage of the TCJA, deduction for state and local taxes was unlimited
for individuals who itemized their deductions. The new cap applies for tax years beginning after Jan. 1, 2018, and
sunsets for tax years after Dec. 31, 2025.
Recently Passed State Legislation
As one of the TCJA’s more politically controversial provisions, the limitation on the deductibility of state and local
taxes (“SALT cap”) has been criticized for disproportionately impacting taxpayers in high-tax states. Several state
legislatures, including Connecticut, New York and New Jersey, have passed laws allowing taxpayers to circumvent
the cap by making alternative payments in lieu of state and local taxes in exchange for a credit that can be used to
offset state tax liability.
While various approaches to bypass the SALT cap have been proposed, most legislation is structured in one of the
1. Charitable Contribution for Credit Model (New York, Connecticut and New Jersey): The charitable
contribution approach allows localities to provide a property tax credit to individuals donating to select
community organizations. The credit is generally equal to the lesser of the amount of property tax owed or a
certain percentage of the donation to the community organization. The intent of these programs is to provide
taxpayers with not only a state credit for their donation, but also a federal tax deduction for the charitable
States have defined community organizations differently. Some specify that the funds must be set up by
municipalities or school districts to finance public projects, while others are purposefully vague and do not
specify the types of organizations that qualify for the deduction.
The charitable contribution approach predates the TCJA. Starting in 1986, Congress disallowed the SALT
deduction for taxpayers subject to the federal alternative minimum tax (AMT), while preserving the charitable
contribution deduction. As a result, states enacted tax credit programs that followed a similar structure to the
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current proposals: taxpayers who made charitable donations to approved organizations or funds would receive
a state income tax credit to offset the cost of the donation. The amount of the state credit was generally a set
percentage of the donation amount. For example, if a taxpayer made a $100 donation in a state providing a 70
percent credit, the taxpayer would receive a state income tax credit of $70.
About 33 states had charitable contribution for credit programs prior to the enactment of the TCJA. The IRS
had not published official guidance addressing the question of whether a state or local tax credit was a quid
pro quo benefit that would affect the amount of a taxpayer’s deduction under section 170(a). However, this
issue had been discussed in several Chief Counsel Advice memoranda, which are not precedential. In these
memoranda, the IRS took the position that the amount of the taxpayer’s charitable contribution deduction is not
reduced by the amount of the state tax credit.
2. Passthrough Model (Connecticut): Under this approach, states create a new entity-level state tax on a
passthrough’s taxable income (e.g., 6.99 percent tax in Connecticut). Since state and local taxes paid by
businesses are still deductible at the federal level, members and owners of participating passthroughs may
lower their federal tax liability by claiming the new tax as a business deduction. Individual members of the
passthrough entity subsequently receive a corresponding refundable individual income tax credit to offset the
taxes paid at the entity level. This approach is based on the fact that passthrough income is taxed at the
individual level and not taxed at the entity level. By imposing a tax at the entity level, the proposal shifts the tax
liability from a non-deductible source to a deductible source.
The proposed regulations do not address the passthrough model.
3. Payroll Tax Model (New York): States that employ this approach have designed a voluntary employer payroll
tax program that allows participating employers to assume an employee’s state tax liability (e.g., New York’s
employer compensation expense program, or ECEP). Participating employers would pay a set percentage
payroll tax on wages in excess of a threshold amount per employee. The employee would then receive a tax
credit equal to the payroll tax paid by the employer, which could be used to reduce the employee’s own SALT
liability. The employer would subsequently deduct that voluntary payroll tax expense from its own tax bill since
the TCJA does not prevent corporations from taking such deductions.
The proposed regulations do not address the payroll tax model.
Prior Guidance on SALT Cap
On May 23, 2018, in response to states enacting legislation to bypass the TCJA’s SALT cap, the IRS issued Notice
2018-54, stating its intent to propose regulations addressing the federal income tax treatment of legislation that
gives taxpayers a state tax credit against their state and local taxes.
The guidance issued today follows Notice 2018-54 and is intended to help taxpayers understand the proper
characterization of payments in lieu of state and local taxes in exchange for credits for federal income tax
August 24, 2018
Overview of the Proposed Rules
The proposed regulations provide clarification on the relationship between the federal charitable contribution
deduction, the availability of corresponding state or local tax credits and deductions, and the recently enacted
SALT cap. Although some states had charitable contribution for credit programs prior to the amendment of Sec.
164(b)(6), the regulations note that the enactment of TCJA’s SALT cap changes the analysis of what constitutes
donative intent and whether payments to charitable organizations in exchange for a reduction in state tax liability
are considered the receipt of a quid pro quo, which would ultimately negate donative intent. The regulations further
state that the passage of the TCJA also requires the IRS and Treasury to consider congressional intent in
amending Section 164(b)(6) and introducing the SALT cap. As discussed in the proposed regulations, sanctioning
both pre- and post-TCJA charitable-contribution-for-credit legislation would result in revenue losses that would
undermine the intent behind implementing the SALT cap. Additionally, as discussed in the examples of the
proposed regulations, the IRS and Treasury state that they believe that both pre- and post-TCJA contribution-forcredit
The proposed regulations address the following issues:
1. Treatment of Payments in Exchange for Deductions vs. Credits. The proposed regulations discuss the
proper federal income tax treatment of payments to charitable organizations under Section 170(c) in exchange
a. A corresponding state or local tax credit; or
b. A state or local tax deduction.
The IRS and Treasury state that if a taxpayer makes a payment or transfers property to an organization eligible
to receive tax-deductible contributions, and the taxpayer receives or expects to receive a state or local tax
credit in return for the payment, then the tax credit constitutes a quid pro quo. As a result, the amount
otherwise deductible as a charitable contribution must be reduced by the value of the state or local tax credit
received or expected to be received. Therefore, taxpayers who make payments to organizations eligible to
receive tax-deductible contributions must reduce their charitable deduction by the amount of any state or local
tax credit received, just as they would with any other benefit. However, the regulations do provide a de minimis
exception (see below).
The proposed regulations draw a distinction between state or local tax credits and state or local deductions
claimed in connection with a taxpayer’s charitable contribution or transfer. Specifically, the proposed
regulations allow taxpayers to disregard dollar-for-dollar state or local tax deductions received in exchange for
payments or property transfers to a charitable organization. However, if the taxpayer receives a state or local
tax deduction that exceeds the amount of the taxpayer’s payment or property transfer, the taxpayer’s
charitable contribution deduction must be reduced. The proposed rules do not specify how to determine the
amount of this reduction.
The IRS and Treasury justify the distinction between state or local credits and deductions on the grounds that
August 24, 2018
the benefit of a dollar-for-dollar deduction is limited to the taxpayer’s state and local marginal rate. As a result,
the risk of a deduction being used to circumvent the new SALT cap is comparatively low
Additionally, the proposed regulations note that the treatment of state or local tax deductions for charitable
contributions as a quid pro quo benefit would pose an administrative burden for both taxpayers and the IRS by
making the calculation of federal and state and local taxes difficult. This is because the value of a deduction
varies based on the taxpayer’s marginal or effective state and local tax rates.
Example A: State X grants taxpayers a 70 percent state tax credit for payment of contributions to an
eligible entity under Section 170(c). The taxpayer contributes $1,000 to an eligible entity and the taxpayer
receives a $700 state or local tax credit. The taxpayer must reduce the $1,000 contribution by the $700
state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s federal income tax
return. The proposed regulations also apply to payments made by trusts or decedents’ estates in
determining the amount of their contribution deduction.
Example B: An individual contributes $1,000 to an eligible charitable entity and in exchange receives a
state tax deduction equal to the amount contributed to the entity. The individual is not required to reduce
the federal charitable contribution deduction on account of the state tax deduction because it is not a quid
pro quo transaction.
De Minimis Exception. The IRS and Treasury provide a de minimis exception to the proposed regulations
limiting the availability of a charitable contribution deduction when a taxpayer receives a state or local tax credit
in exchange for payments to a charitable organization.
Generally, taxpayers may disregard a state or local tax credit if the credit does not exceed 15 percent of the
taxpayer’s payment or fair market value of the property transferred by the taxpayer to a charitable organization.
As a result, if a state or local tax credit is not greater than 15 percent, it will not reduce the taxpayer’s federal
deduction for a charitable contribution.
The de minimis exception is intended to provide consistent treatment between state or local tax credits that
provide a benefit equivalent to state or local tax deductions.
A taxpayer makes a $1,000 contribution to an eligible entity and receives a state tax credit of $100. The
taxpayer is not required to reduce the $1,000 deduction by the value of the credit because it is less than
15 percent of the fair market value of the contribution. The taxpayer may include the $1,000 contribution
as a charitable deduction on the taxpayer’s federal income tax return.
August 24, 2018
2. An “Opt-Out” Mechanism. The proposed regulations also consider a potential rule that would allow a
taxpayer to decline the receipt or anticipated receipt of a state or local tax credit at the time of the taxpayer’s
payment or transfer to a charitable organization. While the proposed regulations do not include any details on
such an opt-out mechanism, the intent behind this proposal would be to allow taxpayers to choose to receive
the full benefits of a charitable contribution deduction if they refuse the value of a state or local tax credit.
Request for Comments
The IRS and Treasury have asked for written comments on the published guidance within 45 days of the date the
proposed regulations are published in the Federal Register. We anticipate that the comments will be due in early
October. A public hearing has also been scheduled for Nov. 5, 2018, at 10 a.m.
Specifically, comments have been requested on the following aspects of the proposed
1. Whether there should be recognition of gain or loss when property is transferred in consideration for state or
local tax credits that are not de minimis;
2. Determination of the basis of a transferable tax credit that a taxpayer sells or exchanges;
3. Procedures by which a taxpayer may establish that the taxpayer declined receipt of the state or local tax credit;
4. Substantiation and reporting requirements for donors and donees making or receiving payments or transfers of
property in return for state and local tax credits;
5. Suggestions for calculating the reduction to the charitable contribution deduction for a taxpayer that receives or
a state or local tax deduction in an amount that exceeds the amount of the taxpayer’s payment or the fair
market value of the property transferred to an entity listed in section 170(c);
6. Whether the regulations should address other state or local tax benefits, such as tax exclusions, that may be
provided as consideration for certain payments or transfers to an entity listed in section 170(c);
7. Potential compliance savings, compliance costs, costs related to increased tax planning, or any effects on
charitable contribution decisions that may occur; and
8. Impact on contributions to state and local tax credit programs.
Impact and Next Steps
The proposed regulations will have a significant impact on tax-exempt organizations, state and local government
credit programs and charitable giving decisions. We believe that it is important for individuals and entities affected
by these proposed regulations to engage in the rulemaking process. The IRS and Treasury have specifically asked
for comments on how these rules will impact charitable giving and whether taxpayers and other affected
organizations will face compliance burdens. It is important that they hear from all stakeholders on the scope and
impact of the proposed rules.
Our Federal Tax Policy team can assist as you consider the impact that these rules may have for you. Our team
has significant knowledge on the taxation of exempt organizations as well as significant experience with the
rulemaking process. To the extent questions are unanswered or the rules are not clear, our team can create a
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dialogue with policymakers to help get your issues resolved. By doing so, policymakers will have a better
understanding of the impact these rules will have on individuals and exempt organizations and the challenges you
may face in trying to implement them.
For more information, contact:
Strategic Advisor and Counsel
Senior Policy Advisor
This document is intended to provide you with general information regarding proposed regulations addressing the
federal income tax treatment and characterization of state legislation allowing certain charitable contribution
payments made by taxpayers in exchange for a corresponding credit against state and local taxes. The contents of
this document are not intended to provide specific legal advice. If you have any questions about the contents of
this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular
Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some