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Introduction
On June 11, 2019, the IRS published a guidance notice stating that certain individuals who receive state or local tax credits in exchange for contributions to or for the use of a charity or other entity described in section 170(c) can treat the contribution as a state or local tax payment. The Treasury Department and IRS requested comments on this Notice by July 11, 2019.
The IRS’s rationale for allowing individuals to classify these donations as tax payments is that the state tax credit programs effectively give the taxpayer a choice of making a tax payment or donating to an entity for which the state offers a tax credit. Either way, the taxpayer has to make a payment. Without the safe harbor provided by the Notice, an individual below the SALT cap could deduct the tax payment but could not deduct an equivalent donation for which he or she receives a tax credit.
This rationale is sound, but there is an additional rationale rooted in the regulatory analysis principles of Executive Order 12866. Simply put, taxpayers below the SALT cap are not a source of the tax avoidance problem the IRS regulation is intended to solve. Without the Notice, the regulation is overly broad; it would penalize taxpayers below the SALT cap who choose to make contributions in exchange for tax credits instead of simply paying their state and local taxes. The Notice corrects this problem.
The IRS also speculates that a limited number of taxpayers would be affected by the Notice. Going forward, the IRS should use data to test this hypothesis by requiring disclosure of deductible state and local tax credits on Schedule A, using state data, or econometrically estimating the relationship between the number of taxpayers below the SALT cap who itemize deductions and the number of individuals who contribute to at least some of the programs or which states offer tax credits.