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Economics of State Sponsored Charities in lieu of Income or Real Estate Taxes

July 27, 2018

Ron Hegt, CPA

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The Tax Cuts and Jobs Act of 2017, as part of overall tax reform, limited an individual’s deduction for state and local income and real estate taxes to $10,000 per year. In response to that, some states and localities have enacted legislation to help counteract the impact of that legislation.

For example, one state has enacted legislation that would allow a credit against either income or real estate taxes due in amounts equal to either 85% or 90% of the amount contributed to the chosen charity. The remaining 15% or 10% would remain due.
In reaction to these pieces of legislation, the Treasury Department issued a notice in May, 2018 (Notice 2018-54). The Notice said in part that “the proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers.”

We have analyzed the economics of these proposals on the assumption that an individual has already paid $10,000 in deductible taxes, is in the maximum federal and state tax bracket and pays an additional $10,000 to an 85% charity using three different potential results:

  • The regulations disallow the entire transaction as having no economic substance;
  • The regulations allow a charitable deduction for the 15% of the charitable contribution that does not result in a credit against the tax bill
  • The regulations fully respect the transaction as designed.

If Treasury disallows the entire transaction as having no economic substance, a taxpayer would be out of pocket $11,500 ($10,000 to the charity and $1,500 to cover the balance of the tax bill) which is $1,500 worse than paying the tax directly.

If Treasury allows a charitable deduction for the $1,500 that is not creditable against the tax bill, the taxpayer would be out of pocket $10,825 ($11,500 in disbursements less $675 of tax savings on the allowed contribution).

Finally, in the unlikely event that Treasury allows the transaction, a taxpayer would be out of pocket $7,000 ($11,500 paid less $4,500 tax savings).

We suggest that you consult with your Citrin Cooperman adviser or a member of the firm’s Tax Team if you have questions before considering entering into one of these transactions.