Treasury and the IRS’s proposed regulations addressing charitable contributions in exchange for state tax credits are too broad, according to speakers from across the political spectrum.
By far the most addressed subject at the IRS’s November 5 public hearing on the proposed regulations (REG-112176-18) was the impact of the rules on contributions to private scholarship-granting organizations. The proposed regulations would treat as a quid pro quo any state or local tax credit that a taxpayer expects to receive for a donation to an entity listed in IRC section 170(c), which includes both government and private charities, and would require the taxpayer to reduce his or her federal charitable deduction by the amount of the state credit.
But another theme turned out to be persistent criticism that the proposed regulations go beyond the scope of the initial problem that Treasury and the IRS sought to address: state attempts to circumvent the Tax Cuts and Jobs Act’s (P.L. 115-97) $10,000 cap on the section 164 SALT deduction.
For example, former Indiana Senate Majority Leader Brandt Hershman — now of counsel with Barnes & Thornburg LLP and outside counsel to EdChoice Inc., a nonprofit research center on school policy choice — described how Indiana fundamentally restructured its tax system during 2009-2018, when he chaired the Senate’s tax committee. The changes included developing a state tax incentives review process that the Pew Foundation now recognizes as a leader nationally, he said.
Indiana analyzed its state tax credits and eliminated dozens that had outlived their usefulness or were not providing desired policy results, Hershman said. Under then-Gov. Mike Pence, Indiana not only chose to preserve tax credits for scholarship-granting organizations but to expand them, after demonstrating from independent research that they have meaningful impact on students from families of limited means, Hershman said.
“We were fully aware that the effectiveness of such credits was leveraged by the deductibility of the donation at the federal level, and created our system with that synergy in mind,” Hershman said, adding that the credits “reflect policy decisions that are the purview of state legislatures.”
“Any attempt[s] to pass judgment on the merits of them are clearly beyond the scope of this inquiry,” Hershman said. “And many of the comments today I believe are thinly veiled attempts to litigate policy battles that were lost at the state level.” Hershman went one step further, saying he believes the drafters of the TCJA placed limits on the federal SALT deduction in part because the Republican-controlled Congress “disapproved of the policy of forcing residents of low-tax states to subsidize the policy decisions of legislators in high-tax states via the federal tax code.”
“This too was a policy decision made by Congress, and beyond the scope of this inquiry,” Hershman said. “I see no evidence that the law authorized or contemplated wholesale reexamination of charitable-giving regulations,” he said, adding that even so, it appears that the purpose of the proposed regulations “is to prevent manipulation of the SALT cap through improper characterization of what are clearly tax receipts as charitable donations.”
Hershman suggested that rather than seeking to reduce benefits created through state policy decisions to encourage legitimate charitable deductions, the IRS and Treasury consider targeting contributions that directly or indirectly benefit state governments as defined in section 164(b)(2). He said that such an approach would also suggest applying the SALT deduction cap to any 170(c)(1) donations made to state governments.
Steven Bellone (D), county executive for Suffolk County, New York, made similar arguments, but from the perspective of a local official in a state where leaders have filed a legal challenge to the SALT cap. He said the proposed regulations would amount to a tax increase of several thousand dollars per year on many New York state residents.
“It is not fair; it is not rational; it is not tenable; and I believe it is not legal,” Bellone said. Through the proposed regulations, Treasury and the IRS would prevent taxpayers from using “a perfectly fair and accepted mechanism to achieve tax benefits,” he said, adding that prohibiting the use of such mechanisms to particular taxpayers is not only unfair but “an arbitrary and capricious use of regulations.”
“If Congress wants to change the law, then they should do so,” Bellone said.
Rabbi Abba Cohen of Agudath Israel of America was yet another speaker who echoed these sentiments. “We do agree with those who believe that the proposed regulations are overbroad; they were intended to target a specific problem dealing with a specific workaround, SALT workarounds, and yet those go much broader than that specific problem,” Cohen said.
“This should not be a discussion on the merits of school choice,” he said, adding that those who have concerns about school choice should go to court, while people who have problems with scholarship-granting organizations should take the issue up with their state legislatures. Cohen also said that it’s unfortunate that phrases like “tax shelters” and “double dipping” are part of these discussions; states adopted the credits-in-exchange-for-contributions programs to advance good public policy.
The two dozen speakers covered familiar ground in debate about the proposed regulations, and were almost evenly split between those who generally support the approach taken by Treasury and the IRS and those seeking withdrawal of the regulations. Also, while several speakers asked the IRS and Treasury to include a carveout in the proposed regs to preserve preexisting state credit programs, nearly as many asked federal officials to deny such requests and applauded the proposed end of a long-standing private school voucher tax shelter.
Duke University law professor Lawrence A. Zelenak also generally supported the proposed regulations. “If a so-called contribution to a state produces a 100 percent state tax credit, then under long-established principles of substance over form in tax law, all that has happened is that the state and the taxpayer have collaborated in attaching a charitable contribution label to what is obviously the payment of state income tax in substance,” he said.
“There is no way such schemes should succeed in avoiding the $10,000 SALT ceiling, even in the absence of any new regulations,” Zelenak said. He urged that the preamble to the final regulations say that SALT cap workarounds would be ineffective even without the new regulations.