This will raise the effective tax rate for taxpayers who claim the itemized deduction and pay state and local taxes in excess of the SALT Cap.
Missouri has long maintained a robust state tax credit program through which taxpayers have received state tax credits upon contributing to certain charities. In light of the SALT Cap, states began to create charitable funds intended to convert state and local tax deductions subject to the SALT Cap to charitable contribution deductions subject to more generous limitations by awarding generous state tax credits for gifts into the charitable funds. In late August, the IRS issued proposed regulations to block state programs to mitigate the impact of the SALT Cap.
The new proposed rules are sufficiently broad to also change the impact of existing programs, such as those maintained by Missouri. Under the proposed regulations, the deductible portion of any charitable donation generally must be reduced by any state credit received (with the exception of any de minimis credit were the value received is less than 15% of your contribution). The effective date for the new standard is August 28, 2018, so donations made before this date are likely outside the scope of the new regulations (though not necessarily immune from IRS challenge).
Provided here is an illustration to show the before and after results of these changes. Our example assumes a taxpayer itemizes their deductions and has a combined federal and state income tax rate of 43%. The taxpayer made a $100 contribution and received 70% of the donation amount in Missouri credits.
Federal itemized deduction $100
State tax credit $70
Value of itemized deduction (federal and state) $43 ($100 x 43%)
After tax benefit of the donation $13 ($70 + $43 – $100)
Federal itemized deduction $30 ($100 – $70)
State tax credit $70
Value of itemized deduction (Fed and state) $13 ($30 x 43%)
After tax cost of the donation $17 ($100 – $70 – $13)
The result for business owners may be different. According to the IRS, the proposed regulations are not intended to require a reduction if credits are issued for payments that can be fairly deducted as business expenses and not as charitable contributions. For example, if a business gives $1,000 for a charity event and receives advertising benefits, the business would not be required to reduce its $1,000 advertising deduction by any state tax credits received.
We encourage you to reach out to your trusted WK advisor for more information and tax planning as you consider future contributions to state programs.