Federal Register, Volume 84 Issue 114 (Thursday, June 13, 2019)

[Federal Register Volume 84, Number 114 (Thursday, June 13, 2019)]
[Rules and Regulations]
[Pages 27513-27531]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-12418]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9864]
RIN 1545-BO89

Contributions in Exchange for State or Local Tax Credits

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains a final regulation under section 170 of
the Internal Revenue Code (Code). The final regulation provides rules
governing the availability of charitable contribution deductions under
section 170 when a taxpayer receives or expects to receive a
corresponding state or local tax credit. This document also provides a
final regulation under section 642(c) to apply similar rules to
payments made by a trust or decedent's estate.

DATES:
Effective date: These regulations are effective August 12, 2019.
Applicability dates: For dates of applicability, see Sec. 1.170A-
1(h)(3)(viii) and Sec. 1.642(c)-3(g)(2).

FOR FURTHER INFORMATION CONTACT: Mon L. Lam or Richard C. Gano IV at
(202) 317-4059 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Section 170(a)(1) generally allows an itemized deduction for any
``charitable contribution'' paid within the taxable year. Section
170(c) defines ``charitable contribution'' as a ``contribution or gift
to or for the use of'' any entity described in that section. Under
section 170(c)(1), such an entity includes a State, a possession of the
United States, or any political subdivision of the foregoing, or the
District of Columbia. Entities described in section 170(c)(2) include
certain corporations, trusts, or community chests, funds, or
foundations, organized and operated exclusively for religious,
charitable, scientific, literary, or educational purposes, or to foster
national or international amateur sports competition, or for the
prevention of cruelty to children or animals.
To be deductible as a charitable contribution under section 170, a
transfer to an entity described in section 170(c) must be a
contribution or gift. A contribution or gift for this purpose is a
voluntary transfer of money or property without the receipt of adequate
consideration, made with charitable intent. In Rev. Rul. 67-246, 1967-2
C.B. 104, the Internal Revenue Service (IRS) addressed the taxpayer's
burden of proof for establishing charitable intent when the taxpayer
receives a privilege or benefit in conjunction with its contribution.
In this revenue ruling, the IRS set out a two-part test for determining
whether the taxpayer is entitled to a charitable contribution deduction
under these circumstances. First, the taxpayer has the burden of
proving that its payment to the charity exceeds the market value of the
privileges or other benefits received. Second, the taxpayer must show
that it paid the excess with the intention of making a gift.
In United States v. American Bar Endowment, 477 U.S. 105, 116-18
(1986), the Supreme Court elaborated on the test set out in Rev. Rul.
67-246. The Court interpreted the phrase ``charitable contribution'' in
section 170 as it relates to the donor's receipt of consideration, and
stated that the ``sine qua non of a charitable contribution is a
transfer of money or property without adequate consideration.'' Id. at
118. The Court concluded that ``[a] payment of money generally cannot
constitute a charitable contribution if the contributor expects a
substantial benefit in return,'' (id. at 116), (hereinafter referred to
as the ``quid pro quo principle''). The Court recognized that some
payments may have a ``dual character''--part charitable contribution
and part return benefit. Id. at 117. The Court reasoned that in dual
character cases ``it would not serve the purposes of section 170 to
deny a deduction altogether''; therefore, a charitable deduction is
allowed, but only to the extent the amount donated or the fair market
value of the property transferred by the taxpayer exceeds the fair
market value of the benefit received in return, and only if the excess
amount was transferred with the intent of making a gift. Id. See also
Hernandez v. Commissioner, 490 U.S. 680, 690 (1989) (stating that
Congress intended to differentiate between unrequited payments and
payments made in return for goods or services). Because this inquiry
focuses on the donor's expectation of a benefit, it does not matter
whether the donor expects the benefit from the recipient of the payment
or transfer, or from a third party. See, for example, Singer Co. v.
United States, 449 F.2d 413, 422-23 (Ct. Cl. 1971); cited with approval
in American Bar Endowment, 477 U.S. at 116-17.
In Hernandez, 490 U.S. at 690-91, the Supreme Court reaffirmed the
quid pro quo standard articulated in American Bar Endowment.
Specifically, the Court held that payments to a charity that entitled
the taxpayers to receive an identifiable benefit in return for their
money were part of a ``quintessential quid pro quo exchange,'' and
thus, were not contributions or gifts within the meaning of section
170. Id. at 691. In making this determination, the Court noted the
importance of examining the ``external features of a transaction,''
thereby ``obviating the need for the IRS to conduct imprecise inquiries
into the motivations of individual taxpayers.'' Id. at 690-91. Thus,
both American Bar Endowment and Hernandez indicate that objective
considerations guide the determination of whether the taxpayer
purposely contributed money or property in excess of the value of any
benefit received in return. In addition, these cases continue to
recognize the requirement that the taxpayer have charitable intent. See
American Bar

[[Page 27514]]

Endowment, 477 U.S. at 118; Hernandez, 490 U.S. at 691.
Section 164 generally allows an itemized deduction for the payment
of certain taxes, including state and local, and foreign, real property
taxes; state and local personal property taxes; and state and local,
and foreign, income, war profits, and excess profits taxes. Section
164(b)(6), as added by section 11042 of ``An Act to provide for
reconciliation pursuant to titles II and V of the concurrent resolution
on the budget for fiscal year 2018'' (``the Act''), Public Law 115-97,
limits an individual's deduction for the aggregate amount of state and
local taxes paid during the calendar year to $10,000 ($5,000 in the
case of a married individual filing a separate return). This limitation
applies to taxable years beginning after December 31, 2017, and before
January 1, 2026. This limitation does not apply to foreign taxes
described in section 164(a)(3) or to any taxes described in section
164(a)(1) and (2) that are paid and incurred in carrying on a trade or
business or an activity described in section 212.
In response to the new limitation under section 164(b)(6), some
taxpayers are seeking to pursue tax planning strategies with the goal
of avoiding or mitigating the limitation. These strategies rely on
state and local tax credit programs under which states provide tax
credits in return for contributions by taxpayers to or for the use of
certain entities described in section 170(c). The use of state or local
tax credits to incentivize charitable giving has become increasingly
common over the past 20 years. Moreover, since the enactment of the
limitation under section 164(b)(6), states and local governments have
created additional programs intended to work around the new limitation
on the deduction of state and local taxes.
The new limitation, and the resulting efforts by states and
taxpayers to devise alternate means for deducting the disallowed
portion of their state and local taxes, has generated increased
interest in the question of whether a state or local tax credit should
be treated as a return benefit--a quid pro quo--when received in return
for making a payment or transfer to an entity described in section
170(c). The Treasury Department and the IRS did not publish formal
guidance on this question before the enactment of the limitation under
section 164(b)(6). In 2010, however, the IRS Chief Counsel advised
that, under certain circumstances, a taxpayer may take a deduction
under section 170 for the full amount of a contribution made in
exchange for a state tax credit, without subtracting the value of the
credit received in return. See CCA 201105010 (Oct. 27, 2010) (``the
2010 CCA''). IRS Chief Counsel has also taken the position in Tax Court
litigation that the amount of a state or local tax credit that reduces
a tax liability is not an accession to wealth includible in income
under section 61 or an amount realized for purposes of section 1001. In
these cases, the Tax Court agreed with the Chief Counsel's position.
See, for example, Maines v. Commissioner, 144 T.C. 123, 134 (2015);
Tempel v. Commissioner, 136 T.C. 341, 351-54 (2011); aff'd sub nom.
Esgar Corp. v. Commissioner, 744 F.3d 648 (10th Cir. 2014).
Upon reviewing the authorities under section 170, the Treasury
Department and the IRS questioned the reasoning of the 2010 CCA. On
June 11, 2018, the Treasury Department and the IRS issued Notice 2018-
54, 2018-24 I.R.B. 750, announcing the intention to propose regulations
addressing the federal income tax treatment of contributions pursuant
to state and local tax credit programs. On August 27, 2018, the
proposed regulations (REG-112176-18) were published in the Federal
Register (83 FR 43563).
The proposed regulations generally stated that if a taxpayer makes
a payment or transfers property to or for the use of an entity listed
in section 170(c), and the taxpayer receives or expects to receive a
state or local tax credit in return for such payment, the tax credit
constitutes a return benefit, or quid pro quo, to the taxpayer and
reduces the taxpayer's charitable contribution deduction. The proposed
regulations included a separate rule for state and local tax
deductions, providing that they do not constitute a quid pro quo unless
they exceed the amount of the donor's payment or transfer. The proposed
regulations also included an exception under which a state or local tax
credit is not treated as a quid pro quo if the credit does not exceed
15 percent of the taxpayer's payment or 15 percent of the fair market
value of the property transferred by the taxpayer. Finally, the
proposed regulations would amend Sec. 1.642(c)-3 to provide similar
rules for payments made for a purpose specified in section 170(c) by a
trust or decedent's estate.
The Treasury Department and the IRS received over 7,700 comments
responding to the proposed regulations and 25 requests to speak at the
public hearing, which was held on November 5, 2018. Copies of written
comments received and the list of speakers at the public hearing are
available for public inspection at www.regulations.gov or upon request.
The comments and revisions are discussed generally in this preamble.
After considering the comments received and the concerns expressed at
the public hearing, the Treasury Department and the IRS adopt the
proposed regulations with certain revisions explained subsequently.
Additionally, in response to concerns raised in comments, the
Treasury Department and the IRS have issued other guidance providing
safe harbors on certain issues. On December 28, 2018, the Treasury
Department and the IRS issued Rev. Proc. 2019-12, 2019-04 I.R.B. 401,
providing a safe harbor under section 162 for certain payments made by
a C corporation or specified passthrough entity to or for the use of an
organization described in section 170(c) if the C corporation or
specified passthrough entity receives or expects to receive a state or
local tax credit in return for such payment. On June 11, 2019, the
Treasury Department and the IRS will have issued Notice 2019-12, 2019-
27 I.R.B., providing a safe harbor for payments made by certain
individuals. Under the safe harbor, an individual who itemizes
deductions and makes a payment to a section 170(c) entity in return for
a state or local tax credit may treat the portion of such payment that
is or will be disallowed as a charitable contribution deduction under
section 170 as a payment of state or local tax for purposes of section
164. This disallowed portion of the payment may be treated as a payment
of state or local tax under section 164 when and to the extent an
individual applies the state or local tax credit to offset the
individual's state or local tax liability. Notice 2019-12 requests
comments for purposes of incorporating the safe harbor into anticipated
proposed regulations under section 164. In general, the Treasury
Department and the IRS will continue to consider comments and provide
additional guidance in this area as needed.

Explanation of Provisions and Summary of Comments

Explanation of Provisions

The final regulations generally retain the proposed amendments set
forth in the proposed regulations, with certain clarifying and
technical changes. First, the final regulations retain the general rule
that if a taxpayer makes a payment or transfers property to or for the
use of an entity described in section 170(c), and the taxpayer receives
or expects to receive a state or local tax credit in return for such
payment, the tax credit constitutes a return benefit to the

[[Page 27515]]

taxpayer, or quid pro quo, reducing the taxpayer's charitable
contribution deduction.
Second, the Treasury Department and the IRS have concluded that
state tax credits and state tax deductions should be treated
differently in light of policy and tax administration considerations
identified in the preamble of the proposed regulations. Accordingly,
the final regulations retain the rule that a taxpayer generally is not
required to reduce its charitable contribution deduction on account of
its receipt of state or local tax deductions. However, the final
regulations also retain the exception to this rule for excess state or
local tax deductions. Specifically, the taxpayer must reduce its
charitable contribution deduction if it receives or expects to receive
state or local tax deductions in excess of the taxpayer's payment or
the fair market value of property transferred by the taxpayer.
Third, the final regulations retain the 15-percent exception, under
which a taxpayer may disregard state and local tax credits as a return
benefit where such credits do not exceed 15 percent of the taxpayer's
payment. However, the final regulations clarify that this 15-percent
exception applies only if the sum of the taxpayer's state and local tax
credits received, or expected to be received, does not exceed 15
percent of the taxpayer's payment or 15 percent of the fair market
value of the property transferred by the taxpayer.
Fourth, the final regulations reflect the correction of a
typographical error in Sec. 1.170A-1(h)(3)(i) of the proposed
regulations. The introductory clause should refer to the 15-percent
exception set forth in paragraph (h)(3)(vi), not paragraph (h)(3)(v).
In addition, the final regulations clarify the terms used to describe
entities that may receive charitable contributions under section
170(c). Specifically, the final regulations refer to entities
``described'' in section 170(c), rather than entities ``listed'' under
section 170(c).
Finally, the final regulations include the proposed amendments to
Sec. 1.642(c)-3 providing that the final rules under Sec. 1.170A-
1(h)(3) apply to payments made by a trust or decedent's estate in
determining its charitable contribution deduction under section 642(c).

Summary of Comments

1. Comments in Support of the Proposed Regulations
Approximately 70 percent of commenters recommended that the
Treasury Department and the IRS finalize the proposed regulations
without change. Some commenters characterized state and local tax
credit programs as tax shelters and explained how taxpayers could use
the programs to generate profits. A substantial number of commenters
expressed concerns regarding the effect of these programs on public
functions, including public education. Many commenters stated that the
proposed regulations apply section 170 fairly. Many commenters noted
that the proposed regulations applied to donations to organizations
fulfilling both private and public purposes and applied to tax credit
programs created both before and after the enactment of the Act. Some
commenters stated that state tax credit programs are unfair to
individuals who cannot afford to make the contributions and receive the
benefit of the credits. Some commenters generally supported the
proposed regulations, but provided more substantive comments regarding
additional issues posed by the proposed regulations and requested
additional guidance on those issues, either when finalizing the
proposed regulations or in other guidance.
2. Section 170 Regulations in Response to a Section 164 Amendment
Many commenters wrote that it was improper for the Treasury
Department and the IRS to issue regulations under section 170 in
response to the enactment of section 164(b)(6). Commenters stated that
any regulations must be issued under section 164 because an amendment
to section 164 is driving the regulatory change.
The limitation under section 164(b)(6) is the impetus for the
Treasury Department's and the IRS's consideration of the tax treatment
of contributions made in exchange for state and local tax credits.
Prior to the enactment of that limitation, the proper treatment of such
contributions was of limited significance from a federal revenue
perspective and tax administration perspective and was therefore never
addressed in formal guidance. Upon careful review of the issue, the
Treasury Department and the IRS have determined that longstanding
principles under section 170 should guide the tax treatment of these
contributions. Section 170 provides a deduction for taxpayers'
gratuitous payments to qualifying entities, not for transfers that
result in receipt of valuable economic benefits. In applying section
170 and the quid pro quo principle, the Treasury Department and the IRS
do not believe it is appropriate to categorically exempt state or local
tax benefits from the normal rules that apply to other benefits
received or expected to be received by a taxpayer in exchange for a
contribution. The final regulations are consistent with longstanding
principles under section 170 and sound tax policy. Therefore, the
regulations are issued under section 170, and not section 164.
3. Treatment of State and Local Tax Credits as Return Benefits
Commenters expressed differing views of the proposed regulation's
requirement that a taxpayer reduce the taxpayer's charitable
contribution deduction under section 170 by the total amount of state
and local tax credits received or expected to be received. Many
commenters agreed with the Treasury Department and the IRS that the
quid pro quo principle should be applied to the receipt or expectation
of receipt of state and local tax credits. However, some commenters
questioned the application and effect of the quid pro quo principle
under section 170 and the tax consequences of such application.
The Treasury Department and the IRS have determined that it is
appropriate to apply longstanding principles under section 170 that
require a taxpayer to reduce the amount treated as a charitable
contribution by the value of the return benefit received. As discussed
earlier in this preamble and in the preamble of the proposed
regulations, the final regulations are consistent with the principle
that a ``payment of money generally cannot constitute a charitable
contribution if the contributor expects a substantial benefit in
return.'' American Bar Endowment, 477 U.S. at 116. While the Supreme
Court has not addressed the specific issue of contributions in exchange
for state or local tax credits, the final regulations are a reasonable
interpretation of section 170 that accords with the logic of American
Bar Endowment and Hernandez. The final regulations are also supported
by important tax policy considerations, including the need to prevent
revenue loss from the erosion of the limitation under section
164(b)(6). Thus, the final regulations adopt the rule that the amount
otherwise deductible as a charitable contribution under section 170
must generally be reduced by the total amount of state and local tax
credits received or expected to be received.
a. Prior Chief Counsel Advice Memoranda and Case Law
Many commenters noted that the proposed regulations reflect a
change in the IRS's treatment of charitable contributions that result
in state or local tax credits. The commenters pointed to

[[Page 27516]]

several CCAs issued by IRS Chief Counsel from 2002 to 2010. See, for
example, the 2010 CCA (addressing contributions of money or property to
governments or charitable entities under several state tax credit
programs); CCA 200435001 (July 28, 2004) (reviewing a program issuing
state tax credits in return for contributions to certain child care
organizations); CCA 200238041 (July 24, 2002) (considering a program
issuing tax credits in return for the transfer of conservation
easements). The preamble to the proposed regulations noted that, in
each of these CCAs, IRS Chief Counsel recognized the complexity of the
federal tax law issues involving the tax treatment of the receipt or
expectation of receipt of state tax credits, particularly where the tax
credits are granted for transfers to section 170(c) entities. The
preamble also noted that two of the CCAs declined to provide specific
guidance on the availability of the charitable contribution deduction,
and suggested the issuance of formal guidance to address this question.
Although CCAs are released to the public under section 6110, they are
not official rulings or positions of the IRS, and cannot be cited as
precedent. See sections 6110(b)(1)(A) and 6110(k)(3).
The Treasury Department and the IRS acknowledge that the proposed
and final regulations depart from the conclusion of the 2010 CCA in
important respects. As noted in the Background section of this
preamble, the 2010 CCA concluded that a taxpayer may take a deduction
under section 170 for the full amount of a contribution made in
exchange for a state tax credit, without subtracting the value of the
credit received in return. The 2010 CCA, however, failed to
persuasively explain why state and local tax credits should not count
as return benefits for purposes of applying the quid pro quo principle.
The 2010 CCA cited cases in which courts had found that a donor's
subjective motivation to minimize taxes is not a basis for disallowing
a charitable deduction, but these cases did not specifically address
whether the value of state or local tax credits should be treated as a
quid pro quo that reduces the amount of the deduction. See McLennan v.
United States, 24 Cl. Ct. 102,106 n.8 (1991); Skripak v. Commissioner,
84 T.C. 285, 319; Allen v. Commissioner, 92 T.C. 1, 7 (1989). The 2010
CCA also cited a case in which the value of a tax deduction was not
treated as income under section 61, but that case did not address the
application of the quid pro quo principle under section 170. See
Browning v. Commissioner, 109 T.C. 303 (1997). Furthermore, the
analysis in the 2010 CCA assumed that after the taxpayer applied the
state or local tax credit to reduce the taxpayer's state or local tax
liability, the taxpayer would receive a smaller deduction for state and
local taxes under section 164. With the enactment of section 164(b)(6),
that assumption no longer holds true for the vast majority of
taxpayers. The changes in the tax laws reduce the number of taxpayers
who will itemize deductions, and for taxpayers who itemize and have
state and local tax liabilities above the new limitation, the use of
the tax credit would not reduce the deduction for state and local
taxes.
In light of the section 164(b)(6) limitation, the Treasury
Department and the IRS have specifically considered the application of
the quid pro quo principle to state and local tax credit programs.
After careful consideration of comments submitted in response to the
proposed regulations, the Treasury Department and the IRS have
determined that it is appropriate to treat the receipt or the
expectation of receipt of state and local tax credits as return
benefits. As discussed previously in this preamble, the final
regulations are supported by the Supreme Court's interpretation of the
term ``charitable contribution'' under section 170. In American Bar
Endowment, 477 U.S. at 118, the Court stated that the ``sine qua non of
a charitable contribution is a transfer of money or property without
adequate consideration''--that is, without the expectation of a quid
pro quo. Thus, the Court held that a ``payment of money generally
cannot constitute a charitable contribution if the contributor expects
a substantial benefit in return.'' Id. at 116. The Supreme Court
reaffirmed this principle in Hernandez, 490 U.S. at 690-91, and this
principle has been consistently applied by the courts in subsequent
decisions. See, for example, Rolfs v. Commissioner, 135 T.C. 471
(2010), aff'd, 668 F.3d 888 (7th Cir. 2012) (holding that taxpayers
were not entitled to a charitable contribution deduction for the
donation of their lake house because they did not show that the market
value of the property they donated exceeded the market value of the
benefit (demolition services) they received in return); Triumph Mixed
Use Investments III, LLC v. Commissioner, T.C. Memo. 2018-65 (holding
that value of real property and development credits transferred by
taxpayer to city in return for development plan approvals was not
deductible under section 170 because taxpayer expected a return
benefit); Pollard v. Commissioner, T.C. Memo. 2013-38 (holding that
petitioner's granting of conservation easements to the county was part
of a quid pro quo exchange for the county's approval of the taxpayer's
subdivision exemption request, a substantial benefit to the taxpayer.
This treatment is consistent not only with the purpose of section
170, but also with the section 164(b)(6) limitation. If the Treasury
Department and the IRS were to allow taxpayers to claim a full
charitable contribution deduction for contributions made in exchange
for state tax credits, this treatment would result in significant
federal tax revenue losses that would undermine the limitation on the
deduction for state and local taxes in section 164(b)(6). Such an
approach would enable taxpayers to characterize payments as fully
deductible charitable contributions for federal income tax purposes,
while using the same payments to satisfy their state tax liabilities.
As a result, the final regulations reject the 2010 CCA's conclusion
that the contribution deduction does not need to be reduced by the
value of the state and local tax credit received or expected to be
received.
Commenters also cited recent cases, such as Maines v. Commissioner
and Tempel v. Commissioner, to conclude that the receipt of a state or
local tax credit is, for federal tax purposes, a reduction or potential
reduction in the taxpayer's state or local tax liability and not a
payment includible in the taxpayer's gross income. Maines, 144 T.C. at
134 (citing Randall v. Loftsgaarden, 478 U.S. 647, 657 (1986)); Tempel,
136 T.C. at 350; see also Rev. Rul. 79-315, 1979-2 C.B. 27 (Holding (3)
(amounts credited against unpaid tax is neither includible in
taxpayer's income nor deductible as a state income tax paid)). The
analysis for determining whether an item is included in gross income is
separate and distinct from the analysis for determining whether a
payment or transfer is a deductible contribution under section 170.
Section 61(a) provides that gross income ``means all income from
whatever source derived'' unless otherwise provided in Subtitle A,
Income Taxes. In contrast, to be deductible as a charitable
contribution under section 170, a transfer to an entity described in
section 170(c) must be a contribution or gift, without the expectation
or receipt of a return benefit. Neither Maines nor Tempel addressed
whether a taxpayer's expectation or receipt of a state or local tax
credit may reduce a taxpayer's charitable contribution deduction under
section 170, and therefore, these cases

[[Page 27517]]

are not relevant for purposes of interpreting section 170.
Some commenters cited Arizona Christian School Tuition Organization
v. Winn, 563 U.S. 125, 142-44 (2011), to support their position that
the regulations should permit a full charitable contribution deduction
when amounts are contributed to a charitable organization, even if the
donor receives tax credits in return. While that case involved the
types of contributions affected by the proposed regulations, the Court
did not address whether such contributions are deductible under section
170 or whether the contributors received a substantial benefit in
exchange for their contributions.
b. Tax Consequences of Quid Pro Quo Benefits
Some commenters pointed out that the proposed regulations failed to
fully address the tax consequences of treating tax credits as quid pro
quo benefits and suggested that additional guidance is needed. For
example, commenters noted that the proposed regulations did not address
the tax treatment of the sale, use, or lapse of the credits. In
particular, commenters suggested that additional guidance may be needed
to clarify application of the rules under sections 61, 164, 1001, and
1012 to the receipt, expectation of receipt, or use of tax credits. The
Treasury Department and the IRS agree with commenters that additional
guidance is necessary to address these complex issues.
Regarding the treatment of return benefits under section 164, the
Treasury Department and the IRS issued Notice 2019-12 on [Month DD],
2019. As discussed previously in this preamble, Notice 2019-12 provides
a safe harbor under section 164 for an individual who itemizes
deductions and who makes a payment to a section 170(c) entity in return
for a state or local tax credit. The Treasury Department and the IRS
will continue to consider comments regarding other tax consequences of
treating tax credits as quid pro quo benefits and will provide
additional guidance as needed.
c. Application of Substance Over Form Doctrine
Some commenters suggested that the proposed regulations should have
relied in whole or in part on the substance over form doctrine rather
than the quid pro quo principle. Under a substance over form approach,
commenters explained, the proposed regulations could treat
contributions to funds established by state or local government
entities in exchange for tax credits as, in substance, a payment of
taxes to those government entities. These commenters stated that by
relying on the substance over form doctrine, the proposed regulations
could have been more easily tailored to address only those
contributions paid to funds established to assist taxpayers in avoiding
the limitation on state and local tax deductions. The commenters also
stated that a focus on contributions to funds established by state and
local government entities would more directly target the potential
revenue loss.
The Treasury Department and the IRS have considered the substance
over form doctrine in analyzing the proper tax treatment of
contributions in exchange for tax credits, but have ultimately decided
that, as a general matter, the application of the quid pro quo
principle provides a more sound, comprehensive, and administrable
approach. While a payment made to a state (or to an entity designated
by the state) in exchange for a tax credit might in some circumstances
seem similar to a payment of tax under section 164, the analysis raises
additional issues and finds less support under other substance over
form authorities. Specifically, this approach would result in the
significant expansion in the definition of ``tax'' under section 164,
would raise questions involving the proper timing of deductions for
such payments, and would result in different treatments for similarly
situated taxpayers. Furthermore, even if the substance over form
doctrine were applied to treat payments or transfers to certain
organizations as a payment of taxes, the proper treatment of these
amounts under section 170, including the application of the quid pro
quo principle, would continue to be relevant for taxpayers that make
payments or transfers to certain charities in return for tax credits.
The Treasury Department and the IRS have determined that the tax laws
and sound tax policy support the treatment of a state tax credit as a
return benefit that reduces the amount of the taxpayer's charitable
contribution deduction under section 170, regardless of whether the
entity to which the contribution is made is controlled by a state or
local government. The quid pro quo principle is applicable to
contributions made to all types of donee entities. Section 170(c)
provides an expansive list of the types of entities to which a taxpayer
may contribute and receive a charitable contribution deduction. This
list includes organizations controlled by state or local governments.
If a contribution is made to or for the use of any such entity, the
contribution may qualify as a charitable contribution, provided it
meets all other requirements.
Moreover, a substance over form approach would not fully address
concerns raised by commenters regarding state and local tax credit
programs. Such programs can be used to generate tax benefits in excess
of the amount the taxpayer contributes to the charitable organization,
regardless of whether the contribution is made to an entity controlled
by a state or local government. Finally, the Treasury Department and
the IRS have serious concerns about the practicability of delineating
clear and administrable criteria for distinguishing between state and
local government entities and section 170(c)(2) organizations that are
closely connected to state and local governments.
d. Quid Pro Quo Provided by Third Party
Some commenters expressed a belief that under current law a quid
pro quo received or expected to be received by a taxpayer does not
reduce the taxpayer's charitable contribution deduction if the quid pro
quo comes from a party that is not the donee. Based on that belief,
these commenters concluded that a tax credit from a state or local
government should not reduce the charitable contribution deduction for
a payment to a section 170(c)(2) organization. At least one commenter
recommended that where contributions are made to section 170(c)(2)
entities in exchange for tax credits provided by the state or local
government, the benefit should be treated as income to the donor.
In support of this position, many commenters referred to Sec.
1.170A-1(h)(1) (payment in exchange for consideration) and Sec.
1.170A-13(f)(6) (defining ``in consideration for'' as a donee
organization providing goods and services in consideration for
taxpayer's payment). One commenter expressed the view that the quid pro
quo analysis cannot be applied to contributions to charitable
organizations other than state or government entities because when a
taxpayer makes a contribution to a charity, but receives consideration
from a third party such as the state, the transaction cannot be
characterized as a purchase. Commenters suggested that the language in
the proposed regulations at Sec. 1.170A-1(h)(3)(iii) creating an
exception from the ``in consideration for'' language of Sec. 1.170A-
13(f)(6) for state or local tax credits provided by third parties is
evidence that the proposed regulations depart from established law.
Commenters suggested,

[[Page 27518]]

as an alternative, that the final regulations set forth a general rule
applying quid pro quo principles to benefits a taxpayer receives from
any source, regardless of whether the benefits are provided by the
donee or a third party. That rule would be applicable in determining if
there is any quid pro quo under section 170 in all contexts, not just
when a taxpayer receives state or local tax credits.
Section 1.170A-1(h)(1) provides that no part of a payment that a
taxpayer makes to or for the use of an organization described in
section 170(c) that is in consideration for (as defined in Sec.
1.170A-13(f)(6)) goods or services (as defined in Sec. 1.170A-
13(f)(5)) is a contribution or gift within the meaning of section
170(c) unless the taxpayer (i) intends to make a payment in an amount
that exceeds the fair market value of the goods or services; and (ii)
makes a payment in an amount that exceeds the fair market value of the
goods or services. Section 1.170A-1(h)(2) states that the charitable
contribution deduction under section 170(a) may not exceed the amount
of cash paid or the fair market value of property transferred to an
organization over the fair market value of goods or services the
organization provides in return. Section 1.170A-13(f)(5) defines goods
or services as cash, property, services, benefits, and privileges, and
Sec. 1.170A-13(f)(6) provides that a donee provides goods or services
in consideration for a taxpayer's payment if, at the time the taxpayer
makes a payment to the donee, the taxpayer receives or expects to
receive goods or services in exchange for that payment.
The Treasury Department and the IRS acknowledge that the current
regulations do not address situations in which the benefits a donor
receives or expects to receive come from a third party. While the
proposed regulations modify the existing regulations to address the
specific case of payments in exchange for tax credits, the Treasury
Department and the IRS intend to propose additional regulations setting
forth a general rule for all benefits received or expected to be
received from third parties, not just tax credits. In the interim, the
final regulations regarding tax credits specify an exception to the
existing definition of ``in consideration for.'' However, the
application of the quid pro quo principle to benefits received or
expected to be received from third parties is consistent with existing
law.
In American Bar Endowment and Hernandez, the Supreme Court made
clear that a payment is not a charitable contribution if the donor
expects to receive a substantial benefit in return. American Bar
Endowment, 477 U.S. at 116-17 (1986); Hernandez, 490 U.S. at 691-92.
The source of the return benefit is immaterial from the donor's
financial perspective. The quid pro quo principle is thus equally
applicable regardless of whether the donor expects to receive the
benefit from the donee or from a third party. In either case, the
donor's payment is not a charitable contribution or gift to the extent
the donor expects a substantial benefit in return.
The Supreme Court in American Bar Endowment and Hernandez did not
directly address the question of third party benefits because the
return benefits at issue in those cases were provided by the donees.
The Court derived its quid pro quo principle in part from a lower court
decision and a revenue ruling that had addressed the question. See
American Bar Endowment, 477 U.S. at 117 (citing Singer, 449 F.2d 413
(Ct. Cl. 1971) and Rev. Rul. 67-246); Hernandez, 490 U.S. at 691
(citing Singer). In Singer v. United States, the appellate division of
the Court of Claims (the predecessor to the Federal Circuit) held that
a sewing machine company was not eligible for a charitable contribution
deduction for selling sewing machines to schools at a discount because
the company ``expected a return in the nature of future increased
sales'' to students. Singer, 449 F.2d at 423-24. In so holding, the
court expressly rejected the company's argument that this expected
benefit should be ignored because it came from the students (i.e.,
third parties), rather than directly from the schools. Id. at 422-23.
The court stated, ``Obviously, we cannot agree with plaintiff's
distinction.'' Id. Similarly, in Rev. Rul. 67-246, Example 11, a local
department store agreed to award a transistor radio, worth $15, to each
person who contributed $50 or more to a specific charity. The ruling
concluded that if a taxpayer received a $15 radio as a result of a $100
payment to the charity, only $85 qualified as a charitable contribution
deduction. It did not matter that the donor received the $15 radio from
the department store, a third party, rather than from the charity. This
understanding guides the IRS's audit practices. See IRS Conservation
Easement Audit Techniques Guide (Rev. Jan. 24, 2018, p. 16) (stating
that a ``quid pro quo contribution is a transfer of money or property
partly in exchange for goods or services in return from the charity or
a third party'', and ``a quid pro quo may be in the form of an indirect
benefit from a third party'').
The Treasury Department and the IRS conclude that, under the most
logical and consistent application of existing law, a charitable
contribution deduction is reduced by any consideration a donor receives
or expects to receive, regardless of whether the donee is the party
from whom consideration is received or expected to be received. To
conclude otherwise would provide incentives for taxpayers, charitable
organizations, states, and localities to structure transactions
involving third party benefits to bypass the requirements to reduce
contribution deductions by the value of benefits received or expected
to be received. Accordingly, the Treasury Department and the IRS do not
adopt the recommendation of the commenters to limit application of the
final regulations to circumstances in which a tax credit is provided by
the donee, and as noted previously, the Treasury Department and the IRS
intend to propose amendments to the existing regulations to make clear
that the quid pro quo principle applies regardless of whether the party
providing the quid pro quo is the donee.
4. Comments on Section 164(b)(6)
A number of commenters stated that the section 164(b)(6) limitation
favors low-tax states, is a form of double taxation, or infringes on
states' rights. These comments regarding the statutory limitation
itself are beyond the scope of the proposed regulations.
5. Conservation Easement Contributions
A large number of comments from conservation easement donors, land
trusts, and government entities involved in conservation easement
donations were specific to conservation easements. Conservation
easement comments that relate to the applicability date of the
regulations are addressed under the ``Applicability Dates'' heading
later in this section.\1\
---------------------------------------------------------------------------

\1\ Although commenters used the term ``effective date,'' it is
clear that commenters were referring to the ``applicability date''
as the term is used herein.
---------------------------------------------------------------------------

One group of comments relating to conservation easements expressed
the view that donations of conservation easements to land trusts should
be excluded from the rules in the final regulations because of the
importance of land conservation, because Congress has provided extra
incentives for contributions of conservation easements over the years,
and because easement donations are not intended as section 164(b)(6)
workarounds. The Treasury Department and the IRS recognize that
conservation easements provide unique and perpetual benefits that are
accorded favorable tax treatment by state governments as well as by
Congress.

[[Page 27519]]

Specifically, Congress treats deductions for conservation easement
contributions more favorably than other charitable contribution
deductions in some contexts, such as the percentage limitation and
carryover rules.
The final regulations do not adopt this suggestion. These
regulations are based on longstanding rules of general applicability
relating to quid pro quo and charitable intent, and there is no
authority under section 170 that would void the application of the quid
pro quo principle and charitable intent doctrine to donors of
conservation easements.
A second group of comments state that determining the value of a
conservation easement tax credit may be difficult for donors and also
for donees who prepare contemporaneous written acknowledgments. In at
least one state, easement donors receive a property tax credit for each
of the years that they continue to own the underlying property.
Commenters stated that it is unknowable at the time of the donation how
many years the donor would be eligible for the property tax credit or
how to value a right to a tax credit that could continue many years
into the future. Also, an expected credit may not necessarily be
granted, may be granted in a subsequent tax year, may be subsequently
reduced, or might never be used or transferred. The Treasury Department
and the IRS understand that in some cases taxpayers may never receive
the maximum credit. Nevertheless, it is well settled that an
expectation of a return benefit negates the requisite charitable
intent, and the regulations apply that rule. The final regulations at
Sec. 1.170A-1(h)(3)(iv) state that the reduction in the amount treated
as a charitable contribution is an amount equal to the maximum credit
allowable that corresponds to the amount of the taxpayer's payment or
transfer. If there is no clear maximum credit allowable, taxpayers may
reduce their charitable contribution deduction using a good faith
estimate of the value of the credit.
A third group of comments noted that conservation easement donors
who sell their credit should get basis in the credit equal to the
amount of the reduction in the charitable contribution deduction. A
number of states have conservation easement tax credit programs that
allow the donor to sell the credit. Under existing case law, an
easement donor has no gain or loss on receipt of a credit but
recognizes capital gain upon its sale. See, for example, Tempel v.
Commissioner, 136 T.C. at 354-55 (concluding that conservation easement
donors had no basis in the tax credits that they sold). The Treasury
Department and the IRS agree with this comment that this basis issue
warrants additional consideration. Although the basis issue is beyond
the scope of these regulations, the Treasury Department and the IRS
intend to consider this issue for future guidance.
6. Taxpayers at or Below the Section 164(b)(6) Limit
A number of commenters recommended that the Treasury Department and
the IRS revise how the proposed regulations apply to taxpayers whose
state and local tax deduction is at or below the $10,000 limit in
section 164(b)(6). Under the proposed regulations, a taxpayer who
itemizes and is not subject to the alternative minimum tax (AMT), and
whose state or local tax deduction is at or below $10,000, may have
adverse federal tax consequences. This taxpayer may have made a
nondeductible contribution (in exchange for state or local tax credits)
in lieu of a fully or partially deductible payment of state or local
tax. Accordingly, some commenters recommended that taxpayers whose
state and local tax liabilities fall at or below the $10,000 limit be
allowed to deduct contributions made in exchange for state or local tax
credits up to $10,000. Some commenters recommended allowing these
taxpayers to deduct the contributions only when the taxpayers'
contributions are to the state (as opposed to an entity described in
section 170(c)(2)). Other commenters recommended allowing the deduction
only when the taxpayers' contributions are to a state or local tax
credit program that was in existence as of December 22, 2017, the date
of the enactment of the Act. Many commenters cited case law,
legislative intent, and general principles of fairness. Several
commenters suggested further study or exceptions for taxpayers with
state and local tax liabilities below the $10,000 limit. These
commenters were concerned that the impact to these taxpayers may be
greater than the Treasury Department forecasted. After considering
these comments, the Treasury Department and the IRS published a notice
of intent to propose regulations, Notice 2019-12, providing a safe
harbor, as discussed previously in this preamble.
7. Application of Section 162 for Business Taxpayers
Some commenters stated that business taxpayers are treated more
favorably than others because business taxpayers may be able to claim
deductions for payments to section 170(c) entities as ordinary and
necessary business expenses under section 162. These commenters are
correct that taxpayers engaged in a trade or business may be permitted
a section 162 deduction for amounts paid to charitable organizations in
some circumstances. See, for example, Marquis v. Commissioner, 49 T.C.
695 (1968) (taxpayer's cash payments to clients that were charitable
entities furthered her travel agency business and were therefore not
subject to the limitations of section 170). However, some commenters
raised questions regarding whether a payment for a tax credit would
always bear a direct relationship to a taxpayer's business.
A few commenters opined that the proposed regulations further
escalate the disparate treatment of charitable contributions by
individual wage earners as compared to similar contributions by
passthrough entities and their members who are individuals. These
commenters noted that the limitation imposed by section 164(b)(6) does
not apply to state or local real or personal property taxes paid or
accrued in carrying on a trade or business or an activity described in
section 212. As a result of this exception to the limitation under
section 164 and the availability of business expense deductions under
section 162, commenters stated that a taxpayer-owner of a passthrough
entity will continue to receive the benefits of an allocable share of
tax credits received by the passthrough entity. In addition, commenters
pointed out that several states have enacted or considered enacting
legislation that shifts state taxes from individuals to passthrough
entities and entitles the owners to claim a credit on the owner's state
tax return for the amount of the owner's distributive share of taxes
paid by the passthrough entity.
The proposed and final regulations apply to charitable
contributions by business taxpayers. Specifically, a business taxpayer,
like an individual taxpayer, must reduce the charitable contribution
deduction by the amount of any return benefit received or expected to
be received. Thus, the commenters' concerns do not result from
disparate treatment of business taxpayers under section 170, but rather
result from the application of sections 162 and 164, including
application of the limitation under section 164(b)(6) to passthrough
entities and their owners. The Treasury Department and the IRS
recognize that the final regulations may raise additional questions
regarding the application of sections 162 and 164 to business entities
that make payments to section 170(c) entities and that receive or
expect to receive state or local tax credits in return for such
payments. In

[[Page 27520]]

response to these questions, the Treasury Department and the IRS
published Rev. Proc. 2019-12, as previously discussed in this preamble,
which provides safe harbors under section 162 for certain payments made
by C corporations or specified passthrough entities. Neither the final
regulations nor the safe harbors in the revenue procedure otherwise
affect the availability of a business expense deduction under section
162 for payments that are ordinary and necessary expenses incurred in
carrying on a trade or business. The Treasury Department and the IRS
will continue to study comments involving the effect of the final
regulation on various business entities and will provide additional
guidance as needed.
8. Disclaiming the Tax Credit
If a taxpayer properly declines receipt of a benefit, the taxpayer
will not be treated as receiving or expecting to receive the benefit,
and the charitable contribution deduction will not be reduced by the
amount of the benefit. See Rev. Rul. 67-246, 1967-2 C.B. 104, 108,
Example 3 (taxpayer who wants to support charity, but does not intend
to use the ticket offered in return for his donation, may refuse to
accept the ticket and receive a charitable contribution deduction
unreduced by the value of the ticket). A number of commenters asked for
guidance on how a taxpayer may decline receipt of state or local tax
credits. Although not specifically stated in the regulations, taxpayers
who prefer to claim an unreduced charitable contribution deduction have
the option of not applying for a state or local income tax credit where
such an application is required in order to receive the credit.
Alternatively, taxpayers may apply for a lesser amount of the credit.
The Treasury Department and the IRS request comments as to how
taxpayers may decline state or local tax credits in other situations.
9. Cliff Effect of the 15-Percent Exception
The proposed regulations include an exception under which a
taxpayer may disregard a state or local tax credit if the credit does
not exceed 15 percent of the taxpayer's payment or 15 percent of the
fair market value of the property transferred by the taxpayer. A number
of commenters stated that the 15-percent exception results in an unfair
``cliff effect'' because credits above 15 percent do not receive the
benefit of this exception. The commenters note that this unfairness is
most significant where credits only exceed 15 percent by a small
amount. A number of commenters suggested that an amount equal to the
first 15 percent of all credits should be disregarded. Commenters also
noted that the proposed regulations penalized donors of smaller amounts
because 15 percent of a large payment results in a much larger amount
covered by the exception than 15 percent of a small payment. Commenters
also noted that a 15-percent exception would typically permit a
deduction for an amount that is more than the amount treated as de
minimis under the rules of section 170. See, for example, Rev. Proc.
90-12, 1990-1 C.B. 471 (providing guidelines for determining whether
the provision of small items or benefits of token value in return for a
contribution have insubstantial value such that the contribution is
fully deductible under section 170). On the other hand, some commenters
requested that a higher percentage be treated as de minimis.
The suggestion to disregard an amount equal to 15 percent of the
donor's transfer or otherwise change the 15-percent exception was not
adopted. The 15-percent exception was designed to provide consistent
treatment for state or local tax deductions and state or local tax
credits that provide a benefit that is generally equivalent to a
deduction. The 15-percent exception is intended to reflect the combined
benefit of state and local tax deductions, that is, the combined top
marginal state and local tax rates, which the Treasury Department and
the IRS understand currently do not exceed 15 percent. The Treasury
Department and the IRS considered tailoring this exception to the
combined marginal state and local tax rates applicable for a taxpayer's
particular jurisdiction. The Treasury Department and the IRS determined
that using a single rate sufficient to cover the highest existing
marginal rates would avoid the complexity and burden that would arise
if a taxpayer had to compute the sum of the taxpayer's state and local
marginal tax rates to determine whether the tax credit received
exceeded the benefit that the taxpayer would have received as a
deduction. The exception ensures that taxpayers in states offering
state tax deductions and taxpayers in states offering economically
equivalent credits are treated similarly. This exception is not
intended to be an application of the de minimis standard for
insubstantial or inconsequential benefits under Rev. Proc. 90-12, 1990-
1 C.B. 471.
10. Application to State and Local Tax Deductions
Some commenters expressed concern that the proposed regulations do
not apply the quid pro quo analysis to state and local tax deductions.
These concerns reflect the view that the quid pro quo analysis under
section 170 is equally applicable to tax benefits in the form of state
or local tax deductions as it is to state or local tax credits. As
noted in the preamble to the proposed regulations, the Treasury
Department and the IRS believe that considerations of tax policy and
sound tax administration do not support the application of quid pro quo
principles in the case of dollar-for-dollar state or local tax
deductions. The economic benefit of a dollar-for-dollar deduction is
limited because it is based on a taxpayer's state and local marginal
rate. Therefore, the risk of a taxpayer using such deductions to
circumvent section 164(b)(6), and the potential revenue loss, is
comparatively low. This is true even in high tax states. In addition,
if state and local tax deductions for charitable contributions were
treated as return benefits, it would make the accurate calculation of
federal taxes and state and local taxes difficult for both taxpayers
and the IRS. For example, the value of a deduction would vary based on
the taxpayer's marginal state and local tax rates, making for more
complex computations and adding to administrative and taxpayer burden.
Also, many states use federal taxable income as the starting point for
computing state taxable income, and the amount reported as a charitable
contribution deduction on a taxpayer's federal tax return is typically
the amount of the deduction on the taxpayer's state tax return.
Allowing an unreduced federal charitable contribution deduction even
though a state provides a similar deduction in measuring state taxable
income would avoid administrative complications. Accordingly, a dollar-
for-dollar state or local tax deduction does not raise the same
concerns as a state or local tax credit, and it would produce unique
complications if it were to be subject to the quid pro quo principle.
Thus, the final regulations allow taxpayers to calculate their federal
tax deductions without regard to their dollar-for-dollar state and
local tax deductions. However, the Treasury Department and the IRS are
concerned that the granting of state or local tax deductions in excess
of the amounts paid or the fair market value of property transferred to
an entity described in section 170(c) could result in more substantial
economic benefits to the taxpayer and should be treated as a quid pro
quo. Accordingly, the final regulations also retain the exception to
general rule for excess state or local tax deductions.

[[Page 27521]]

Some commenters also contended that the proposed regulations
disfavor state and local governments relative to the federal
government. These commenters noted that the proposed regulations do not
require a taxpayer to reduce the taxpayer's charitable contribution
deduction by the value of the federal tax deduction. However, as
discussed in the prior paragraph, the final regulations do not treat
state charitable contribution deductions any differently than federal
charitable contribution deductions. Under the final regulations neither
state nor federal charitable contribution deductions are treated as
return benefits in determining the taxpayer's charitable contribution
deduction under section 170. The economic benefit of a state or federal
charitable contribution deduction is limited because both are based on
a taxpayer's marginal tax rate. In addition, there is minimal risk that
a taxpayer will use either of these deductions to circumvent section
164(b)(6), and the potential revenue loss, in both cases, is
comparatively low. Furthermore, unlike state or local governments,
Congress would not be motivated to enact a provision enabling an excess
charitable contribution to circumvent its other federal tax laws. Thus,
the final regulations specifically address the workarounds stemming
from taxpayer's use of state and local tax credit programs, but
continue to provide parallel treatment of both federal and state
charitable contributions deductions.
11. Contributions to Foreign Charitable Organizations
A small number of commenters expressed the view that the proposed
regulations favor payments to foreign charities. Charitable
contributions made to foreign organizations generally are not
deductible for federal income tax purposes. See section 170(c)(2).
Moreover, in the limited situations where these deductions are allowed,
taxpayers are treated as if they are making such contributions to
entities that are organized in the United States, and accordingly, such
contributions would be subject to the rules and regulations under
section 170. As a result, while tax credits provided by foreign
governments for contributions to foreign charities are outside the
scope of the final regulation, if the taxpayer is seeking to deduct
such charitable contributions under section 170, the quid pro quo
principle set out under section 170 would be equally applicable.
12. Valuation and Substantiation of the Credits
Commenters expressed concerns about the challenges for taxpayers
and donees in determining the value of a state or local tax credit.
Under the proposed regulations, a taxpayer needs to know the ``maximum
credit allowable'' that corresponds to the amount of the taxpayer's
transfer to the donee. This amount would typically be the stated amount
of the credit, and unless the 15-percent exception applies, the
taxpayer's charitable contribution deduction would generally be reduced
by this amount. However, if the credit does not have a clear maximum
credit allowable, a taxpayer's good faith estimate of the value will
satisfy the rules of the final regulations.
Commenters have also expressed concerns about substantiation of a
charitable contribution when the donee does not know whether the donor
expects to receive a state or local tax credit. If a donee is not the
entity providing the credit, the contemporaneous written acknowledgment
rules do not require that the amount of the credit be reported in the
acknowledgment. See section 170(f)(8) (stating that a contemporaneous
written acknowledgment includes a statement of whether the donee
provided goods and services and if so, includes a good faith estimate
of the value of those goods or services). Further, under Sec. 1.170A-
13(f)(5), goods and services include benefits.
One commenter asked about compliance with section 6115, which
generally requires donee disclosures in connection with quid pro quo
contributions (as defined in section 6115(b)), and specifically
requires section 170(c) organizations (but not section 170(c)(1)
entities) to provide donors with a good faith estimate of the value of
goods or services they provide. If a section 170(c)(2) organization is
not providing the state or local tax credit to the donor, section 6115
does not apply. Accordingly, there is no section 6115 requirement for
section 170(c)(2) organizations to disclose information about a tax
credit provided by a state or local government.
13. Regulatory Flexibility Act
Some commenters stated that the Regulatory Flexibility Act (5
U.S.C. chapter 6) (``RFA'') applies to the regulations because small
tax-exempt organizations and small governmental jurisdictions would be
affected by the proposed regulations due to a potential reduction in
contributions. These commenters recommended that the final regulations
contain a RFA analysis. Other commenters noted that some donors may be
small entities affected by the regulation. The Treasury Department and
the IRS do not agree that a RFA analysis is required. The organizations
and small governmental jurisdictions that receive deductible
contributions as part of a state or local tax credit program are not
subject to the proposed regulations, and any potential effect on
contributions to these organizations is an indirect effect of the
regulation. The RFA does not apply to entities indirectly affected by
the regulation. See, for example, Cement Kiln Recycling Coalition v.
EPA, 255 F.3d 855, 868 (D.C. Cir. 2001); Mid-Tax Elec. Coop v. FERC,
773 F.2d 327 (D.C. Cir. 1985). For small entities that are donors, and
potentially subject to the regulations, the regulations do not impose
more than nominal costs and do not impose a collection of information
requirement.
14. Concerns About Reduced Charitable Giving
A large number of commenters expressed concern that the proposed
regulations would result in an overall decline in charitable giving.
Many of the commenters expressed concern about the impact of the
regulations on particular charities or types of charities. A large
number of comments were received on tax credit programs that encourage
contributions to organizations that help fund public and private school
programs. A number of commenters were concerned that the proposed
regulations would decrease education opportunities for impoverished and
special needs children in grades K-12. Some commenters suggested that
the final regulations apply only to contributions to governments or
government entities and not to private school organizations, while
others suggested postponing the applicability date of final regulations
to allow time to study the effects on scholarship granting
organizations. A few commenters expressed a concern that the proposed
regulations may result in a decrease in donations to scholarship
granting organizations and increase the burden on public schools, given
that private schools may not be able to provide as many scholarships to
low-income students. Other commenters expressed concern that some state
or local tax credit programs unfairly incentivize contributions to
private organizations, thus diverting resources from public functions,
such as public schools.

[[Page 27522]]

Other commenters recommended that donations of conservation
easements should be exempted from the rules in the regulations.
Commenters representing land trusts expressed concern that the
regulations would reduce the number of donated conservation easements,
thereby reducing the ability of the federal government, state and local
governments, and land trusts to conserve in perpetuity significant
natural lands, water, and habitats. A commenter noted the needs of
struggling farmers and other landowners who might not be able to afford
to donate a conservation easement without a state tax credit. Some
commenters observed that because of the significance of land
conservation, Congress has already provided special incentives for
conservation easement donations under section 170, and the commenters
suggested the Treasury Department and the IRS follow Congress's lead by
making an exception in the final regulations for donations of
conservation easements.
Commenters from health care organizations, such as rural hospital
foundations, expressed concern that the proposed regulations would
reduce charitable giving for health care, reducing the ability of
health care organizations to offset rising medical costs and declining
patient revenue. Other commenters expressed concerns that the proposed
regulations would undermine state programs that offer tax credits for
contributions supporting a variety of local initiatives, including
public arts, education, health, human services, environment, enterprise
zones, and community betterment. Other commenters were concerned about
the effect of the regulations on child care programs. A few commenters
opined that the proposed regulations would further strain state and
local finances that are already adversely impacted by the new
limitation on deductions of state or local taxes. The commenters stated
that the new limitation would potentially force states and localities
to confront difficult choices regarding tax rates and public services.
In addition, several commenters suggested that the Treasury Department
and the IRS adopt a facts-and-circumstances test to differentiate
between tax credit programs that are consistent with state and federal
policy goals and those that are designed for tax avoidance.
The Treasury Department and the IRS recognize the importance of the
federal charitable contribution deduction, as well as state tax credit
programs, in encouraging charitable giving. The final regulations
continue to allow a charitable contribution deduction for the portion
of a taxpayer's charitable contribution that is a gratuitous transfer,
and the regulations also leave unchanged the state-level benefit
provided by state tax credits. In combination with Notice 2019-12, the
regulations will not alter the charitable giving incentives for the
overwhelming majority of taxpayers as compared to the incentives under
federal tax law prior to enactment of section 164(b)(6). As discussed
previously in this preamble, Notice 2019-12 provides a safe harbor for
certain individual taxpayers who itemize deductions and who make
payments to a section 170(c) entity in return for a state or local tax
credit. Under the safe harbor, these individuals may treat the portion
of such payment that is or will be disallowed as a charitable
contribution deduction under section 170 as a payment of state or local
tax for purposes of section 164. Notice 2019-12 will mitigate the
impact of the final regulations on state or local tax credit programs
that incentivize giving to all section 170(c) entities, including
entities supporting educational scholarship programs, child care,
public health, and other important goals. Thus, the impact on
taxpayers' choices will be small.
The final regulations apply longstanding principles regarding
charitable intent and quid pro quo, and therefore treat all
contributions to entities described in section 170(c) similarly. Those
principles apply equally to all charitable contributions, regardless of
the charitable purpose or type of donee. Accordingly, the final
regulations do not adopt a facts-and-circumstances test or a test based
on the type of section 170(c) organization.
15. Programs in Existence Before the Act
A large number of commenters suggested that the final regulations
exempt tax credit programs that were established before the date of the
enactment of section 164(b)(6). The commenters noted that the pre-
existing programs could not have been intended as section 164(b)(6)
workarounds. Other commenters explained that many taxpayers made
payments or transfers to existing programs in anticipation of receiving
state or local tax credits as well as deductions, and the regulations
would cause financial hardships. Further, some commenters expressed an
opinion that the regulations are politically motivated, allegedly
targeting states and localities with high tax rates. Commenters also
stated that exempting pre-existing programs would not lead to an
unanticipated revenue loss because revenue implications were known when
the Act was enacted.
The regulations are based on longstanding federal tax law
principles that apply equally to all taxpayers. To ensure fair and
consistent treatment, the final regulations do not distinguish between
taxpayers who make transfers to state and local tax credit programs
enacted after the Act and those who make transfers to tax credit
programs existing prior to the enactment of the Act. Neither the intent
of the section 170(c) organization, nor the date of enactment of a
particular state tax credit program, are relevant to the application of
the quid pro quo principle. Accordingly, the final regulations apply
the rules equally to all state and local tax credit programs, and the
final regulations do not adopt commenter recommendations to create
exceptions to the general rule for various types of state tax credit
programs.
Regarding the comment on revenue implications for pre-existing
programs, state and local governments have the ability to change the
parameters, including the aggregate dollar amount of credits, of these
programs. In addition, as noted previously, some states and taxpayers
have pursued tax planning strategies through the use of pre-existing
state or local tax credit programs that would have the effect of
allowing taxpayers to deduct their payments of state and local taxes in
excess of the limitation under section 164(b)(6). These strategies
would increase the revenue loss to the federal government beyond
estimates when the Act was enacted.
16. Applicability Date
A number of commenters requested a delayed applicability date, or
in the alternative, a phased-in implementation of the proposed
regulations. The majority of these commenters requested an
applicability date of January 1, 2019. Others suggested dates of up to
five years after the enactment of the Act, and still others did not
propose a specific date. Some commenters requested a delayed
applicability date with respect to all tax credit programs, while
others requested a delayed applicability date for only certain tax
credit programs.
Many commenters requesting a delayed applicability date expressed
concern about the adverse impact on state scholarship tax credit
programs. Some commenters noted that a phased-in implementation or
delayed applicability date may minimize uncertainty for students.
Commenters also described the application process for certain state tax
credit programs, requesting a delayed applicability date

[[Page 27523]]

of October 31, 2018, or December 31, 2018, to ensure that states would
have sufficient time to inform applicants as to whether their
applications were accepted, and to provide applicants with sufficient
time to make contributions prior to the date of applicability of the
proposed regulations.
Some commenters requested a delayed applicability date of January
1, 2019 or 2020, for conservation easement donations. These commenters
stated that donations of conservation easements are unique in that they
are time-consuming and costly for donors to plan for and finalize. For
example, a conservation easement donor may have to expend tens of
thousands of dollars to hire an appraiser, an attorney, a surveyor, and
in some jurisdictions, pay an application fee. Also, it takes many
months, sometimes more than a year, for the donor to take all the
necessary steps to contribute an easement that is deductible under
section 170(h) and also creditable under state law, and many easements
are donated at the end of the calendar year. The commenters stated that
the mid-year applicability date in the proposed regulations has created
complexity for taxpayers.
These suggestions were not adopted. The Treasury Department and the
IRS continue to believe that the proposed applicability date of August
27, 2018, provides maximum certainty for taxpayers making contributions
in exchange for state and local tax credits and minimizes revenue loss.
If the proposed applicability date had not been contemporaneous with
the proposed regulations, the Treasury Department and the IRS believe
that taxpayers would have engaged in significant tax planning in
advance of the regulations being finalized, resulting in a significant
loss of revenue. Additionally, Notice 2018-54, released May 23, 2018,
gave taxpayers timely notice that formal guidance was forthcoming. It
would be inequitable to revise the applicability date at this point, as
some taxpayers have made decisions regarding their charitable
contributions based on the applicability date in the proposed
regulations. Finally, any delay in applying the rules of the final
regulation would potentially undermine the purposes of the limitation
in section 164(b)(6).

Special Analyses

Executive Orders 12866 and 13563 direct agencies to assess costs
and benefits of available regulatory alternatives and, if regulation is
necessary, to select regulatory approaches that maximize net benefits
(including potential economic, environmental, public health and safety
effects, distributive impacts, and equity). Executive Order 13563
emphasizes the importance of quantifying both costs and benefits, of
reducing costs, of harmonizing rules, and of promoting flexibility.
This rule has been designated as subject to review under Executive
Order 12866 (E.O. 12866) pursuant to the Memorandum of Agreement (April
11, 2018) between the Treasury Department and the Office of Management
and Budget (OMB) regarding review of tax regulations. OMB has
determined that the rule is economically significant and therefore
subject to review under section 1(c) of the Memorandum of Agreement
(MOA). Elsewhere in the Special Analyses, the economic effects of the
rule are analyzed in conjunction with Notice 2019-12, which provides a
safe harbor that taxpayers may immediately rely upon and that likely
diminishes the effects of the rule. OMB has made its determination
based only on the economic effects of the rule. This rule is a
regulatory action under Executive Order 13771.
The following analysis provides further detail regarding the
anticipated impacts of the rule. Part I explains the need for the rule.
Part II specifies the baseline for the economic analysis. Part III
summarizes the economic effects of the rulemaking, relative to this
baseline. Part IV provides illustrative scenarios. Part IV.A describes
the tax effects of charitable contributions prior to enactment of the
statutory limitation on deductions for state and local taxes under
section 164(b)(6) (the ``SALT limitation'') in the Act. Part IV.B
provides examples comparing the tax effects of charitable contributions
after enactment of the SALT limitation, but absent the rule (the
baseline) to the tax effects under the rule and notice. Finally, Part V
provides a qualitative assessment of the potential costs and benefits
of the rule and notice compared to the baseline.

I. Need for Regulation

This regulation provides guidance on the deductibility of
charitable contributions when a taxpayer receives or expects to receive
a corresponding state or local tax credit. The regulation is intended
to clarify the relationship between the federal charitable contribution
deduction under section 170 and the recently-enacted SALT limitation.
Compelling policy considerations reinforce the interpretation and
application of section 170 in this context. Disregarding the value of
state and local tax credits received or expected to be received in
return for charitable contributions would precipitate revenue losses
that would undermine the limitation on the deduction for state and
local taxes adopted by Congress under the Act.
In this regard, the Treasury Department and the IRS note that the
Joint Committee on Taxation (JCT) estimated that the limitation on
state and local tax deductions along with certain other reforms of
itemized deductions would raise $668 billion over ten years. See Joint
Committee on Taxation, ``Estimated Budget Effects of the Conference
Agreement for H.R. 1, The `Tax Cuts and Jobs Act,' '' JCX-67-17,
December 18, 2017, at https://www.jct.gov/publications.html?func=startdown&id=5053. A substantial amount of this
revenue would be lost if state tax benefits received in exchange for
charitable contributions were ignored in determining the charitable
contribution deduction. This estimate is not a revenue estimate of the
rule, in part because it includes other reforms of itemized deductions
but does not reflect certain other provisions of the Act. In addition,
this does not represent an estimate of the non-revenue economic effects
of the rule. Still, the JCT estimate provides a rough upper bound of
the potential revenue loss and individual contribution choices at stake
in this rulemaking.

II. Baseline

Prior to the proposed and final regulation, the Treasury Department
and the IRS had not issued formal guidance on the deductibility of
contributions to entities described in section 170(c) that give rise to
state or local tax credits. There was also no guidance, aside from
Notice 2018-54, addressing the interaction between section 170 and the
newly enacted SALT limitation. As a result, there was a degree of
taxpayer uncertainty as to whether state and local tax credits were a
return benefit that reduces a taxpayer's charitable contribution
deduction, and absent further guidance, taxpayers would likely have
taken different filing positions. For informational and analytical
purposes, however, this analysis assumes as a baseline that state and
local tax credits are generally not treated as a return benefit or
consideration and therefore do not reduce the taxpayer's charitable
contribution deduction under section 170(a). The illustrative scenarios
presented below make use of alternative baseline scenarios to provide
clarity on the incremental impacts arising out of the rule and notices.

[[Page 27524]]

III. Summary of Economic Effects

Section 2 of the MOA stipulates that tax regulations that are
likely to have a non-revenue effect on the economy of $100 million or
more (identified in section 1(c) of the MOA) will be subject to the
analytical requirements applicable to significant regulations under
section 6(a)(3)(B) of E.O. 12866, as well as the additional
requirements applicable to economically significant regulations under
section 6(a)(3)(C) of E.O. 12866. Those requirements entail an
assessment of potential costs and benefits of significant regulatory
actions. Section 6(a)(3)(C) of E.O. 12866 also states that to the
extent feasible, quantitative assessments including the underlying
analyses for a non-inclusive list of factors shall be provided for the
costs and benefits of rules that have an annual effect on the economy
of $100 million or more or adversely affect in a material way the
economy or certain aspects of the economy.
At the proposed rule stage, the Treasury Department and the IRS
determined that the proposed rulemaking would not result in costs,
benefits, or non-revenue transfers in excess of $100 million per year,
and thus would not be economically significant. However, the Treasury
Department and the IRS acknowledge that there is limited quantitative
data available for purposes of evaluating economic effects. Given the
level of public interest and engagement, and possible economic and/or
behavioral impact, including to individuals' contribution choices,
beyond what can be reasonably anticipated with quantitative methods and
available data, the final rule has been designated by OMB as
economically significant, and it is therefore subject to the analytical
requirements for an economically significant rule.
The Treasury Department and the IRS note, however, that the non-
revenue impacts of the final rule could be below the economically
significant threshold, especially when the potential effects are
considered in conjunction with Notice 2019-12, which is to be issued
with the final rule. The requirements in the Notice have not been
finalized or incorporated into this final rulemaking, but as noted
earlier in this preamble, the Treasury Department and the IRS
anticipate issuing a proposed rule formalizing the guidance in the
Notice shortly after this final rule is issued.
The Treasury Department and the IRS expect that the main effect of
this rulemaking with Notice 2019-12 would be to reduce the incentive
for individual taxpayers to reallocate state and local taxes from
general public funds to funds designated for specific public purposes,
solely to generate a charitable gift for federal tax purposes. These
transfers from one public fund to another would not be substantive in
nature and therefore are not anticipated to generate real economic
effects. The rulemaking with Notice 2019-12 would also increase
compliance and administrative costs for some taxpayers and charitable
entities but decrease them for others. As discussed in Part V of the
Special Analyses, the Treasury Department and the IRS expect these
effects are likely small and, on net, expect a reduction in compliance
burdens (because fewer transactions performed solely for tax avoidance
will be undertaken).
The rulemaking with Notice 2019-12 may also marginally reduce the
incentive to make contributions to charitable organizations that result
in state and local tax credits, which may have the effect of reducing
aggregate contributions. But the Treasury Department and the IRS expect
this effect to be small. For example, for an individual taxpayer who
claims itemized deductions on a Federal income tax return, has more
than $10,000 of state and local tax liability, and has a Federal
marginal tax rate of 24%, a $1,000 contribution to an organization
described in section 170(c) that gives rise to a dollar-for-dollar
state tax credit in exchange for the contribution yields a combined
$1,240 of tax benefits under the baseline ($240 from the deduction
under section 170(a) and $1,000 from the state tax credit). Under the
rulemaking with Notice 2019-12, the same $1,000 contribution yields
only $1,000 in tax benefits. A substantial incentive to give to the
organization still exists (as the cost of giving is $0), though that
incentive is reduced because of the rulemaking.
In addition, the direct incentive to make contributions to
organizations that do not give rise to state or local tax credits is
unchanged by the rulemaking with Notice 2019-12. The reduction in the
relative benefit of contributing to organizations that result in state
or local credits might induce some taxpayers to contribute to other
organizations instead. However, this effect may be modest because the
tax benefit of donating to an organization eligible for a large state
tax or local credit is still greater than the benefit of donating to
another charitable organization. (See column A versus column B for each
example in Table 1.) Moreover, transfers between similar charitable
organizations (or between the state and a charitable organization
generating a state or local tax credit) might have little or no effect
on the ultimate beneficiaries of the charitable organizations or on
consumers of public goods.
As noted earlier, E.O. 12866 calls for quantitative analysis to the
extent feasible. One commenter to the proposed regulations also stated
that the analyses should have included quantitative estimates of the
costs and benefits of the rule, including estimates of the potential
size of state and local tax credits, federal revenue losses, and
efficiency losses. The commenter further stated that without
quantitative estimates it is not known ``whether the potential problem
is significant enough to justify this change in tax regulations.''
The Treasury Department and the IRS provide in this Special
Analyses an economic analysis, including to the extent feasible,
quantitative estimates that offer context regarding the scope of
possible impacts arising out of these final regulations. In particular
the Treasury Department and the IRS provide examples of how different
types of taxpayers would or would not be affected by this rulemaking as
well as estimates of the shares of taxpayers potentially affected by
the rulemaking with Notice 2019-12. However, because taxpayers do not
report whether a charitable donation has given rise to a state or local
tax credit, the extent to which states would create new tax credit
programs and taxpayers would make contributions to such programs under
the baseline or regulations is uncertain, and the extent to which the
welfare of the ultimate beneficiaries of such charitable contributions
or state spending is uncertain, the Treasury Department and the IRS
have not quantified the non-revenue economic effects of the rule.

IV. Illustrative Scenarios ²
---------------------------------------------------------------------------

\2\ While the illustrative scenarios and the analysis that
follow focuses on individual taxpayers, the final regulations also
apply to business taxpayers. Businesses making payments to entities
described in section 170(c), however, may deduct certain of these
payments as ordinary and necessary business expenses under section
162. In addition, Rev. Proc. 2019-12, 2019-04 I.R.B. 401, provides
safe harbors under section 162 for certain payments by businesses.
Therefore, the Treasury Department and the IRS expect that few
business donors would be impacted by the final regulations.
---------------------------------------------------------------------------

For the following illustrative scenarios, assume the following
facts: Charitable organizations A and B are entities described in
section 170(c) and are equally efficient in providing similar public
goods. Contributions to charity A are eligible for a dollar-for-dollar
state tax credit. Contributions to charity B are ineligible for this
credit but are deductible from state taxable income. The taxpayer
itemizes deductions, and

[[Page 27525]]

these itemized deductions in aggregate are at least $1,000 more than
the standard deduction. The taxpayer has the choice to contribute
$1,000 to charity A, and this $1,000 contribution generates a state tax
credit of $1,000.\3\ That is, the tax credit is dollar-for-dollar but
does not otherwise figure into the calculation of the taxpayer's state
tax liability. The taxpayer has more than $1,000 of state tax
liability, so that the taxpayer's state tax liability is reduced by the
entire $1,000 of the state tax credit. Finally, if the taxpayer makes
the $1,000 contribution that generates a state tax credit of $1,000,
the taxpayer reduces by $1,000 the withholding and payments of state
tax during the taxable year in question. The state tax liability is
therefore reduced by the full amount of the state tax credit in the
same taxable year as the contribution is made.\4\ Further assume a
taxpayer is in the 24 percent federal tax bracket, itemizes federal tax
deductions, and has a state tax rate of 5 percent. If the taxpayer is
subject to the AMT, assume an AMT marginal tax rate of 26 percent.
---------------------------------------------------------------------------

\3\ Note that this analysis only addresses state tax credits
offering a 100% benefit. The results may differ for credits offering
a lower benefit, but the comparative results of the illustrative
examples would be similar.
\4\ The results of the examples are generally unchanged if the
taxpayer instead receives the credit as a refund of state taxes paid
that were deducted from federal taxable income, as such refund would
be includible in federal taxable income in the following year.
---------------------------------------------------------------------------

The Act, this rule, and the safe harbor for certain individuals
described in Notice 2019-12 alter the incentives some taxpayers face
about whether and how much to give to organizations that receive
charitable contributions, as well as to which organizations. This is
illustrated in the following scenarios, which are also summarized in
Table 1.

A. Prior Law: Section 170 Charitable Contributions Prior to the Act

The tax effects of contributions prior to enactment of the Act are
illustrated in the columns labeled ``Prior Law'' in Table 1.
1. Taxpayer Not Subject to the AMT
Prior to enactment of the Act, if the taxpayer made a $1,000
contribution to charity A that generated a state tax credit of $1,000,
the deduction for charitable contributions under section 170(a)
increased by $1,000, and the taxpayer's liability for state and local
taxes deductible under section 164 decreased by $1,000. The taxpayer's
itemized deductions, taxable income, and federal tax liability were
unchanged from what they would have been in the absence of the
contribution.\5\ The taxpayer's state tax liability decreased by $1,000
because of the state tax credit. The combined federal and state tax
benefits of the $1,000 contribution were therefore $1,000, and the cost
to the taxpayer and to the federal government of making the
contribution was $0. This is shown in column A under Prior Law for
Example 1 in Table 1 and replicated in the same column for Example 2.
---------------------------------------------------------------------------

\5\ This assumes the taxpayer was not subject to limitations
such as the overall limitation on itemized deductions under section
68 or subject to a percentage limitation for the deduction under
section 170, an assumption that is maintained throughout the
succeeding discussion.
---------------------------------------------------------------------------

2. Taxpayer Subject to the AMT
If the taxpayer were subject to the AMT under section 55, however,
there was a net benefit to the taxpayer from contributions to charity
A, which provided state tax credits. State and local taxes are not
deductible in determining taxable income under the AMT, but charitable
contributions are deductible in determining taxable income under the
AMT. If the taxpayer contributed $1,000, taxable income under the AMT
was reduced by $1,000 due to the charitable contribution deduction
under section 170, but there was no corresponding reduction in the
deduction for state and local taxes. Under an AMT marginal tax rate of
26 percent, the federal tax benefit of this $1,000 contribution would
be $260. Because of the dollar-for-dollar state tax credit, the
taxpayer received a combined federal and state tax benefit of $1,260
for a $1,000 contribution; that is, the taxpayer received $260 more in
tax benefits than the amount of the contribution. This is shown in
column A under Prior Law for Example 3 in Table 1.
3. Comparison of Contributions to Different Organizations Under Prior
Law
In combination, state and federal tax laws generally provide a
greater incentive to contribute to organizations eligible for state tax
credits (charity A) than to other organizations (charity B). The
effects of a contribution to charity A are described in Parts IV.A1 and
IV.A2 previously.
Prior to enactment of the Act, for a taxpayer not subject to the
AMT, a $1,000 contribution to charity B yielded a smaller combined
federal and state tax benefit than to charity A. The state tax benefit
was $50 ($1,000 multiplied by the 5 percent state tax rate). The
taxpayer's itemized deductions at the federal level increased by $950
(the $1,000 charitable contribution deduction less the $50 reduction in
state taxes paid). The federal tax benefit of this increase was $228
($950 multiplied by the 24 percent federal tax rate), resulting in a
combined federal and state tax benefit of $278. The net cost to the
taxpayer of the $1,000 contribution was $722. This is shown in column B
under Prior Law for Example 1 in Table 1 and replicated in the same
column for Example 2.
For a taxpayer subject to the AMT, a $1,000 contribution to charity
B yielded a combined federal and state benefit of $310--the $1,000
contribution multiplied by the taxpayer's marginal tax rate under the
AMT of 26 percent, or $260, plus the value of the deduction from state
tax, or $50 ($1,000 multiplied by the 5 percent state tax rate). The
net cost to the taxpayer of the $1,000 contribution was $690. This is
shown in column B under Prior Law for Example 3 in Table 1.
Contributing to either charity A or charity B reduced the
taxpayer's combined federal and state tax liability, but the existence
of the state tax credit for contributions to charity A made
contributions to that organization more attractive. This is seen by
comparing the Total Tax Benefit in column A under Prior Law to the
corresponding value in column B for each of the three examples. For
taxpayers not subject to the AMT, contributions to charity A yielded a
combined federal and state tax benefit of $1,000, compared to a
combined federal and state tax benefit of $278 for a contribution to
charity B. The AMT increased the disparity for contributions to charity
A versus charity B, resulting in a combined federal and state tax
benefit of $1,260 for a contribution to charity A versus $310 for a
contribution to charity B.

B. Examples of Current Law and Practices Under the Act and Final Rule
With Notice 2019-12

The enactment of the SALT limitation in the Act has, in limited
circumstances, altered the federal tax effects of charitable
contributions as described in the following examples. These are
illustrated in the columns labeled ``Baseline'' and ``Final Rule with
Notice 2019-12'' in Table 1.
1. Example 1: Taxpayer Is Above the SALT Limitation and Not Subject to
the AMT
a. Baseline
If a taxpayer who has a state tax liability of more than $1,000
above the SALT limitation and is not subject to the AMT makes a $1,000
contribution to charity A, the deduction for charitable contributions
under section 170(a)

[[Page 27526]]

increases by $1,000, but the deduction for state and local taxes paid
under section 164 is unchanged. Consequently, itemized deductions
increase by $1,000, and taxable income decreases by $1,000. If the
taxpayer is in the 24 percent bracket, federal liability will decrease
by $240, and state tax liability will decrease by the $1,000 state tax
credit. The combined federal and state tax benefits of the $1,000
contribution are therefore $1,240, and the taxpayer receives a $240 net
benefit while the federal government has a loss of $240. This is shown
in column A under Baseline for Example 1 in Table 1.
b. Final Rule With Notice 2019-12
If the same taxpayer makes the $1,000 contribution to charity A
under the rule with Notice 2019-12, the entire $1,000 contribution is
not deductible under section 170(a), and the deduction for state and
local taxes paid under section 164 is unchanged due to the SALT
limitation. The taxpayer's itemized deductions, taxable income, and
federal tax liability are unchanged from what they would be in the
absence of the contribution. The taxpayer's state tax liability
decreases by $1,000 because of the state tax credit. The combined
federal and state tax benefits of the $1,000 contribution are therefore
$1,000, or $240 less than under the baseline. This is shown by
comparing the Total Tax Benefit in column A under Final Rule with
Notice 2019-12 with the corresponding value in column A under Baseline
for Example 1 in Table 1. However, the benefit of the contribution for
this taxpayer is the same as the taxpayer faced prior to enactment of
the Act. This is shown by comparing the Total Tax Benefit under column
A under Final Rule with Notice 2019-12 with the corresponding value in
column A under Prior Law for Example 1 in Table 1.
c. Comparison of Contributions to Different Organizations and Final
Rule With Notice 2019-12
Under the baseline and this rule with Notice 2019-12, for a
taxpayer with state and local taxes paid over the SALT limitation, the
value of a contribution to charity B, that is a contribution that
results in a one-for-one state income tax deduction and not a state tax
credit, is slightly higher than it was pre-Act. This increase is
because the state deduction does not reduce the federal deduction for
state and local taxes for a taxpayer above the SALT limitation. As
shown in the Total Tax Benefit row under the B columns for Example 1,
under the baseline and this rule with Notice 2019-12, the value of a
$1,000 contribution to charity B is $290--the charitable contribution
deduction from federal tax ($1,000 multiplied by the 24 percent federal
tax rate, or $240), plus the value of the deduction from state tax
($1,000 multiplied by the 5 percent state tax rate, or $50)--compared
to $278 for contributions under prior law (described in Part IV.A3
previously). By comparison, as shown in the Total Tax Benefit row under
the A columns for Example 1, a contribution to charity A, eligible for
a state tax credit, yields a $1,240 tax benefit under the baseline and
a $1,000 benefit under this rule with Notice 2019-12.
2. Example 2: Taxpayer Is Below the SALT Limitation and Not Subject to
the AMT
a. Baseline
If a taxpayer who has state and local taxes paid below the SALT
limitation and is not subject to the AMT makes the $1,000 contribution
to charity A, the deduction for charitable contributions under section
170(a) increases by $1,000, and the deduction for state and local taxes
paid under section 164 decreases by $1,000. The taxpayer's itemized
deductions, taxable income, and federal tax liability are unchanged
from what they would be in the absence of the contribution. The
taxpayer's state tax liability decreases by $1,000 because of the state
tax credit. The combined federal and state tax benefits of the $1,000
contribution are therefore $1,000, and the cost to the taxpayer and to
the federal government of making the contribution is $0. This situation
is identical to prior law or what the taxpayer faced prior to enactment
of the Act. This is shown is column A under Baseline and Prior Law for
Example 2 in Table 1.
b. Final Rule With Notice 2019-12
If the same taxpayer makes the $1,000 contribution to charity A
under the proposed rule, the entire $1,000 contribution is not
deductible under section 170(a), but the deduction for state and local
taxes paid under section 164 still decreases by $1,000 because of the
$1,000 state tax credit. If the taxpayer is in the 24 percent bracket,
the federal tax liability will increase by $240. The taxpayer's state
tax liability decreases by the $1,000 state tax credit. The combined
federal and state tax benefits of the $1,000 contribution are therefore
$760, or $240 less than the baseline. This is shown by comparing the
Total Tax Benefit in column A under Proposed Rulemaking with the
corresponding value in column A under Baseline for Example 2. In this
case, the proposed rule has the effect of increasing the taxpayer's
federal taxable income compared to the baseline if the taxpayer makes a
contribution to charity A.
One commenter to the proposed regulations suggested that Example 2
be revised to indicate that the purported donation is a tax for
purposes of section 164 if the state is the donee. As noted earlier in
the preamble, that issue is outside of the scope of these regulations,
but the Treasury Department and the IRS have issued Notice 2019-12,
which provides a safe harbor for certain individuals. As described
earlier in the preamble, under the safe harbor, an individual who
itemizes deductions and who makes a payment to a section 170(c) entity
in return for a state or local tax credit may treat the portion of such
payment that is disallowed as a charitable contribution deduction under
section 170 as a payment of state or local tax for purposes of section
164. This disallowed portion of the payment may be treated as a payment
of state or local tax under section 164 when the individual applies the
credit to offset the individual's state or local tax liability.
Under the final rule with Notice 2019-12, if the same taxpayer
makes the $1,000 contribution to charity A, the entire $1,000
contribution is not deductible under section 170(a), but the deduction
for state and local taxes paid under section 164 is unchanged because
of the safe harbor. The taxpayer's federal liability is unchanged. The
taxpayer's state tax liability decreases by the $1,000 state tax
credit. The combined federal and state tax benefits of the $1,000
contribution are therefore $1,000, the same as under prior law and the
baseline. This is shown by comparing the Total Tax Benefit in column A
under Final Rule with Notice 2019-12 with the corresponding value in
column A under Baseline for Example 2.
c. Comparison of Contributions to Different Organizations, Under Prior
Law, Baseline, and Final Rule With Notice 2019-12
Under the baseline scenario and this final rule with Notice 2019-
12, the tax benefit of charitable contributions to charity B, which are
not eligible for a state tax credit but are deductible from both
federal and state taxable income, is unchanged from prior law for
taxpayers below the SALT limitation. Thus, in this example, the benefit
of making a contribution to charity B remains $278, as described
previously. This is shown in the Total Tax Benefit row under the

[[Page 27527]]

B columns for Example 2. By comparison, as shown in the Total Tax
Benefit row under the A columns for Example 2, a $1,000 contribution to
charity A, eligible for a state tax credit, yields a $1,000 tax benefit
under the baseline and under the final rule with Notice 2019-12. Under
the final rule with Notice 2019-12 contributions to charity A are less
costly than contributions to charity B in the same manner as under
prior law for taxpayers with itemized state and local tax deductions of
$10,000 or less.
3. Example 3: Taxpayer Is Subject to the AMT \6\
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\6\ The Act increased the amount of income exempt from AMT. The
Treasury Department estimates that in 2018 only about 150,000
taxpayers will be subject to the AMT under the Act, compared to more
than 5 million under prior law.
---------------------------------------------------------------------------

a. Baseline
If a taxpayer subject to the AMT makes a $1,000 contribution to
charity A, the contribution reduces the taxpayer's taxable income under
the AMT by $1,000. Using an AMT marginal tax rate of 26 percent, the
federal tax benefit of this $1,000 contribution is $260. Because of the
dollar-for-dollar state tax credit, the taxpayer would receive a
combined federal and state tax benefit of $1,260 for a $1,000
contribution, or a $260 net benefit. This result is identical to the
result under prior law (prior to enactment of the Act). This is shown
in the A columns under Baseline and Prior Law for Example 3 in Table 1.
b. Final Rule With Notice 2019-12
If the same taxpayer makes the $1,000 contribution to charity A
under the final rule with Notice 2019-12, the entire $1,000 is not
deductible under section 170(a). Therefore, the taxpayer's taxable
income and federal tax liability under the AMT would be unchanged from
what they would be in the absence of the contribution. The taxpayer's
state tax liability decreases by $1,000 because of the state tax
credit. The combined federal and state tax benefits of the $1,000
contribution are therefore $1,000, or $260 less than under the baseline
and under the law prior to enactment of the Act. This is shown by
comparing the A columns of Example 3 in Table 1. However, under the
rule, taxpayers subject to the AMT are in the same position as other
taxpayers making a $1,000 contribution to charity A. This is shown by
comparing the Total Tax Benefit amount under column A for the Final
Rule with Notice 2019-12 for Example 3 to that for Examples 1 and 2.
c. Comparison of Contributions to Different Organizations, Under Prior
Law, Baseline and Final Rule With Notice 2019-12
Under the baseline and the final rule with Notice 2019-12, the
treatment of charitable contributions that are deductible from both
federal and state taxable income is unchanged from prior law for
taxpayers subject to the AMT. This is shown in the B columns for
Example 3 in Table 1. In this example, the benefit of making a
contribution to charity B remains $310, as described previously for
contributions under prior law. By comparison, a contribution to a
charity A, eligible for a state tax credit, yields a $1,260 tax benefit
under the baseline and a $1,000 benefit under the final rule with
Notice 2019-12. This is shown in column A under Baseline and Final Rule
with Notice 2019-12 for Example 3 in Table 1.
4. Example 4: State Tax Credit of 15 Percent or Less
Suppose, for this example only, that contributions to charity A
generate a state tax credit with a rate of 10 percent, instead of 100
percent as described in Examples 1 through 3. If a taxpayer makes the
$1,000 contribution to charity A under the final rule with Notice 2019-
12, the deduction for charitable contributions under section 170(a)
increases by $1,000. The deduction under section 170(a) is not reduced
by the value of the credit because it does not exceed 15 percent. Thus,
the taxpayer's federal tax liability is the same under the final
regulations as under the baseline. The result is also the same as it
would have been if the taxpayer's marginal state tax rate were 10
percent and the taxpayer were allowed a dollar-for-dollar deduction
from state taxable income instead of a credit.
If the taxpayer is above the SALT limitation or subject to the AMT,
the taxpayer's taxable income under the regular tax and under the AMT
decreases by $1,000. If the taxpayer is not subject to the AMT and is
in the 24 percent bracket, federal tax liability will decrease by $240,
and state tax liability will decrease by $100. The combined federal and
state tax benefits of the $1,000 contribution are therefore $340. If
the taxpayer is subject to the AMT and has an AMT marginal tax rate of
26 percent, federal tax liability will decrease by $260, and state tax
liability will decrease by $100, yielding a combined federal and state
benefit of $360 for the $1,000 contribution.
If the taxpayer is below the SALT limitation, the taxpayer's
deduction for state and local taxes treated as paid under section 164
decreases by $100, and the taxpayer's taxable income decreases by $900.
If the taxpayer is in the 24 percent bracket, federal tax liability
will decrease by $216, and state tax liability will decrease by $100.
The combined federal and state tax benefits of the $1,000 contribution
are therefore $316.

V. Expected Benefits and Costs

A. Benefits

This regulation likely reduces economically inefficient choices
motivated by the potential tax benefits available if this regulation
were not promulgated. Under the prior law and baseline scenarios, state
and local governments have an incentive to fund governmental activities
through entities that are eligible to receive deductible contributions
and to establish tax credits. This incentive is particularly strong
under a SALT limitation scenario where state and local governments may
do so solely to enable some taxpayers to circumvent the SALT
limitation. The final rule with Notice 2019-12 substantially diminishes
this incentive to engage in economically inefficient tax-avoidance
behavior. As a result, it is expected that fewer such credit programs
would be established in the future under the rule than under the
baseline.
To the extent this result occurs, the Treasury Department and the
IRS estimate that this rule would reduce the overall complexity burden
for states and for taxpayers who would otherwise make charitable
contributions solely for the purpose of reducing their state and local
tax liability. In addition, the Treasury Department and the IRS
anticipate that the rule will also spare some taxpayers compliance
costs associated with complex tax planning designed to avoid the SALT
limitation.
In addition, the rule is expected to make the federal tax system
more neutral to taxpayers' decisions regarding making donations to
state and local tax credit programs versus making donations to other,
similar charitable organizations that do not give rise to state or
local tax credits. Under the baseline scenarios, the combined federal
and state tax benefits favor contributions to organizations that give
rise to a state tax credit for taxpayers, particularly for taxpayers
above the SALT limitation. Under the final rule and Notice 2019-12,
this economic distortion is expected to be reduced.
The proposed regulations requested comments from the public on the
potential extent of this expected

[[Page 27528]]

reduction in economic distortion. One commenter responded that
increased neutrality in the treatment of contributions to organizations
that qualify for tax credits and those that do not is not a benefit of
the rule. The commenter argued that such a conclusion ignores the
possibility that tax credit programs provide a social benefit. The
conclusion in the proposed regulations does not ignore the social
benefits that tax credit programs might provide. The Treasury
Department and the IRS have clarified in Part IV previously that their
analysis was specific to cases where two organizations, one eligible
for tax credits and the other not, are equally efficient in their
provision of similar public goods. That is, both provide the same
social benefit given the same level of contributions.
Finally, the final rule provides more certainty to taxpayers by
clarifying the rules governing the amount that they can claim as a
charitable contribution deduction when they receive or expect to
receive a state or local tax credit or a state or local tax deduction
in exchange for the contribution.
One commenter asserted that increased certainty is not a benefit of
this rule because other possible rules could also have provided
certainty. While the commenter is correct that rules other than the
proposed and final rule could also provide certainty, it remains the
case that the proposed and final rule provide the benefit of certainty,
relative to the baseline of no regulatory guidance at all.
One commenter suggested that the proposed rule would be beneficial
because it would promote more efficient state and local spending
decisions by making taxpayers bear more of the true cost of those
decisions. The SALT limitation imposed by the Act reduced the federal
subsidy of state and local spending, and the rule is consistent with
this purpose of the Act provision. The reduction in the subsidy has the
potential to make state spending decisions more efficient.

B. Costs

The rule may result in some increase in compliance costs for
taxpayers who make contributions that generate state or local tax
credits. Under the baseline, for purposes of the charitable
contribution deduction under section 170(a), taxpayers did not need to
address state or local tax credits received or expected to be received
for purposes of claiming a charitable contribution; however, they would
know the amount of credits received as part of the filing process for
state returns. In contrast, under the final rule with Notice 2019-12,
taxpayers making a contribution to an organization described in section
170(c) will need to determine the amount of any state or local tax
credits they received or expect to receive in order to reduce their
charitable contribution deduction under section 170(a). This additional
step will generate some additional compliance costs.
The compliance burden for recipient organizations that directly
issue tax credits may increase under the rule. Under section 170(f)(8),
in order to take a charitable contribution deduction of $250 or more, a
taxpayer must have a contemporaneous written acknowledgment (CWA) from
the donee entity, usually provided in the form of a letter. The CWA
includes the amount received by the entity or a description of property
received. The CWA must also disclose whether the donee provided any
goods or services in consideration for the contribution and a
description and good faith estimate of the value of those goods or
services. State and local tax credits are not generally provided by the
donee entity, but there may be situations in which the entity would be
providing the credit and would need to disclose the credit amount in
the CWA provided to the donor. The proposed regulations requested
comments on whether additional guidance is needed on substantiation and
reporting requirements for donors and donees making or receiving
payments or transfers of property in return for state and local tax
credits and the extent to which entities do provide tax credits under
certain circumstances. As mentioned earlier in this preamble, some
commenters expressed concerns about substantiation of a charitable
contribution when the donee does not know whether the donor receives or
expects to receive a state or local tax credit. If a donee is not the
entity providing the credit, the CWA rules do not require that the
amount of the credit be reported in the acknowledgment. This mitigates
the compliance burden for these entities.
The proposed regulations requested comments as to how the rule
might alter incentives regarding contributions to state and local tax
credit programs. As mentioned previously in the preamble, many
commenters expressed concern that the rule would result in an overall
decline in charitable giving and in declines in charitable giving to
entities or causes they deem to be particularly meritorious. One
commenter expressed concern about the lack of evidence provided in
support of the statement that this rule will have at most a highly
limited, marginal effect on taxpayer decisions to donate to tax credit
programs, and the statement that most taxpayers have never contributed
to such programs. Another commenter asserted that the rule would cause
states to drop tax credit programs that support conservation easements.
The commenter noted that this was particularly likely to occur in low-
tax states, where more taxpayers will have SALT deductions under
$10,000. Several other commenters asserted that a substantial share of
donors to tax credit organizations would be affected by the rule.
Based on an analysis of confidential taxpayer return data and
forecasts using that data, the Treasury Department and the IRS estimate
that this rule will leave charitable giving incentives entirely
unchanged for the vast majority of taxpayers. The Treasury Department
and the IRS estimate that, after passage of the Act (which
significantly increased the standard deduction), 90 percent of
taxpayers will not claim itemized deductions of any kind. Those
taxpayers are entirely unaffected by this rule.
Approximately five percent of taxpayers are projected to claim
itemized deductions and have state and local income tax deductions in
excess of the SALT limitation. Under the rule and Notice 2019-12,
taxpayers in this group who are not subject to the AMT will receive the
same federal tax treatment for donating to organizations providing tax
credits as they received prior to the Act, as shown in Example 1 in
Table 1 of this special analysis.
Approximately five percent of taxpayers are projected to claim
itemized deductions and have SALT deductions below the limitation.
Taxpayers in this group who are not subject to the AMT would have faced
smaller incentives to donate to organizations resulting in state or
local tax credits in excess of 15 percent under the proposed rule.
However, these taxpayers will receive the same federal tax benefits for
cash contributions under the final rule and Notice 2019-12 as they
received prior to the Act and under the baseline, as described in
Example 2 in Table 1 of this special analysis.\7\
---------------------------------------------------------------------------

\7\ Taxpayers who contribute property do not satisfy the
requirements of the safe harbor provided in Notice 2019-12 and may
be impacted by the final regulations.
---------------------------------------------------------------------------

It is the case that, for taxpayers subject to the AMT, the cost of
giving to state and local credit organizations is higher under the rule
with Notice 2019-12 than under the baseline and under prior law. The
Treasury Department and the IRS estimate that fewer than 150,000

[[Page 27529]]

taxpayers (less than 0.1 percent of taxpayers) will be subject to the
AMT and claim itemized deductions after enactment of the Act. These
taxpayers could be affected by the final rule, but only if they
contribute to programs that entitle them to state and local tax credits
of greater than 15 percent. (The tax data do not indicate whether a
taxpayer has made a contribution that generated a state or local tax
credit.) However, as described in Example 3 in Table 1 of this special
analysis, the cost of contributing to an organization resulting in a
100 percent state tax credit will be zero for these taxpayers, as it is
for other taxpayers under the final rule with Notice 2019-12.

Table 1--Tax Treatment of $1,000 Contribution to (A) Organization that Gives Rise to $1,000 State Tax Credit and (B) Organization for Which Contribution
Is Deductible at the State Level
--------------------------------------------------------------------------------------------------------------------------------------------------------
Prior law Baseline Proposed rulemaking Final rule with notice
------------------------------------------------------------------------------ 2019-12
Change in -------------------------
A B A B A B A B
--------------------------------------------------------------------------------------------------------------------------------------------------------
Example 1: Taxpayer Above the SALT Limitation, Not Subject to the AMT; Taxpayer Remains Above SALT Limitation After Contribution
--------------------------------------------------------------------------------------------------------------------------------------------------------
State Income Tax Liability...................... -1,000 -50 -1,000 -50 -1,000 -50 -1,000 -50
Federal Income Tax:
Charitable Contribution Deduction........... 1,000 1,000 1,000 1,000 0 1,000 0 1,000
Deduction for State and Local Taxes......... -1,000 -50 0 0 0 0 0 0
Itemized Deductions......................... 0 950 1,000 1,000 0 1,000 0 1,000
Taxable Income.............................. 0 -950 -1,000 -1,000 0 -1,000 0 -1,000
Federal Tax Liability........................... 0 -228 -240 -240 0 -240 0 -240
Total Tax Benefit (Federal + State)............. 1,000 278 1,240 290 1,000 290 1,000 290
Net Cost to Taxpayer of $1,000 Contribution..... 0 722 -240 710 0 710 0 710
--------------------------------------------------------------------------------------------------------------------------------------------------------
Example 2: Taxpayer Below the SALT Limitation, Not Subject to the AMT
--------------------------------------------------------------------------------------------------------------------------------------------------------
State Income Tax Liability...................... -1,000 -50 -1,000 -50 -1,000 -50 -1,000 -50
Federal Income Tax:
Charitable Contribution Deduction........... 1,000 1,000 1,000 1,000 0 1,000 0 1,000
Deduction for State and Local Taxes......... -1,000 -50 -1,000 -50 -1,000 -50 0 -50
Itemized Deductions......................... 0 950 0 950 -1,000 950 0 950
Taxable Income.............................. 0 -950 0 -950 1,000 -950 0 -950
Federal Tax Liability........................... 0 -228 0 -228 240 -228 0 -228
Total Tax Benefit (Federal + State)............. 1,000 278 1,000 278 760 278 1,000 278
Net Cost to Taxpayer of $1,000 Contribution..... 0 722 0 722 240 722 0 722
--------------------------------------------------------------------------------------------------------------------------------------------------------
Example 3: Taxpayer Subject to the AMT
--------------------------------------------------------------------------------------------------------------------------------------------------------
State Income Tax Liability...................... -1,000 -50 -1,000 -50 -1,000 -50 -1,000 -50
Federal Income Tax:
Alternative Minimum Taxable Income.......... -1,000 -1,000 -1,000 -1,000 0 -1,000 0 -1,000
Federal Tax Liability........................... -260 -260 -260 -260 0 -260 0 -260
Total Tax Benefit (Federal + State)............. 1,260 310 1,260 310 1,000 310 1,000 310
Net Cost to Taxpayer of $1,000 Contribution..... -260 690 -260 690 0 690 0 690
--------------------------------------------------------------------------------------------------------------------------------------------------------
Assumptions: The taxpayer itemizes deductions and has more than $1,000 of state tax liability. Under prior law, the taxpayer is not subject to the
overall limitation on itemized deductions under section 68. The taxpayer faces a 24 percent marginal rate under the Federal income tax. If the
taxpayer is subject to the AMT, the taxpayer faces a 26 percent marginal rate. A $1,000 contribution to charitable organization A generates a $1,000
state tax credit. A $1,000 contribution to charitable organization B is ineligible for a state tax credit but is deductible under the state's income
tax. The taxpayer faces a 5 percent marginal rate under the state's income tax. The baseline assumes continuation of the IRS administrative position
that state and local tax credits are not reflected as a return benefit or consideration and therefore do not reduce the taxpayer's charitable
contribution deduction under section 170(a). Total Tax Benefit refers to the absolute value of the reduction of the taxpayer's combined federal and
state tax liability.

Regulatory Flexibility Act

As noted previously, pursuant to the RFA (5 U.S.C. chapter 6), it
is hereby certified that this rule will not have a significant economic
impact on a substantial number of small entities. This certification is
based on the fact that the regulations primarily affect individuals. It
is possible for a small business donor to be affected by this rule.
However, small entities will often be able to claim a business expense
deduction instead of a charitable donation, and would therefore be
unaffected by the rule. For the very few small entity donors that might
nevertheless choose to claim a charitable donation deduction and might
be directly affected by the regulation, there is no significant
economic impact. The rule would impose only nominal costs of
subtracting the amount of the credit from the amount contributed, in
order to determine the deduction allowed under section 170. There is no
collection of information requirement on small entities. Therefore, a
regulatory flexibility analysis is not required. Pursuant to section
7805(f), the proposed regulations were submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small businesses, and no comments were received.

Unfunded Mandates Reform Act

Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated costs and benefits and take
certain other actions before issuing a final rule that includes any
Federal mandate that may result in expenditures in any one year by a
state, local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. In 2018, that threshold is approximately $150 million. This
rule does not include any Federal mandate that may result in
expenditures by state, local, or tribal governments, or by the private
sector in excess of that threshold.

Executive Order 13132: Federalism

Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements

[[Page 27530]]

of section 6 of the Executive Order. This final rule does not have
federalism implications and does not impose substantial direct
compliance costs on state and local governments or preempt state law
within the meaning of the Executive Order.

Congressional Review Act

The Administrator of the Office of Information and Regulatory
Affairs of the Office of Management and Budget has determined that this
is a major rule for purposes of the Congressional Review Act (CRA) (5
U.S.C. 801 et seq.).

Drafting Information

The principal authors of these regulations are personnel from the
Office of the Associate Chief Counsel (Income Tax and Accounting).
However, other personnel from the IRS and the Treasury Department
participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.170A-1 is amended by redesignating paragraphs (h)(3)
through (5) as paragraphs (h)(4) through (6), and adding a new
paragraph (h)(3) to read as follows:

Sec. 1.170A-1 Charitable, etc., contributions and gifts; allowance of
deduction.

* * * * *
(h) * * *
(3) Payments resulting in state or local tax benefits--(i) State or
local tax credits. Except as provided in paragraph (h)(3)(vi) of this
section, if a taxpayer makes a payment or transfers property to or for
the use of an entity described in section 170(c), the amount of the
taxpayer's charitable contribution deduction under section 170(a) is
reduced by the amount of any state or local tax credit that the
taxpayer receives or expects to receive in consideration for the
taxpayer's payment or transfer.
(ii) State or local tax deductions--(A) In general. If a taxpayer
makes a payment or transfers property to or for the use of an entity
described in section 170(c), and the taxpayer receives or expects to
receive state or local tax deductions that do not exceed the amount of
the taxpayer's payment or the fair market value of the property
transferred by the taxpayer to the entity, the taxpayer is not required
to reduce its charitable contribution deduction under section 170(a) on
account of the state or local tax deductions.
(B) Excess state or local tax deductions. If the taxpayer receives
or expects to receive a state or local tax deduction that exceeds the
amount of the taxpayer's payment or the fair market value of the
property transferred, the taxpayer's charitable contribution deduction
under section 170(a) is reduced.
(iii) In consideration for. For purposes of paragraph (h)(3)(i) of
this section, the term in consideration for shall have the meaning set
forth in Sec. 1.170A-13(f)(6), except that the state or local tax
credit need not be provided by the donee organization.
(iv) Amount of reduction. For purposes of paragraph (h)(3)(i) of
this section, the amount of any state or local tax credit is the
maximum credit allowable that corresponds to the amount of the
taxpayer's payment or transfer to the entity described in section
170(c).
(v) State or local tax. For purposes of paragraph (h)(3) of this
section, the term state or local tax means a tax imposed by a State, a
possession of the United States, or by a political subdivision of any
of the foregoing, or by the District of Columbia.
(vi) Exception. Paragraph (h)(3)(i) of this section shall not apply
to any payment or transfer of property if the total amount of the state
and local tax credits received or expected to be received by the
taxpayer is 15 percent or less of the taxpayer's payment, or 15 percent
or less of the fair market value of the property transferred by the
taxpayer.
(vii) Examples. The following examples illustrate the provisions of
this paragraph (h)(3). The examples in paragraph (h)(6) of this section
are not illustrative for purposes of this paragraph (h)(3).

(A) Example 1. A, an individual, makes a payment of $1,000 to
X, an entity described in section 170(c). In exchange for the
payment, A receives or expects to receive a state tax credit of 70
percent of the amount of A's payment to X. Under paragraph (h)(3)(i)
of this section, A's charitable contribution deduction is reduced by
$700 (0.70 x $1,000). This reduction occurs regardless of whether A
is able to claim the state tax credit in that year. Thus, A's
charitable contribution deduction for the $1,000 payment to X may
not exceed $300.
(B) Example 2. B, an individual, transfers a painting to Y, an
entity described in section 170(c). At the time of the transfer, the
painting has a fair market value of $100,000. In exchange for the
painting, B receives or expects to receive a state tax credit equal
to 10 percent of the fair market value of the painting. Under
paragraph (h)(3)(vi) of this section, B is not required to apply the
general rule of paragraph (h)(3)(i) of this section because the
amount of the tax credit received or expected to be received by B
does not exceed 15 percent of the fair market value of the property
transferred to Y. Accordingly, the amount of B's charitable
contribution deduction for the transfer of the painting is not
reduced under paragraph (h)(3)(i) of this section.
(C) Example 3. C, an individual, makes a payment of $1,000 to
Z, an entity described in section 170(c). In exchange for the
payment, under state M law, C is entitled to receive a state tax
deduction equal to the amount paid by C to Z. Under paragraph
(h)(3)(ii)(A) of this section, C's charitable contribution deduction
under section 170(a) is not required to be reduced on account of C's
state tax deduction for C's payment to Z.

(viii) Effective/applicability date. This paragraph (h)(3) applies
to amounts paid or property transferred by a taxpayer after August 27,
2018.
* * * * *

Sec. 1.170A-13 [Amended]

0
Par. 3. Section 1.170A-13 is amended in paragraph (f)(7) by removing
the cross-reference ``Sec. 1.170A-1(h)(4)'' and adding in its place
``Sec. 1.170A-1(h)(5)''.

0
Par. 4. Section 1.642(c)-3 is amended by adding paragraph (g) to read
as follows:

Sec. 1.642(c)-3 Adjustments and other special rules for determining
unlimited charitable contributions deduction.

* * * * *
(g) Payments resulting in state or local tax benefits--(1) In
general. If the trust or decedent's estate makes a payment of gross
income for a purpose specified in section 170(c), and the trust or
decedent's estate receives or expects to receive a state or local tax
benefit in consideration for such payment, Sec. 1.170A-1(h)(3) applies
in determining the charitable contribution deduction under section
642(c).
(2) Effective/applicability date. Paragraph (g)(1) of this section
applies

[[Page 27531]]

to payments of gross income after August 27, 2018.

Kirsten Wielobob,

Deputy Commissioner for Services and Enforcement.
Approved: June 3, 2019.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2019-12418 Filed 6-11-19; 4:15 pm]
BILLING CODE 4830-01-P