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Tax Guide

IRS Response to State Run Charitable Funds & Tax Credits

IRS Response to State Run Charitable Funds & Tax Credits
Ines Zemelman, EA
27 August 2018

New York and other states try creative accounting

The cap on state and local tax deductions was one of the more controversial provisions of the tax reform. 

New York lawmakers have passed a proposal to let state residents skirt the new $10,000 federal cap. Under the proposal, New York taxpayers will be able to make a charitable contribution to new state-run charitable funds to finance education and healthcare. For doing so, they will get a state tax credit worth 85% of their contribution — which effectively reduces their state tax bill by that amount. They could then deduct 100% of their contribution on their federal return since there is no federal cap on charitable deductions. Similar tax credits were introduced by other states.

IRS Counters

In response, the IRS came up with a counter-proposal.  

When taxpayers (individual or business) claim a deduction for charitable contributions on 2018 tax return - the deductible portion of the contributions should be reduced by the amount of state or local tax credit provided on the contribution.

For example, if a state grants a 70 percent state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer must then reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s federal income tax return. The proposed regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their contribution deduction.

The proposed regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred. A taxpayer who makes a $1,000 contribution to an eligible entity is not required to reduce the $1,000 deduction on the taxpayer’s federal income tax return if the state or local tax credit received or expected to be received is no more than $150.

Ines Zemelman, EA
founder of Taxes for Expats