Contributions in Exchange for State or Local Tax Credits, 27513-27531 [2019-12418]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[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\
---------------------------------------------------------------------------

    \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