Treatment of Payments to Charitable Entities in Return for Consideration, 68833-68842 [2019-26969]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 84, Number 242 (Tuesday, December 17, 2019)]
[Proposed Rules]
[Pages 68833-68842]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-26969]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-107431-19]
RIN 1545-BP40


Treatment of Payments to Charitable Entities in Return for 
Consideration

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notification of public 
hearing.

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SUMMARY: This document provides proposed amendments to the regulations 
under sections 162, 164, and 170 of the Internal Revenue Code (Code). 
First, the proposed amendments update the regulations under section 162 
to reflect current law regarding the application of section 162 to a 
taxpayer that makes a payment or transfer to an entity described in 
section 170(c) for a business purpose. Second, the proposed amendments 
provide safe harbors under section 162 to provide certainty with 
respect to the treatment of payments made by business entities to an 
entity described in section 170(c). Third, the proposed amendments 
provide a safe harbor under section 164 for payments made to an entity 
described in section 170(c) by individuals who itemize deductions and 
receive or expect to receive a state or local tax credit in return. 
Fourth, the proposed amendments update the regulations under section 
170 to reflect past guidance and case law regarding the application of 
the quid pro quo principle under section 170 to benefits received or 
expected to be received by a donor from a third party.

DATES: Written or electronic comments must be received by January 31, 
2020 Requests to speak and outlines of topics to be discussed at the 
public hearing scheduled for February 20, 2020, must be received by 
January 31, 2020.

ADDRESSES: Submit electronic submissions via the Federal eRulemaking 
Portal at https://www.regulations.gov (indicate IRS and REG-107431-19) 
by following the online instructions for submitting comments. Once 
submitted to the Federal eRulemaking Portal, comments cannot be edited 
or withdrawn. The Department of the Treasury (Treasury Department) and 
the IRS will publish for public availability any comment received to 
its public docket, whether submitted electronically or in hard copy. 
Send hard copy submissions to: CC:PA:LPD:PR (REG-107431-19), Room 5203, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
107431-19), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Mon L. Lam and Merrill D. Feldstein at (202) 317-4059; concerning 
submission of comments and requests to speak at the public hearing, 
Regina Johnson at (202) 317-6901 (not toll-free numbers) or 
[email protected].

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

I. Contributions in Exchange for State and Local Tax Credits

    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 '' an entity described in that section. Under 
section 170(c)(1), such entities include a State, a possession of the 
United States, or any political subdivision of the foregoing, or the 
District of Columbia. Section 170(c)(2) includes 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. Section 1.170A-1(c)(5) of the Income Tax Regulations provides 
that transfers of property to an organization described in section 
170(c) that bear a direct relationship to the taxpayer's trade or 
business and that are made with a reasonable expectation of financial 
return commensurate with the amount of the transfer may constitute 
allowable

[[Page 68834]]

deductions as trade or business expenses rather than as charitable 
contributions. Section 162(a) allows a deduction for all the ordinary 
and necessary expenses paid or incurred during the taxable year in 
carrying on any trade or business. Section 162(b) provides that no 
deduction shall be allowed under subsection (a) for any contribution or 
gift that would be allowable as a deduction under section 170 were it 
not for the percentage limitations, the dollar limitations, or the 
requirements as to the time of payment set forth in that section.
    Section 1.162-15(a) applies to contributions to entities described 
in section 170(c). Section 1.162-15(a)(1) currently provides that no 
deduction is allowable under section 162(a) for a contribution or gift 
by an individual or a corporation if any part thereof is deductible 
under section 170. For example, if a taxpayer makes a contribution of 
$5,000 and only $4,000 of this amount is deductible under section 
170(a) (whether because of the percentage limitation under either 
section 170(b)(1) or (2), the requirement as to time of payment, or 
both), no deduction is allowable under section 162(a) for the remaining 
$1,000. However, Sec.  1.162-15(a)(2) clarifies that the limitations 
provided in section 162(b) and Sec.  1.162-15(a)(1) apply only to 
payments that are in fact contributions or gifts to organizations 
described in section 170. For example, payments by a transit company to 
a local hospital (which is a charitable organization within the meaning 
of section 170) in consideration of a binding obligation on the part of 
the hospital to provide hospital services and facilities for the 
company's employees are not contributions or gifts within the meaning 
of section 170 and may be deductible under section 162(a) if the 
requirements of section 162(a) are otherwise satisfied.
    Section 164(a) allows a deduction for the payment of certain taxes, 
including: (1) State and local, and foreign, real property taxes; (2) 
state and local personal property taxes; and (3) state and local, and 
foreign, income, war profits, and excess profits taxes. In addition, 
section 164 allows a deduction for taxes not described in the preceding 
sentence that are paid or accrued within the taxable year in carrying 
on a trade or business or an activity described in section 212. 
Moreover, under section 164(b)(5), taxpayers may elect to deduct state 
and local general sales taxes in lieu of state and local income taxes.
    Section 164(b)(6), as added by section 11042(a) of the Tax Cuts and 
Jobs Act Public Law 115-97, (the ``TCJA'') provides that in the case of 
an individual, deductions for foreign real property taxes are not 
allowable under section 164(a)(1), and the deduction for the aggregate 
amount of the following state and local taxes paid during the calendar 
year is limited to $10,000 ($5,000 in the case of a married individual 
filing a separate return): (1) Real property taxes; (2) personal 
property taxes; (3) income, war profits, and excess profits taxes; and 
(4) general sales taxes. This limitation applies to taxable years 
beginning after December 31, 2017, and before January 1, 2026, and 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 or accrued 
in carrying on a trade or business or an activity described in section 
212.
    In response to the limitation in section 164(b)(6), some taxpayers 
have considered tax planning strategies to avoid or mitigate its 
effects. Some of these strategies rely on state and local tax credit 
programs under which states provide tax credits in return for 
contributions by taxpayers to entities described in section 170(c), and 
some state and local governments have created new programs intended to 
facilitate use of these strategies.
    On June 11, 2018, the Treasury Department and the IRS announced 
their intention to propose regulations addressing the proper 
application of sections 164 and 170 to taxpayers who make contributions 
under state and local tax credit programs to entities described in 
section 170(c). See Notice 2018-54, 2018-24 I.R.B. 750. On August 27, 
2018, proposed regulations (REG-112176-18) under sections 170 and 
642(c) were published in the Federal Register (83 FR 43563) (``2018 
proposed regulations''). The 2018 proposed regulations proposed 
amending Sec.  1.170A-1(h)(3) to provide, in general, 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 or transfer, the tax credit constitutes a return benefit to the 
taxpayer and reduces the taxpayer's charitable contribution deduction. 
The 2018 proposed regulations were premised, in part, on the quid pro 
quo principle articulated by the Supreme Court in United States v. 
American Bar Endowment, 477 U.S. 105, 116 (1986), and its progeny that 
``a payment of money generally cannot constitute a charitable deduction 
if the contributor expects a substantial benefit in return.'' The 2018 
proposed regulations also proposed amending regulations under section 
642(c), to provide a similar rule for payments made by a trust or 
decedent's estate.
    The Treasury Department and the IRS received over 7,700 comments 
responding to the 2018 proposed regulations and 25 requests to speak at 
the public hearing, which was held on November 5, 2018. After taking 
into account the comments received and the concerns expressed at the 
public hearing, the Treasury Department and the IRS published final 
regulations in the Federal Register on June 13, 2019 (T.D. 9864, 84 FR 
27513) (``the final regulations''). The final regulations retained the 
rules set out in the 2018 proposed regulations, with certain clarifying 
and technical changes. Most significantly, the final regulations 
retained 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 transfer, the tax credit 
constitutes a return benefit to the taxpayer, or quid pro quo, reducing 
the taxpayer's charitable contribution deduction. See Sec.  1.170A-
1(h)(3) of the final regulations.
    In response to Notice 2018-54 and the 2018 proposed regulations, 
commenters raised several ancillary issues. These issues involved: (1) 
Treatment of business entity payments to entities described in section 
170(c); (2) treatment of payments by individuals with total state and 
local tax liabilities that were less than or equal to the section 
164(b)(6) limitations; and (3) application of the quid pro quo 
principle under section 170 to benefits received or expected to be 
received by the donor from a party other than the donee.
    Although the Treasury Department and the IRS have provided sub-
regulatory safe harbors related to the first two issues (in Rev. Proc. 
2019-12, 2019-04 I.R.B. 401, and Notice 2019-12, 2019-27 I.R.B. 57), 
the Treasury Department and the IRS believe that it is appropriate to 
include these safe harbors in proposed regulations and to request 
comments. Further, in the preamble to the final regulations, the 
Treasury Department and the IRS extensively addressed the third issue--
whether a benefit received or expected to be received from a party 
other than the donee may constitute a quid pro quo that reduces the 
taxpayer's charitable contribution deduction under section 170. The 
preamble to the final regulations stated that the Treasury Department 
and the IRS would propose additional regulations setting forth a 
general rule for benefits received or

[[Page 68835]]

expected to be received from third parties. Accordingly, the proposed 
regulations, provided herein, would amend the regulations under 
sections 162, 164, and 170 to provide guidance on these three issues.

II. Payments by Business Entities in Exchange for State or Local Tax 
Credits

    After the issuance of Notice 2018-54, and continuing after the 
publication of the 2018 proposed regulations, the Treasury Department 
and the IRS received inquiries from taxpayers regarding the application 
of the proposed regulations to businesses that make payments to 
entities described in section 170(c) pursuant to state and local tax 
credit programs. The taxpayers sought guidance as to whether a business 
entity may deduct these payments under section 162 as ordinary and 
necessary business expenses incurred in carrying on a trade or 
business. In response, on September 5, 2018, the IRS released a 
frequently asked question (``FAQ'') stating that a business taxpayer 
making a payment to an entity described in section 170(c) is generally 
permitted to deduct such payment as an ordinary and necessary business 
expense under section 162 if the payment is made with a business 
purpose. However, after the release of the FAQ, taxpayers continued to 
express concern about whether the business purpose requirement is met 
for contributions that result in a tax credit. Specifically, taxpayers 
asked whether payments by business entities in exchange for state and 
local tax credits would bear a direct relationship to the taxpayer's 
trade or business such that these payments would qualify as ordinary 
and necessary business expenses of carrying on a trade or business 
under section 162(a).
    On December 28, 2018, the IRS issued Rev. Proc. 2019-12, providing 
a safe harbor under section 162 for payments made by a business entity 
that is 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 state or 
local tax credits in return. The revenue procedure states that, to the 
extent that a C corporation receives or expects to receive a state or 
local tax credit in return for a payment to an organization described 
in section 170(c), it is reasonable to conclude that there is a direct 
benefit and a reasonable expectation of commensurate financial return 
to the C corporation's business in the form of a reduction in the state 
or local taxes the C corporation would otherwise be required to pay. 
Thus, the revenue procedure provides a safe harbor that allows a C 
corporation engaged in a trade or business to treat the portion of the 
payment that is equal to the amount of the credit received or expected 
to be received as meeting the requirements of an ordinary and necessary 
business expense under section 162.
    The IRS determined that a similar analysis is appropriate in the 
case of a business entity other than a C corporation if (1) the 
business entity is regarded as separate from its owner for all Federal 
tax purposes under Sec.  301.7701-3 of the Procedure and Administration 
Regulations (``passthrough entity''); (2) the passthrough entity 
operates a trade or business within the meaning of section 162; (3) the 
passthrough entity is subject to a state or local tax incurred in 
carrying on its trade or business that is imposed directly on the 
entity; and (4) in return for a payment to an entity described in 
section 170(c), the passthrough entity receives or expects to receive a 
state or local tax credit that the entity applies or expects to apply 
to offset a state or local tax other than a state or local income tax. 
Thus, to the extent that a specified passthrough entity makes a payment 
to an entity described in section 170(c) and receives or expects to 
receive a state or local tax credit, Rev. Proc. 2019-12 permits the 
passthrough entity to treat the payment as meeting the requirements of 
an ordinary and necessary business expense under section 162. The safe 
harbors for C corporations and specified passthrough entities apply 
only to payments of cash and cash equivalents.
    In the interest of providing certainty for taxpayers, the Treasury 
Department and the IRS believe that it is appropriate to propose 
regulations to incorporate the safe harbors set out in Rev. Proc. 2019-
12 and to request comments on these safe harbors. Thus, these proposed 
regulations propose amending Sec.  1.162-15(a) to incorporate the Rev. 
Proc. 2019-12 safe harbors. These proposed regulations also propose 
amending Sec.  1.170A-1(c)(5) and (h)(3)(viii) to provide cross 
references to Sec.  1.162-15(a). The Treasury Department and the IRS 
specifically request comments on whether the safe harbors should be 
expanded to apply to an individual who is carrying on a trade or 
business or an activity described in section 212.
    The proposed regulations propose additional revisions to Sec.  
1.162-15(a) to more clearly reflect the current state of the law 
regarding a taxpayer's payment or transfer to an entity described in 
section 170(c). If the taxpayer's payment or transfer bears a direct 
relationship to its trade or business, and the payment is made with a 
reasonable expectation of commensurate financial return, the payment or 
transfer to the section 170(c) entity may constitute an allowable 
deduction as a trade or business expense under section 162, rather than 
a charitable contribution under section 170. See Sec.  1.170A-1(c)(5); 
Marquis v. Commissioner, 49 T.C. 695 (1968). A proposed example 
illustrates that this rule applies regardless of whether the taxpayer 
expects to receive a state or local tax credit in return.
    The proposed revisions are also consistent with the decision in 
American Bar Endowment, which states that a payment to an entity 
described in section 170(c) may have a dual character--part charitable 
contribution and part business expense. 477 U.S. at 117. Under American 
Bar Endowment and Sec.  1.170A-1(h), if a taxpayer makes a payment to 
an entity described under section 170(c) in an amount that exceeds the 
fair market value of the benefit that the taxpayer receives or expects 
to receive in return, and this excess amount is paid with charitable 
intent, the taxpayer is allowed a charitable contribution deduction 
under section 170 for this excess amount.
    In addition, the proposed regulations propose to add a cross-
reference to Sec.  1.170A-1(h) (payments to section 170(c) entities in 
exchange for consideration), which provides more detailed rules for 
determining whether a payment, or a portion of a payment, to an entity 
described in section 170(c) may be deducted under section 162(a) or 
section 170.

III. Payments by Individuals in Exchange for State and Local Tax 
Credits

    After publication of the 2018 proposed regulations, commenters 
expressed concerns that the proposed regulations would create unfair 
consequences for certain individuals who receive state or local tax 
credits in return for their payments. Specifically, commenters noted 
that individuals who itemize deductions for Federal income tax purposes 
and have total state and local tax liabilities for the taxable year of 
$10,000 or less ($5,000 or less in the case of a married individual 
filing a separate return) would be precluded from taking charitable 
contribution deductions to the extent that they receive state or local 
tax credits even though the individuals would have been able to deduct 
equivalent payments of state and local taxes. Thus, if these 
individuals chose to make a payment to a section 170(c) entity through 
a state or local tax credit program instead of

[[Page 68836]]

paying tax to the state or local government, they would lose the 
deduction to which they would otherwise have been entitled under 
section 164 even after the application of the section 164(b)(6) 
limitation.
    These state and local tax credit programs effectively offer 
taxpayers a choice of paying taxes to the state or local government or 
making a payment to a section 170(c) entity and receiving a tax credit 
that offsets a tax liability the taxpayer would otherwise owe to the 
state or local government. This situation can be analogized to 
situations in which an individual entitled to receive a payment from a 
second party directs or permits the second party to satisfy its payment 
obligation by making a payment to a third party. In such situations, 
the payment may be treated, for Federal income tax purposes, as a 
payment by the payor to the individual entitled to receive payment. Cf. 
Rev. Rul. 86-14, 1986-1 C.B. 304, modifying Rev. Rul. 74-75, 1974-1 
C.B. 19 (payment made by an employer to a third party to discharge an 
obligation of an employee treated for Federal income tax purposes as 
made by the employer to the employee).
    For these reasons, on June 11, 2019, the IRS released Notice 2019-
12, announcing that the Treasury Department and the IRS intend to 
publish proposed regulations with a safe harbor under section 164 for 
individuals who make payments to section 170(c) entities in return for 
state or local tax credits. Under this safe harbor, an individual who 
itemizes deductions and who makes a payment to an entity described in 
section 170(c) in exchange for a state or local tax credit may treat as 
a payment of state or local tax for purposes of section 164 the portion 
of such payment for which a charitable contribution deduction is or 
will be disallowed under Sec.  1.170A-1(h)(3). This treatment is 
allowed in the taxable year in which the payment is made, but only to 
the extent that the individual applies the resulting credit pursuant to 
applicable state or local law to offset the individual's state or local 
tax liability for such taxable year or the preceding taxable year. 
Notice 2019-12 requested comments for purposes of incorporating the 
safe harbor in proposed regulations.
    The Treasury Department and the IRS received several comments in 
response to Notice 2019-12. Generally, commenters responded favorably 
to the safe harbor in the notice, finding that its rationale was sound 
and that the rule would effectively eliminate concerns that the final 
regulations under Sec.  1.170A-1(h)(3) unfairly burden individuals who 
itemize deductions and have state and local tax liabilities that are 
less than the section 164(b)(6) limitation. One commenter noted that 
Executive Order 12866, which directs the agency issuing a regulation to 
identify the problem it intends to address and design the regulation in 
the most cost-effective manner to achieve that objective with the least 
amount of burden on society, further supports the safe harbor. See 
Executive Order 12866, section 1(b). This commenter also suggested that 
the IRS should track the effects of the safe harbor by requiring 
taxpayers to disclose state tax and local tax credits on their Form 
1040, Schedule A. Alternatively, the commenter suggested that the IRS 
obtain this information directly from the states. Another commenter 
generally supported the safe harbor, but suggested that the Treasury 
Department and the IRS should avoid creating more safe harbor 
exceptions to Sec.  1.170A-1(h)(3) of the final regulations. This 
commenter also expressed concerns about the application of the safe 
harbor when the state and local tax limitation under section 164(b)(6) 
expires or is modified.
    Other commenters were concerned that Notice 2019-12 did not fully 
address the tax consequences to taxpayers who received or expected to 
receive state or local tax credits. Specifically, these commenters 
asked that the Treasury Department and the IRS provide guidance to 
address the treatment of state or local tax credits for Federal income 
tax purposes upon their sale or expiration. As noted in the preamble to 
the final regulations, the Treasury Department and the IRS recognize 
the significance and complexity of these questions. The Treasury 
Department and the IRS continue to study these issues and invite 
additional comment to inform potential future guidance on these issues.
    The Treasury Department and the IRS continue to believe that the 
notice provides a fair, reasonable, and legally sound basis for the 
safe harbor for individual taxpayers, and that the safe harbor should 
be added to the regulations under section 164. Accordingly, these 
proposed regulations propose adding Sec.  1.164-3(j) to provide a safe 
harbor for individuals who make a payment to or for the use of an 
entity described in section 170(c) in return for a state or local tax 
credit. These proposed regulations also propose adding Sec.  1.170A-
1(h)(3)(ix) to provide a cross reference to the safe harbor proposed 
under Sec.  1.164-3(j) and to request comments.
    Under these proposed regulations, an individual who itemizes 
deductions and who makes a payment to a section 170(c) entity in 
exchange for a state or local tax credit may treat as a payment of 
state or local tax for purposes of section 164 the portion of such 
payment for which a charitable contribution deduction under section 170 
is or will be disallowed under Sec.  1.170A-1(h)(3). This treatment is 
allowed in the taxable year in which the payment is made, but only to 
the extent that the resulting credit is applied pursuant to applicable 
state or local law to offset the individual's state or local tax 
liability for such taxable year or the preceding taxable year. Any 
unused credit permitted to be carried forward may be treated as a 
payment of state or local tax under section 164 in the taxable year or 
years for which the carryover credit is applied in accordance with 
state or local law. The safe harbor for individuals applies only to 
payments of cash and cash equivalents.
    The proposed regulations are not intended to permit a taxpayer to 
avoid the limitations of section 164(b)(6). Therefore, the proposed 
regulations provide that any payment treated as a state or local tax 
under section 164, pursuant to the safe harbor provided in Sec.  1.164-
3(j) of the proposed regulations, is subject to the limitations on 
deductions in section 164(b)(6). Furthermore, the proposed regulations 
are not intended to permit deductions of the same payments under more 
than one provision. Thus, the proposed regulations provide that an 
individual who relies on the safe harbor in Sec.  1.164-3(j) to deduct 
qualifying payments under section 164 may not also deduct the same 
payments under any other section of the Code.

IV. Consideration Provided by Party Other Than the Donee

    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 
and the fair market value of property transferred to an organization 
described in section 170(c) over the fair market value of goods or

[[Page 68837]]

services the organization provides in return. Section 1.170A-13(f)(5) 
defines goods or services as cash, property, services, benefits, and 
privileges. Section 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.
    Section 1.170A-1(h)(3)(iii) defines ``in consideration for'' for 
purposes of determining whether a state or local tax credit should 
reduce a charitable contribution under section 170. This section 
provides that 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.
    Some commenters on the 2018 proposed regulations interpreted the 
definition of ``in consideration for'' under Sec.  1.170A-13(f)(6) to 
suggest that consideration provided by a third party is disregarded in 
calculating the charitable contribution deduction, and that Sec.  
1.170A-1(h)(3)(iii) of the proposed regulations provided an exception 
from this rule solely for state or local tax credits provided by third 
parties. Other commenters disagreed with this interpretation and 
suggested that the final regulations should set forth a general rule 
clarifying that consideration includes all benefits that a taxpayer 
receives or expects to receive, regardless of whether they are provided 
by the donee.
    In the preamble to the final regulations, the Treasury Department 
and the IRS acknowledged that the final regulations did not address all 
situations in which a taxpayer makes a payment or transfers property 
and receives or expect to receive benefits from a party that is not the 
donee. Accordingly, the preamble to the final regulations indicated 
that the Treasury Department and the IRS intended to propose amendments 
to the regulations under section 170 to make clear that the quid pro 
quo principle applies regardless of whether the party providing the 
quid pro quo is the donee.
    As noted in the preamble to the final regulations, in American Bar 
Endowment, 477 U.S. at 116-17, and Hernandez v. Commissioner, 490 U.S. 
680, 691-92 (1989), 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 and Hernandez did not 
directly address the question of benefits provided by third parties; 
the return benefits at issue in those cases were provided by the 
donees. However, the Court derived the quid pro quo principle in those 
cases from a lower court decision and a revenue ruling that directly 
addressed the question. See American Bar Endowment, 477 U.S. at 117 
(citing Singer v. United States, 449 F.2d 413 (Ct. Cl. 1971), and Rev. 
Rul. 67-246, 1967-2 C.B. 104); Hernandez, 490 U.S. at 691 (citing 
Singer). In Singer, the appellate division of the Court of Claims (the 
predecessor to the Court of Appeals for 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 would come from the students 
rather than from the schools. Id. at 422-23. The court stated, 
``Obviously, we cannot agree with plaintiff's distinction.'' Id.
    In Rev. Rul. 67-246, Example 11, a local 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 store, a third party, 
rather than from the charity. This conclusion is reflected in 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 also be in the form of an indirect benefit from a third 
party'').
    Moreover, courts have ruled that a taxpayer's expectation of 
significant financial returns demonstrates a lack of charitable intent. 
For example, in Ottawa Silica Co. v. United States, 699 F.2d 1124 (Fed. 
Cir. 1983), the Federal Circuit denied a taxpayer's charitable 
contribution deduction for the value of land the taxpayer donated for 
construction of a school. The court's analysis focused on the 
taxpayer's expectation of benefits, and not on the source of such 
benefits. The court found that the taxpayer had reason to believe that 
construction of a school would result in the construction of new roads 
that would in turn increase the value of the taxpayer's retained land. 
The court recognized that although the taxpayer did not receive an 
agreement from any party that the roads would be built, the expectation 
of this benefit was a sufficient reason to deny the charitable 
contribution deduction. More recently, in Wendell Falls Development, 
LLC v. Commissioner, T.C. Memo. 2018-45, a taxpayer contributed a 
conservation easement that essentially restricted land for use as a 
park. The taxpayer expected this restriction to increase the value of 
the taxpayer's adjacent property. The Tax Court disallowed the 
taxpayer's claimed charitable contribution deduction for the easement, 
finding that the taxpayer contributed the easement with the expectation 
of receiving a substantial benefit (increased value of taxpayer's 
adjacent property) from the contribution, even though the expected 
benefit would not come from the donee. In accordance with these 
authorities, the source of the return benefit is immaterial in 
determining whether the donee at the time of the contribution expects 
to receive substantial benefits in return.
    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 that the donor expects a substantial 
benefit in return. Accordingly, the Treasury Department and the IRS 
propose amendments to Sec.  1.170A-1(h) that address a donor's payments 
in exchange for consideration in order for the regulation to reflect 
existing law. Specifically, these proposed amendments revise paragraph 
(h)(4) to provide definitions of ``in consideration for'' and ``goods 
and services'' for purposes of applying the rules in Sec.  1.170A-1(h). 
Under the proposed regulations, a taxpayer will be treated as receiving 
goods and services in consideration for a taxpayer's payment or 
transfer to an entity described in section 170(c) if, at the time the 
taxpayer makes the payment or transfer, the taxpayer receives or 
expects to receive goods or services in return.
    The proposed regulations do not amend the language of Sec.  1.170A-
13(f)(6) which discusses ``in consideration for'' for purposes of 
determining whether the taxpayer provides proper substantiation of its 
charitable contribution. Section 1.170A-13(f) details the requirements 
of a contemporaneous written acknowledgment, including a statement of 
whether the donee organization provides any goods or services in 
consideration for any cash or other property transferred to the donee 
organization and a description and a

[[Page 68838]]

good faith estimate of the value of those goods or services. See Sec.  
1.170A-13(f)(2)(ii) and (iii). These substantiation provisions refer 
only to written acknowledgments from donee organizations and do not 
address the application of quid pro quo principles to benefits received 
from parties other than donees. The Treasury Department and the IRS 
request comments on whether guidance concerning substantiation and 
reporting of quid pro quo benefits provided or expected to be provided 
by third parties, including state governments, would be beneficial to 
taxpayers in demonstrating that they have given more than they received 
or expected to receive and to the IRS in administering the proposed 
regulation. In addition, the Treasury Department and the IRS request 
comments regarding the manner by which donors, donees, or third parties 
may report or provide substantiation for the value or type of 
consideration received or expected to be received from third parties.
    For additional clarity, the proposed regulation amends the language 
in Sec.  1.170A-1(h)(2)(i)(B) to clarify that the fair market value of 
goods and services includes the value of goods and services provided by 
parties other than the donee. Also, the proposed regulation adds a 
definition of ``goods and services'' that is the same as the definition 
in Sec.  1.170A-13(f)(5). Finally, the proposed regulation revises the 
cross-references defining ``in consideration for'' and ``goods and 
services'' in paragraphs (h)(1) and (h)(3)(iii) to be consistent with 
the proposed definitions provided in paragraph (h)(4).

Proposed Applicability Dates

    The proposed amendments contained in Sec. Sec.  1.162-15(a)(1) and 
(2) and 1.170A-1(c)(5), regarding the application of section 162 to 
taxpayers that make payments or transfers to entities described in 
section 170(c), are proposed to apply to payments or transfers on or 
after December 17, 2019. However, a taxpayer may rely on these proposed 
regulations for payments and transfers made on or after January 1, 2018 
and before the date regulations finalizing these proposed regulations 
are published in the Federal Register.
    The proposed amendment contained in Sec.  1.162-15(a)(3), regarding 
safe harbors for C corporations and specified passthrough entities 
making payments to or for the use of section 170(c) entities in 
exchange for state or local tax credits, is proposed to apply to 
payments on or after December 17, 2019. However, prior to this date, a 
taxpayer may continue to apply Rev. Proc. 2019-12, which applies to 
payments made on or after January 1, 2018.
    The proposed amendments contained in Sec. Sec.  1.164-3(j) and 
1.170A-1(h)(3)(ix), regarding the safe harbor for payments by certain 
individuals to or for the use of section 170(c) entities, are proposed 
to apply to payments made on or after June 11, 2019, the date that the 
IRS issued Notice 2019-12, announcing it intended to publish proposed 
regulations with a safe harbor under section 164 for individuals who 
make payments to section 170(c) entities in return for state or local 
tax credits. However, individuals may rely on these proposed 
regulations for payments made after August 27, 2018, the applicability 
date of the final regulations, and before the date regulations 
finalizing these proposed regulations are published in the Federal 
Register.
    Finally, the proposed amendments contained in Sec. Sec.  1.170A-
1(h)(1), (h)(2)(i)(B), (h)(3)(iii), and (h)(4)(i), and 1.170A-13(f)(7) 
clarifying ``in consideration for'' for purposes of applying Sec.  
1.170A-1(h) are proposed to apply to payments or transfers on or after 
December 17, 2019.

Special Analyses

Regulatory Planning and Review--Economic Analysis

    Executive Orders 13563 and 12866 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 proposed rule is expected to be an E.O. 13771 regulatory action. 
Details on the estimated costs of this proposed rule can be found in 
the rule's economic analysis.
    These proposed regulations have been designated as subject to 
review under Executive Order 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. The Office of Information and Regulatory Affairs has 
designated these regulations as significant under section 1(b) of the 
MOA. Accordingly, the OMB has reviewed these regulations.
A. Background
    Section 164 of the Code allows a deduction for certain state and 
local taxes paid, including state or local income and property taxes. 
Section 164(b)(6), added by the TCJA, generally limits an individual's 
deduction of these taxes to $10,000 ($5,000 in the case of a married 
individual filing a separate return). The limitation does not apply to 
foreign income taxes or to property taxes that are paid or incurred in 
carrying on a trade or business or an activity described in section 
212. Section 162 allows a deduction for ordinary and necessary expenses 
paid or incurred in carrying on a trade or business. Section 170 allows 
a deduction for charitable contributions, specifically for payments or 
transfers to an entity described in section 170(c); however, the 
deduction must be reduced by any quid pro quo benefit that the taxpayer 
receives or expects to receive in return.
    After the enactment of the TCJA, questions arose regarding the 
interaction of these deductions. To clarify the application of these 
provisions, the Treasury Department and the IRS issued guidance 
including: (1) Final regulations (T.D. 9864, 84 FR 27513) providing 
that a tax credit received or expected to be received in return for a 
payment or transfer to an entity described in section 170(c) (hereafter 
referred to as a charitable entity) is a return benefit to the 
taxpayer, resulting in the reduction of the charitable contribution 
deduction; (2) Notice 2019-12 announcing the intent to issue proposed 
regulations providing a safe harbor for individuals under which a 
charitable contribution that is disallowed because of a return benefit 
of a state or local tax credit may be treated as a payment of state or 
local tax; and (3) Rev. Proc. 2019-12 providing a safe harbor allowing 
as a deductible business expense certain payments by businesses to 
charitable organizations.
B. Need for the Proposed Regulations
    The Treasury Department and the IRS believe that it is appropriate 
to propose as regulations and seek additional public comment on the 
safe harbors provided in Notice 2019-12 and Rev. Proc. 2019-12. In 
addition, comments received in response to Notice 2018-54 and the 2018 
proposed regulations (guidance preceding the final regulations T.D. 
9864) indicate that taxpayers will benefit from additional guidance 
regarding contributions to a charitable entity resulting in a return 
benefit from a third party.

[[Page 68839]]

C. Overview of the Proposed Regulations
    First, these proposed regulations reflect the guidance in Notice 
2019-12. Under the safe harbor an individual who itemizes deductions 
and who makes a payment to a charitable entity in exchange for a state 
or local tax credit may be able to claim a state and local tax 
deduction for the portion of the payment for which a charitable 
contribution deduction is or will be disallowed as a return benefit. 
The safe harbor for individuals applies only to payments of cash and 
cash equivalents. In addition, these payments are subject to the 
overall limitation on state and local deductions added by the TCJA. 
Further, any payment may be deducted under only one provision of the 
Code. Thus, an individual who has total state and local tax liability 
of $10,000 or less, and who makes a payment to a charitable entity and 
receives a state tax credit in return resulting in the disallowance of 
a charitable contribution deduction, may claim an itemized deduction 
for the disallowed amount, subject to other requirements of the Code.
    Second, the proposed regulations incorporate into the regulations 
under section 162 longstanding principles from case law and existing 
section 170 regulations regarding a taxpayer's payment or transfer to a 
charitable entity. Specifically, the proposed regulations confirm that, 
when a taxpayer's transfer or payment bears a direct relationship to 
its trade or business, and that transfer or payment is made with a 
reasonable expectation of commensurate financial return, the transfer 
or payment to the charitable entity may constitute an allowable 
deduction under section 162, rather than under section 170. In 
addition, the proposed regulations incorporate the safe harbors 
provided by Rev. Proc. 2019-12 for certain payments by C corporations 
and specified passthrough entities, for cases in which the financial 
return is a tax credit. Thus, under the proposed regulations, a C 
corporation may treat the portion of the payment to a charitable entity 
that is equal to the amount of tax credit received or expected to be 
received in return as a deductible business expense under section 162. 
Consistent with Rev. Proc. 2019-12, the proposed regulations also 
provide that a specified passthrough entity may treat a payment 
resulting in a tax credit as a business expense if the business is 
regarded as separate from its owner for Federal tax purposes, if it 
operates a trade or business within the meaning of section 162, if it 
is subject to state or local tax incurred in carrying on its trade or 
business that is imposed directly on the passthrough entity, and if it 
receives or expects to receive a state or local tax credit in return 
for the payment.
    Third, the proposed regulations clarify that a payment to a 
charitable entity that results in a return benefit is a quid pro quo 
for purposes of section 170, regardless of whether the donor expects to 
receive the benefit from the donee or from a third party. As a result, 
the contribution is reduced by the amount of the return benefit for 
purposes of determining the amount allowable as a charitable 
contribution deduction.
D. Economic Analysis
1. Baseline
    The Treasury Department and the IRS have assessed the benefits and 
costs of these proposed regulations compared to a no-action baseline 
that reflects anticipated Federal income tax-related behavior in the 
absence of these proposed regulations.
2. Summary of Economic Effects
    The proposed regulations reflect existing, published, Treasury 
Department and IRS policies. As a result, they provide some additional 
clarity to taxpayers by clearly articulating these existing policies as 
regulations. The Treasury Department does not expect any noticeable 
change in taxpayer behavior resulting from these regulations, but 
requests comments on their potential economic effects. The increased 
clarity, in particular the provision of safe harbors, is expected to 
reduce compliance burdens.
    As described in the Special Analyses for the final regulations 
(T.D. 9864), allowing a payment that is disallowed as a charitable 
contribution deduction because of the receipt or expected receipt of a 
tax credit to be deducted as a payment of state or local tax means that 
payments by taxpayers with state and local tax liabilities of $10,000 
or less are subject to the same tax treatment under these proposed 
regulations as under the TCJA (in absence of any guidance) and as under 
the law prior to the TCJA. (See Example 2, Table 1, T.D. 9864.) It also 
means that such taxpayers are not treated less favorably than taxpayers 
with state and local tax liabilities in excess of $10,000 or taxpayers 
subject to the Alternative Minimum Tax. (See Examples 1 and 3 of Table 
1, T.D. 9864.)
    The Treasury Department and the IRS request comments on the 
economic effects of the proposed regulations.
Regulatory Flexibility Act
    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that this proposed rule will not have a significant 
economic impact on a substantial number of small entities. Although 
data are not readily available for the IRS and the Treasury Department 
to assess the number of small entities that are likely to be directly 
affected by the regulations, the economic impact is unlikely to be 
significant.
    As discussed elsewhere in this preamble, the proposed rule largely 
updates the regulations to reflect existing law and policy. The 
proposed amendments would update the section 162 and section 170 
regulations to reflect current law. In addition, the proposed 
amendments add to the regulations safe harbors under section 162 and 
section 164, regarding deductions when payments are made to entities 
described in section 170(c) and the donor receives or expects to 
receive a state or local tax credit in return; these safe harbors were 
provided previously in Internal Revenue Bulletin guidance. These 
regulations are expected to provide some additional certainty to 
taxpayers but are not expected to result in any noticeable change in 
taxpayer behavior. The increased certainty, and in particular the 
provision of safe harbors, is expected to reduce compliance burdens. 
Accordingly, the Treasury Department and the IRS certify that the 
proposed rule will not have a significant economic impact on a 
substantial number of small entities.
    Notwithstanding this certification, the Treasury Department and the 
IRS invite comments about the potential impact of this proposed rule on 
small entities.
    Pursuant to section 7805(f), the proposed regulations will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small businesses.

Comments and Requests and Public Hearing

    Before the regulations proposed herein are adopted as final 
regulations, consideration will be given to any electronic and written 
comments that are submitted timely to the IRS as prescribed in this 
preamble under the ADDRESSES heading. All comments submitted will be 
made available at https://www.regulations.gov or upon request. A public 
hearing has been scheduled for February, 20, 2020, beginning at 10 a.m. 
in the Auditorium of the Internal Revenue Building, 1111 Constitution 
Avenue NW, Washington, DC 20224. Due to building security

[[Page 68840]]

procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance area more than 30 minutes before the 
hearing starts. For information about having your name placed on the 
building access list to attend the hearing, see the FOR FURTHER 
INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit an outline of 
the topics to be discussed and the time to be devoted to each topic by 
January 31, 2020. Submit a signed paper or electronic copy of the 
outline as prescribed in this preamble under the ADDRESSES heading. An 
agenda showing the scheduling of the speakers will be prepared after 
the deadline for receiving outlines has passed. Copies of the agenda 
will be available free of charge at the hearing.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, Notices, and other 
guidance cited in this document are published in the Internal Revenue 
Bulletin (or Cumulative Bulletin) and are available from the 
Superintendent of Documents, U.S. Government Publishing Office, 
Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov.

Drafting Information

    The principal author of these proposed regulations is 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.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be 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 1.162-15 is amended by revising paragraph (a) to read 
as follows:


Sec.  1.162-15   Contributions, dues, etc.

    (a) Payments and transfers to entities described in section 
170(c)--(1) In general. A payment or transfer to or for the use of an 
entity described in section 170(c) that bears a direct relationship to 
the taxpayer's trade or business and that is made with a reasonable 
expectation of financial return commensurate with the amount of the 
payment or transfer may constitute an allowable deduction as a trade or 
business expense rather than a charitable contribution deduction under 
section 170. For payments or transfers in excess of the amount 
deductible under section 162(a), see Sec.  1.170A-1(h).
    (2) Examples. The following examples illustrate the rules of 
paragraph (a)(1) of this section:

    (i) Example 1. A, an individual, is a sole proprietor who 
manufactures musical instruments and sells them through a website. A 
makes a $1,000 payment to a local church (which is a charitable 
organization described in section 170(c)) for a half-page 
advertisement in the church's program for a concert. In the program, 
the church thanks its concert sponsors, including A. A's 
advertisement includes the URL for the website through which A sells 
its instruments. A reasonably expects that the advertisement will 
attract new customers to A's website and will help A to sell more 
musical instruments. A may treat the $1,000 payment as an expense of 
carrying on a trade or business under section 162.
    (ii) Example 2. P, a partnership, operates a chain of 
supermarkets, some of which are located in State N. P operates a 
promotional program in which it sets aside the proceeds from one 
percent of its sales each year, which it pays to one or more 
charities described in section 170(c). The funds are earmarked for 
use in projects that improve conditions in State N. P makes the 
final determination on which charities receive payments. P 
advertises the program. P reasonably believes the program will 
generate a significant degree of name recognition and goodwill in 
the communities where it operates and thereby increase its revenue. 
As part of the program, P makes a $1,000 payment to a charity 
described in section 170(c). P may treat the $1,000 payment as an 
expense of carrying on a trade or business under section 162. This 
result is unchanged if, under State N's tax credit program, P 
expects to receive a $1,000 income tax credit on account of P's 
payment, and under State N law, the credit can be passed through to 
P's partners.

    (3) Safe harbors for C corporations and specified passthrough 
entities making payments in exchange for state or local tax credits--
(i) Safe harbor for C corporations. If a C corporation makes a payment 
to or for the use of an entity described in section 170(c) and receives 
or expects to receive in return a state or local tax credit that 
reduces a state or local tax imposed on the C corporation, the C 
corporation may treat such payment as meeting the requirements of an 
ordinary and necessary business expense for purposes of section 162(a) 
to the extent of the amount of the credit received or expected to be 
received.
    (ii) Safe harbor for specified passthrough entities--(A) Definition 
of specified passthrough entity. For purposes of this paragraph 
(a)(3)(ii), an entity is a specified passthrough entity if each of the 
following requirements is satisfied--
    (1) The entity is a business entity other than a C corporation and 
is regarded for all Federal income tax purposes as separate from its 
owners under Sec.  301.7701-3 of this chapter;
    (2) The entity operates a trade or business within the meaning of 
section 162;
    (3) The entity is subject to a state or local tax incurred in 
carrying on its trade or business that is imposed directly on the 
entity; and
    (4) In return for a payment to an entity described in section 
170(c), the entity described in paragraph (a)(3)(ii)(A)(1) of this 
section receives or expects to receive a state or local tax credit that 
this entity applies or expects to apply to offset a state or local tax 
described in paragraph (a)(3)(ii)(A)(3) of this section.
    (B) Safe harbor. Except as provided in paragraph (a)(3)(ii)(C) of 
this section, if a specified passthrough entity makes a payment to or 
for the use of an entity described in section 170(c), and receives or 
expects to receive in return a state or local tax credit that reduces a 
state or local tax described in paragraph (a)(3)(ii)(A)(3) of this 
section, the specified passthrough entity may treat such payment as 
meeting the requirements of an ordinary and necessary business expense 
for purposes of section 162(a) to the extent of the amount of credit 
received or expected to be received.
    (C) Exception. The safe harbor described in this paragraph 
(a)(3)(ii) does not apply if the credit received or expected to be 
received reduces a state or local income tax.
    (iii) Definition of payment. For purposes of this paragraph (a)(3), 
payment is defined as a payment of cash or cash equivalent.
    (iv) Examples. The following examples illustrate the rules of 
paragraph (a)(3) of this section.

    (A) Example 1: C corporation that receives or expects to receive 
dollar-for-dollar state or local tax credit. A, a C corporation 
engaged in a trade or business, makes a payment of $1,000 to an 
entity described in section 170(c). In return for the payment, A 
expects to receive a dollar-for-dollar state tax credit to be 
applied to A's state corporate income tax liability. Under paragraph 
(a)(3)(i) of this section, A may treat the $1,000 payment as

[[Page 68841]]

an expense of carrying on a trade or business under section 162.
    (B) Example 2: C corporation that receives or expects to receive 
percentage-based state or local tax credit. B, a C corporation 
engaged in a trade or business, makes a payment of $1,000 to an 
entity described in section 170(c). In return for the payment, B 
expects to receive a local tax credit equal to 80 percent of the 
amount of this payment ($800) to be applied to B's local real 
property tax liability. Under paragraph (a)(3)(i) of this section, B 
may treat $800 as an expense of carrying on a trade or business 
under section 162. The treatment of the remaining $200 will depend 
upon the facts and circumstances and is not affected by paragraph 
(a)(3)(i) of this section.
    (C) Example 3: Partnership that receives or expects to receive 
dollar-for-dollar state or local tax credit. P is a limited 
liability company classified as a partnership for Federal income tax 
purposes under Sec.  301.7701-3 of this chapter. P is engaged in a 
trade or business and makes a payment of $1,000 to an entity 
described in section 170(c). In return for the payment, P expects to 
receive a dollar-for-dollar state tax credit to be applied to P's 
state excise tax liability incurred by P in carrying on its trade or 
business. Under applicable state law, the state's excise tax is 
imposed at the entity level (not the owner level). Under paragraph 
(a)(3)(ii) of this section, P may treat the $1,000 as an expense of 
carrying on a trade or business under section 162.
    (D) Example 4: S corporation that receives or expects to receive 
percentage-based state or local tax credit. S is an S corporation 
engaged in a trade or business and is owned by individuals C and D. 
S makes a payment of $1,000 to an entity described in section 
170(c). In return for the payment, S expects to receive a local tax 
credit equal to 80 percent of the amount of this payment ($800) to 
be applied to S's local real property tax liability incurred by S in 
carrying on its trade or business. Under applicable state and local 
law, the real property tax is imposed at the entity level (not the 
owner level). Under paragraph (a)(3)(ii) of this section, S may 
treat $800 of the payment as an expense of carrying on a trade or 
business under section 162. The treatment of the remaining $200 will 
depend upon the facts and circumstances and is not affected by 
paragraph (a)(3)(ii) of this section.

    (v) Applicability of section 170 to payments in exchange for state 
or local tax benefits. For rules regarding the availability of a 
charitable contribution deduction under section 170 where a taxpayer 
makes a payment or transfers property to or for the use of an entity 
described in section 170(c) and receives or expects to receive a state 
or local tax benefit in return for such payment, see Sec.  1.170A-
1(h)(3).
    (4) Applicability dates. Paragraphs (a)(1) and (2) of this section, 
regarding the application of section 162 to taxpayers making payments 
or transfers to entities described in section 170(c), apply to payments 
or transfers on or after December 17, 2019. However, taxpayers may 
choose to apply paragraphs (a)(1) and (2) to payments and transfers on 
or after January 1, 2018. Paragraph (a)(3) of this section, regarding 
the safe harbors for C corporations and specified passthrough entities 
making payments to section 170(c) entities in exchange for state or 
local tax credits applies to payments made by these entities on or 
after December 17, 2019. However, taxpayers may choose to apply the 
safe harbors of paragraph (a)(3) to payments on or after January 1, 
2018.
* * * * *
0
Par. 3. Section 1.164-3 is amended by adding paragraph (j) to read as 
follows:


Sec.  1.164-3   Definitions and special rules.

* * * * *
    (j) Safe harbor for payments by individuals in exchange for state 
or local tax credits--(1) In general. An individual who itemizes 
deductions and who makes a payment to or for the use of an entity 
described in section 170(c) in consideration for a state or local tax 
credit may treat as a payment of state or local tax for purposes of 
section 164 the portion of such payment for which a charitable 
contribution deduction under section 170 is disallowed under Sec.  
1.170A-1(h)(3). This treatment as payment of state or local tax under 
section 164(a) is allowed in the taxable year in which the payment is 
made to the extent that the resulting credit is applied, consistent 
with applicable state or local law, to offset the individual's state or 
local tax liability for such taxable year or the preceding taxable 
year.
    (2) Credits carried forward. To the extent that a state or local 
tax credit described in paragraph (j)(1) of this section is not applied 
to offset the individual's applicable state or local tax liability for 
the taxable year of the payment or the preceding taxable year, any 
excess state or local tax credit permitted to be carried forward may be 
treated as a payment of state or local tax under section 164(a) in the 
taxable year or years for which the carryover credit is applied in 
accordance with state or local law.
    (3) Limitation on individual deductions. Nothing in this paragraph 
(j) may be construed as permitting a taxpayer who applies this safe 
harbor to avoid the limitations of section 164(b)(6) for any amount 
paid as a tax or treated under this paragraph (j) as a payment of tax.
    (4) No safe harbor for transfers of property. The safe harbor 
provided in this paragraph (j) applies only to a payment of cash or 
cash equivalent.
    (5) Coordination with other deductions. An individual who deducts a 
payment under section 164 may not also deduct the same payment under 
any other Code section.
    (6) Examples. In the following examples, assume that the taxpayer 
is an individual who itemizes deductions for Federal income tax 
purposes.

    (i) Example 1. In year 1, Taxpayer A makes a payment of $500 to 
an entity described in section 170(c). In return for the payment, A 
receives a dollar-for-dollar state income tax credit. Prior to 
application of the credit, A's state income tax liability for year 1 
was more than $500. A applies the $500 credit to A's year 1 state 
income tax liability. Under paragraph (j)(1) of this section, A 
treats the $500 payment as a payment of state income tax in year 1. 
To determine A's deduction amount, A must apply the provisions of 
section 164 applicable to payments of state and local taxes, 
including the limitation in section 164(b)(6). See paragraph (j)(3) 
of this section.
    (ii) Example 2. In year 1, Taxpayer B makes a payment of $7,000 
to an entity described in section 170(c). In return for the payment, 
B receives a dollar-for-dollar state income tax credit, which under 
state law may be carried forward for three taxable years. Prior to 
application of the credit, B's state income tax liability for year 1 
was $5,000; B applies $5,000 of the $7,000 credit to B's year 1 
state income tax liability. Under paragraph (j)(1) of this section, 
B treats $5,000 of the $7,000 payment as a payment of state income 
tax in year 1. Prior to application of the remaining credit, B's 
state income tax liability for year 2 exceeds $2,000. B applies the 
excess credit of $2,000 to B's year 2 state income tax liability. 
For year 2, under paragraph (j)(2) of this section, B treats the 
$2,000 as a payment of state income tax under section 164. To 
determine B's deduction amounts in years 1 and 2, B must apply the 
provisions of section 164 applicable to payments of state and local 
taxes, including the limitation under section 164(b)(6). See 
paragraph (j)(3) of this section.
    (iii) Example 3. In year 1, Taxpayer C makes a payment of $7,000 
to an entity described in section 170(c). In return for the payment, 
C receives a local real property tax credit equal to 25 percent of 
the amount of this payment ($1,750). Prior to application of the 
credit, C's local real property tax liability in year 1 was more 
than $1,750. C applies the $1,750 credit to C's year 1 local real 
property tax liability. Under paragraph (j)(1) of this section, for 
year 1, C treats $1,750 of her $7,000 payment as a payment of local 
real property tax for purposes of section 164. To determine C's 
deduction amount, C must apply the provisions of section 164 
applicable to payments of state and local taxes, including the 
limitation under section 164(b)(6). See paragraph (j)(3) of this 
section.

    (7) Applicability date. This paragraph (j) applies to payments made 
to section 170(c) entities on or after June 11, 2019. However, a 
taxpayer may choose to apply this paragraph (j) to payments made to 
section 170(c) entities after August 27, 2018.

[[Page 68842]]

0
Par. 4. Section 1.170A-1 is amended as follows:
0
1. Paragraph (c)(5) is revised.
0
2. In paragraph (h)(1), remove the cross-references to ``Sec.  1.170A-
13(f)(6)'' and ``Sec.  1.170A-13(f)(5)'' and add in their places 
``paragraph (h)(4)(i) of this section'' and ``paragraph (h)(4)(ii) of 
this section'', respectively.
0
3. Paragraphs (h)(2)(i)(B) and (h)(3)(iii) are revised.
0
4. Paragraph (h)(3)(viii) is redesignated as paragraph (h)(3)(x).
0
5. New paragraph (h)(3)(viii) and paragraph (h)(3)(ix) are added.
0
6. Paragraphs (h)(4) through (6) are redesignated as paragraphs (h)(5) 
through (7).
0
7. New paragraph (h)(4) is added.
    The revisions and additions read as follows:


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

* * * * *
    (c) * * *
    (5) For payments or transfers to an entity described in section 
170(c) by a taxpayer carrying on a trade or business, see Sec.  1.162-
15(a).
* * * * *
    (h) * * *
    (2) * * *
    (i) * * *
    (B) The fair market value of the goods or services received or 
expected to be received in return.
* * * * *
    (3) * * *
    (iii) In consideration for. For purposes of paragraph (h) of this 
section, the term in consideration for has the meaning set forth in 
paragraph (h)(4)(i) of this section.
* * * * *
    (viii) Safe harbor for payments by C corporations and specified 
passthrough entities. For payments by a C corporation or by a specified 
passthrough entity to an entity described in section 170(c), where the 
C corporation or specified passthrough entity receives or expects to 
receive a state or local tax credit that reduces the charitable 
contribution deduction for such payments under paragraph (h)(3) of this 
section, see Sec.  1.162-15(a)(3) (providing safe harbors under section 
162(a) to the extent of that reduction).
    (ix) Safe harbor for individuals. Under certain circumstances, an 
individual who itemizes deductions and makes a payment to an entity 
described in section 170(c) in consideration for a state or local tax 
credit may treat the portion of such payment for which a charitable 
contribution deduction is disallowed under paragraph (h)(3) of this 
section as a payment of state or local taxes under section 164. See 
Sec.  1.164-3(j), providing a safe harbor for certain payments by 
individuals in exchange for state or local tax.
* * * * *
    (4) Definitions. For purposes of this paragraph (h), the following 
definitions apply:
    (i) In consideration for. A taxpayer receives goods or services in 
consideration for a taxpayer's payment or transfer to an entity 
described in section 170(c) if, at the time the taxpayer makes the 
payment to such entity, the taxpayer receives or expects to receive 
goods or services from that entity or any other party in return.
    (ii) Goods or services. Goods or services means cash, property, 
services, benefits, and privileges.
    (iii) Applicability date. The definitions provided in this 
paragraph (h)(4) are applicable for amounts paid or property 
transferred on or after December 17, 2019.
* * * * *


Sec.  1.170A-13   [Amended]

0
Par. 5. Section 1.170A-13(f)(7) is amended by removing the cross-
reference to ``Sec.  1.170A-1(h)(5)'' and adding in its place ``Sec.  
1.170A-1(h)(6).''

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2019-26969 Filed 12-13-19; 4:15 pm]
 BILLING CODE 4830-01-P