Treatment of Payments to Charitable Entities in Return for Consideration, 48467-48474 [2020-17393]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 85, Number 155 (Tuesday, August 11, 2020)]
[Rules and Regulations]
[Pages 48467-48474]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-17393]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9907]
RIN 1545-BP40


Treatment of Payments to Charitable Entities in Return for 
Consideration

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under sections 162, 
164, and 170 of the Internal Revenue Code (Code). First, the final 
regulations update the regulations under section 162 to reflect current 
law regarding the application of section 162 to taxpayers that make 
payments or transfers for business purposes to entities described in 
section 170(c). Second, the final regulations provide safe harbors 
under section 162 to provide certainty with respect to the treatment of 
payments made by business entities to entities described in section 
170(c). Third, the final regulations 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 final regulations 
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 a donor who receives or expects to receive benefits from 
a third party. These regulations affect taxpayers who make transfers to 
entities described in section 170(c) for business purposes, and 
taxpayers who receive State or local tax credits in exchange for 
transfers to such

[[Page 48468]]

entities or who receive other third-party benefits in exchange for 
transfers to such entities.

DATES: 
    Effective date: These regulations are effective August 11, 2020.
    Applicability dates: For dates of applicability, see Sec. Sec.  
1.162-15(a)(4), 1.164-3(j)(7), and 1.170A-1(h)(4)(iii).

FOR FURTHER INFORMATION CONTACT: Sarah Daya or Stephen Rothandler 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. 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 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 section 162(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). Prior to amendment by this final regulation, Sec.  
1.162-15(a)(1) provided 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. Section 1.162-15(a)(2) clarified that 
the limitations provided in section 162(b) and Sec.  1.162-15(a)(1) 
applied 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 Public Law 115-
97, commonly referred to as the Tax Cuts and Jobs Act (TCJA), 131 Stat. 
2054, 2085 (2017), provides, in the case of an individual, that 
deductions for foreign real property taxes are not allowable under 
section 164(a)(1), and that 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 Department of the Treasury (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 also proposed 
amending regulations under section 642(c) to provide a similar rule for 
payments made by a trust or decedent's estate.
    In response to the 2018 proposed regulations, commenters raised 
concerns regarding the treatment of business entity payments to 
entities described in section 170(c). The Treasury Department and the 
IRS considered these concerns and issued Rev. Proc. 2019-12, 2019-04 
I.R.B. 401, on December 28, 2018, providing a safe harbor under section 
162 for 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 State or local tax credits in return. Commenters 
also raised a concern regarding the treatment of payments by 
individuals who itemize deductions for Federal income tax purposes and 
who have total State and local tax liabilities that are less than or 
equal to the section 164(b)(6) limitation. The Treasury Department and 
the IRS addressed this concern by issuing Notice 2019-12, 2019-27 
I.R.B. 57, on June 11, 2019, providing a safe harbor under section 164 
for individuals who

[[Page 48469]]

make payments to section 170(c) entities in return for State or local 
tax credits.
    On June 13, 2019, the Treasury Department and the IRS published 
final regulations in the Federal Register (T.D. 9864, 84 FR 27513) 
(2019 final 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). The 2019 
final regulations provided 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). The 2019 final regulations also amended regulations under 
section 642(c) to provide a similar rule for payments made by a trust 
or decedent's estate.
    On December 17, 2019, the Treasury Department and the IRS issued 
proposed regulations under sections 162, 164, and 170 (REG-107431-19, 
84 FR 68833) to include the safe harbors provided under Rev. Proc. 
2019-12 and Notice 2019-12, to update 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, and to clarify the application 
of the quid pro quo principle under section 170 to benefits received or 
expected to be received from third parties.
    The Treasury Department and the IRS received over 40 comments 
responding to the proposed regulations and five requests to speak at 
the public hearing, which was held on February 20, 2020. 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.

Explanation of Provisions and Summary of Comments

Explanation of Provisions

    The Treasury Department and the IRS adopt the proposed regulations 
with clarifications in response to the written comments received and 
testimony provided. First, the final regulations retain the proposed 
amendments to Sec.  1.162-15(a). The final regulations continue to 
clarify that a taxpayer's payment or transfer to a 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. The final regulations also retain the examples 
demonstrating the application of this rule with minor clarifying 
changes.
    Second, the final regulations retain the 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). The 
final regulations provide safe harbors 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. To 
the extent that a C corporation or specified passthrough entity 
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 or 
specified passthrough entity's business in the form of a reduction in 
the State or local taxes that the entity would otherwise be required to 
pay. Thus, the final regulations provide safe harbors that allow a C 
corporation or specified passthrough entity 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 safe harbors for C corporations and specified 
passthrough entities apply only to payments of cash and cash 
equivalents. The safe harbor for specified passthrough entities does 
not apply if the credit received or expected to be received reduces a 
State or local income tax.
    Third, the final regulations retain the 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. The final regulations provide that 
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 final regulations are not intended to permit a taxpayer to 
avoid the limitation of section 164(b)(6). Therefore, the final 
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 final regulations, is subject to the limitation on 
deductions in section 164(b)(6). Furthermore, the final regulations are 
not intended to permit deductions of the same payments under more than 
one provision. Thus, the final 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.
    Lastly, the final regulations retain the amendments to 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 a donor who receives or expects to receive benefits from a third 
party. The final regulations clarify that the quid pro quo principle 
applies regardless of whether the party providing the quid pro quo is 
the donee or a third party. To reflect existing law, the final 
regulations amend the rules in Sec.  1.170A-1(h) that address a donor's 
payments in exchange for consideration. Specifically, the final 
regulations revise Sec.  1.170A-1(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 final 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.
    For additional clarity, the final regulations amend the language in 
Sec.  1.170A-1(h)(2)(i)(B) to state 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 final regulations add a 
definition of ``goods and services'' that

[[Page 48470]]

is the same as the definition in Sec.  1.170A-13(f)(5). Finally, the 
final regulations revise the cross-references defining ``in 
consideration for'' and ``goods and services'' in Sec.  1.170A-1(h)(1) 
and (h)(3)(iii) to be consistent with the definitions provided in 
paragraph Sec.  1.170A-1(h)(4).

Summary of Comments

1. General Comments
    As discussed previously in this preamble, the Treasury Department 
and the IRS received over 40 comments responding to the proposed 
regulations and five requests to speak at the public hearing. 
Approximately half of the commenters expressed support for the proposed 
regulations and recommended that the Treasury Department and the IRS 
finalize the proposed regulations. Many of these commenters expressed 
support for the clarification of the regulations under section 162 
regarding business payments to section 170(c) entities and the 
incorporation of safe harbors previously provided in Rev. Proc. 2019-12 
and Notice 2019-12. However, some of these commenters expressed 
concerns about the impact of the 2019 final regulations on State and 
local programs granting tax credits for contributions by individuals 
and businesses to scholarship granting organizations (SGOs). SGOs are 
entities described in section 170(c) that receive contributions from 
individuals and businesses and then disburse these funds as 
scholarships to enable eligible students to attend qualified private 
schools. Additional commenters were concerned that, even with the 
clarifications in the proposed regulations, the 2019 final regulations 
have resulted in and will continue to result in decreased contributions 
to SGOs and other section 170(c) entities.
2. Payments by Business Entities in Exchange for State or Local Tax 
Credits
    Multiple commenters expressed concern that passthrough entity 
owners may circumvent the section 164(b)(6) limitation by 
recharacterizing the portion of the payment that is not deductible 
under section 170 as a business expense deductible under section 162. 
One commenter requested clarification regarding whether a business 
entity may deduct payments to SGOs under section 162 as ordinary and 
necessary business expenses incurred in carrying on a trade or 
business. A few commenters expressed concern that the regulations may 
incentivize payments to education programs that discriminate against 
students with disabilities or that divert tax dollars from public 
schools to private schools. One commenter opined that State and local 
programs providing tax credits to businesses that donate to certain 
charitable organizations run counter to the concept of charity because 
donors should expect nothing in return for a donation.
    Several commenters suggested revising Example 2 in Sec.  1.162-
15(a)(2)(ii) to clarify that individuals are not allowed to generate 
partnership tax deductions under section 162 in addition to State or 
local tax credits that flow through to partners. Some commenters 
asserted that Example 2 is inconsistent with the safe harbor provided 
for passthrough entities in Sec.  1.162-15(a)(3), which expressly 
excludes situations in which passthrough entities receive State or 
local income tax credits. A commenter suggested including a general 
rule stating that in any case where a State or local tax credit has the 
effect of reducing an otherwise nondeductible State or local tax 
liability, the payment giving rise to the State or local tax credit 
cannot itself be deductible.
    While the Treasury Department and the IRS acknowledge these 
concerns, the regulations retain the clarifications to Sec.  1.162-
15(a)(1) and (a)(2) regarding section 162 deductions for business 
payments to section 170(c) entities, as well as examples illustrating 
the rule. Section 1.162-15(a)(1) mirrors the language of Sec.  1.170A-
1(c)(5), which has been in effect since 1970. Section 1.170A-1(c)(5) 
provided that 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 may constitute an allowable deduction as a trade or business 
expense under section 162, rather than a charitable contribution under 
section 170. See also Marquis v. Commissioner, 49 T.C. 695 (1968). 
Section 1.162-15(a)(1) applies the same standard. Thus, a passthrough 
entity may deduct a payment under Sec.  1.162-15(a)(1) only if the 
entity can demonstrate that the payment satisfies these requirements, 
which limits the possibility of abuse.
    Moreover, the revisions to Sec.  1.162-15(a)(1) are not 
inconsistent with the safe harbor provided for passthrough entities 
under Sec.  1.162-15(a)(3), which expressly excludes situations in 
which passthrough entities receive State or local income tax credits. 
The scope of Sec.  1.162-15(a)(3) is more limited because it provides 
safe harbor relief for taxpayers that receive a State or local tax 
credit in return for a payment to charity, rather than an application 
of the law. As a safe harbor, this section sets forth a simplified 
analysis of a passthrough entity's expenditure--requiring merely the 
receipt or expectation of receipt of a State or local business tax 
credit. In contrast, Sec.  1.162-15(a)(1) reiterates the current law, 
which requires more than the receipt of a credit against a business-
related tax. Section 1.162-15(a)(1) requires a direct business 
relationship to the trade or business and a reasonable expectation of 
commensurate financial return. If a passthrough entity meets these 
requirements, then the payment or transfer to the section 170(c) entity 
may be properly treated as a business expense under section 162.
    Another commenter also expressed concern that the examples under 
Sec.  1.162-15(a)(2) create confusion about deductions for 
institutional or ``good will'' advertising under Sec.  1.162-20(a)(2) 
because both examples contain facts that could describe advertising 
addressed in Sec.  1.162-20(a)(2). The commenter suggested that the 
examples be moved from Sec.  1.162-15(a)(2) to Sec.  1.162-20(a)(2). In 
addition, the commenter suggested that the Treasury Department and the 
IRS revise the examples to clarify the relationship between Sec.  
1.162-15(a)(2) and Sec.  1.162-20(a)(2) and address the requirement 
under Sec.  1.162-20(a)(2) that deductible institutional and good will 
advertising expenditures must relate to patronage that the taxpayer 
might reasonably expect in the future. This commenter also requested 
that the cross-reference to Sec.  1.162-20 in Sec.  1.162-15(d) of the 
existing regulations be modified to provide additional explanation.
    The Treasury Department and the IRS considered these comments but 
have determined that changes to Sec.  1.162-15(a)(1) and (2) to clarify 
the distinctions between Sec.  1.162-15 and Sec.  1.162-20 are beyond 
the scope of these final regulations. Section 1.162-20(a)(2) provides 
rules for deducting expenditures for institutional or good will 
advertising that keeps the taxpayer's name before the public, including 
by encouraging actions or presenting views on various subjects. For 
example, Sec.  1.162-20(a)(2) refers to the costs of advertising that 
encourages contributions to organizations such as the Red Cross, 
encourages the purchase of savings bonds, encourages participation in 
similar causes, or presents views on subjects of a general nature.
    In contrast, Sec.  1.162-15(a) addresses only payments made to 
entities described in section 170(c). Section 1.162-15(a)(1) provides 
that payments to section 170(c) entities may be

[[Page 48471]]

deducted under section 162 if they bear a direct relationship to the 
taxpayer's trade or business and are made with a reasonable expectation 
of financial return commensurate with the amount paid. The examples in 
Sec.  1.162-15(a)(2) of the final regulations are not intended to 
demonstrate the application of Sec.  1.162-20(a)(2), which serves a 
different purpose.
    The final regulations revise Example 1 under Sec.  1.162-
15(a)(2)(i) to refer to ``supporters,'' rather than ``sponsors,'' to 
avoid any potential confusion with the rules governing qualified 
sponsorship payments under section 513. In addition, the final 
regulations revise the cross-reference in Sec.  1.162-15(d) to specify 
that the deductibility of expenditures for institutional and good will 
advertising is addressed in Sec.  1.162-20(a)(2).
3. Quid Pro Quo Provided by a 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. The commenters emphasized 
that the use of State or local tax credits in exchange for donations to 
SGOs is not intended to subvert federal tax law. 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) entity. The commenters suggested that the quid pro quo 
principle should be applied only to contributions to entities described 
in section 170(c)(1). One commenter recommended that if a contribution 
is made to section 170(c)(2) entities in exchange for a State or local 
tax credit, the credit should be treated as income to the donor.
    The Treasury Department and the IRS considered these comments, but 
did not adopt the suggested changes because the established tax law 
does not support them. As discussed in the preamble to the proposed 
regulations, both the courts and the IRS have concluded that the quid 
pro quo principle is equally applicable, regardless of whether the 
donor expects to receive the benefit from the donee or from a third 
party. See, e.g., Singer v. United States, 449 F.2d 413 (Ct. Cl. 1971) 
(rejecting the taxpayer's argument that an expected benefit should be 
ignored because it would be received from a third party); Rev. Rul. 67-
246, 1967-2 C.B. 104 (concluding that the donor's charitable 
contribution deduction must be reduced by the value of a transistor 
radio provided by a local store). Moreover, the courts have concluded 
that a taxpayer's expectation of a substantial benefit in return, from 
any source, reflects a lack of requisite charitable intent on the part 
of the donor. See, e.g., Ottawa Silica Co. v. United States, 699 F.2d 
1124 (Fed. Cir. 1983) (denying a charitable contribution deduction for 
the value of land donated for the construction of a school, where the 
taxpayer had reason to believe such construction would ultimately 
increase the value of its land). Thus, the source of the consideration 
is immaterial in determining whether a donor has received or expects to 
receive a return benefit that reduces its charitable contribution 
deduction.
4. Concerns About Reduced Charitable Giving
    Several commenters expressed concerns about the impact of the 
regulations on donations to SGOs and other section 170(c)(2) entities 
that provide education opportunities for impoverished and special needs 
children in grades K-12. These commenters expressed concern that the 
2019 final regulations have resulted in a decrease in donations to 
SGOs. Several commenters noted that these organizations improve the 
lives of students and criticized the proposed regulations as 
undermining the policy goals of school choice.
    Some commenters stated that individual taxpayers should be able to 
claim a charitable contribution deduction for all payments made 
pursuant to a charitable State tax credit program. Other commenters 
suggested exempting payments and transfers to charitable entities if 
the payments and transfers are made pursuant to tax credit programs 
that were established before the enactment of the TCJA. Many commenters 
suggested providing an exception for State or local tax credits 
provided in exchange for payments to only non-governmental entities 
described under section 170(c). A few commenters suggested revoking the 
2019 final regulations or developing a more narrowly targeted approach.
    As noted in the preamble to the 2019 final regulations, the 
Treasury Department and the IRS recognize the importance of the federal 
charitable contribution deduction, as well as State and local tax 
credit programs, in encouraging charitable giving. However, the 
concerns expressed by these commenters relate more directly to the 2019 
final regulations, and the statutory limitation on individuals' 
deductions of State and local taxes under section 164, than to the 
amendments that are the subject of this rulemaking. The 2019 final 
regulations continue to allow a charitable contribution deduction for 
the portion of a taxpayer's contribution that is a gratuitous transfer, 
and do not affect the ability of states or localities to provide State 
or local tax incentives. In addition, the final regulations provide 
additional clarity to businesses that make payments or transfers to or 
for the use of SGOs and other entities described in section 170(c). 
Similarly, the safe harbor provided under Sec.  1.164-3(j) of the final 
regulations for individuals who itemize deductions will ensure 
equitable treatment for taxpayers whose deductions for State and local 
tax payments would not have exceeded the section 164(b)(6) limitation.
    In addition, for the reasons cited in the preamble to the 2019 
final regulations, those regulations do not distinguish between 
taxpayers who make payments or transfers to State and local tax credit 
programs established after enactment of the TCJA and those who make 
payments or transfers to credit programs established prior to the 
enactment of the TCJA. Similarly, these final regulations apply the 
quid pro quo principle under section 170 equally to all State and local 
tax credit programs, and the final regulations do not adopt commenter 
recommendations to create exceptions for various types of State tax 
credit programs.

Applicability Dates

    The amendments to Sec.  1.162-15 apply to payments or transfers 
made on or after December 17, 2019. However, taxpayers may choose to 
apply the amendments to payments or transfers made on or after January 
1, 2018.
    Section 1.164-3(j) applies to payments made to section 170(c) 
entities on or after June 11, 2019. However, taxpayers may choose to 
apply paragraph (j) to payments made to section 170(c) entities after 
August 27, 2018.
    The definitions provided in Sec.  1.170A-1(h)(4) are applicable to 
amounts paid or property transferred on or after December 17, 2019.

Special Analyses

    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

[[Page 48472]]

quantifying both costs and benefits, of reducing costs, of harmonizing 
rules, and of promoting flexibility. The Administrator of the Office of 
Information and Regulatory Affairs (OIRA), Office of Management and 
Budget, has waived review of this rule in accordance with section 
6(a)(3)(A) of Executive Order 12866.
    Pursuant to the Regulatory Flexibility Act (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. 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 rule largely updates 
the regulations to reflect existing law and policy. The amendments 
update the section 162 and section 170 regulations to reflect current 
law. In addition, the 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 rule 
will not have a significant economic impact on a substantial number of 
small entities. Pursuant to section 7805(f) of the Code, the notice of 
proposed rulemaking preceding this regulation was submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business, and no comments were received.

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 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.

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 1.162-15 is amended by revising paragraphs (a) and (d) 
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 supporters, 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 
the entity applies or expects to apply to offset a State or local tax 
described in paragraph (a)(3)(ii)(A)(3) of this section.

[[Page 48473]]

    (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 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 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 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 made on or after December 17, 2019. Section 1.162-15(a), 
as it appeared in the April 1, 2020 edition of 26 CFR part 1, generally 
applies to payments or transfers made prior to December 17, 2019. 
However, taxpayers may choose to apply paragraphs (a)(1) and (2) of 
this section to payments and transfers made 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 made on or after January 1, 2018.
* * * * *
    (d) Cross reference.--For provisions dealing with expenditures for 
institutional or ``good will'' advertising, see Sec.  1.162-20(a)(2).

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 made 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 a State or local tax 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 limitation 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, the taxpayer is an 
individual who itemizes deductions for Federal income tax purposes.

[[Page 48474]]

    (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 the $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.

0
Par. 4. Section 1.170A-1 is amended as follows:
0
1. Paragraph (c)(5) is revised.
0
2. In paragraph (h)(1) introductory text, 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 credits.
* * * * *
    (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 to amounts paid or property transferred 
on or after December 17, 2019.
* * * * *


Sec.  1.170A-13   [Amended]

0
Par. 5.Section 1.170A-13 is amended in paragraph (f)(7) by removing the 
cross-reference ``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.
    Approved: July 27, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-17393 Filed 8-7-20; 4:15 pm]
BILLING CODE 4830-01-P