The IRS has provided safe harbors for business entities to deduct certain payments made to a charitable organization in exchange for a state or local tax (SALT) credit. A business entity may deduct the payments as an ordinary and necessary business expense under Internal Revenue Code (IRC) Section 162 if made for a business purpose. Proposed regulations that limit the charitable contribution deduction do not affect the deduction as a business expense.
Charitable Contributions and SALT Limit
An individual’s itemized deduction of SALT is limited to $10,000 ($5,000 if married filing separately). Some states and local governments have adopted or considered adopting laws that allowed individuals to receive a tax credit for contributions to funds controlled by the state and local government.
Under proposed regulations, however, an individual, estate, and trust generally must reduce the amount of any charitable contribution deduction by the amount of any SALT credit he or she receives or expects to receive for the transfer. A de minimis exception allows a taxpayer to disregard up to 15% of the payment or transfer to the charitable organization.
If a C corporation makes the charitable payment in exchange for a state and local tax credit, it may deduct the payment as an ordinary and necessary business expense to the extent of any SALT credit received or expected to receive.
Specified Pass-Through Entity
A specified pass-through entity may also deduct the payment as an ordinary and necessary business expense, but only if the SALT credit applies or is expected to apply to offset a SALT other than an income tax. A specified pass-through entity for this purpose is any business entity other than a C corporation that is regarded as separate from its owner for all federal income tax purposes (i.e., disregarded entity). The entity also must operate a trade or business within the meaning of IRC Section 162 and be subject to SALT incurred in carrying on that trade or business that is imposed directly on the entity.
The safe harbors apply to any payments made to a charitable organization in exchange for a SALT credit paid on or after January 1, 2018.
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