Taxing Definitions

Definition — Stirring up the salt

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Are you watching your sodium levels by limiting your salt intake? The IRS says the time has come to limit the SALT on your tax return too—including the SALT you may be treating as charitable deductions under programs run by your state.

SALT is an acronym for state and local taxes. SALT taxes include state, local, and foreign real property taxes; state and local personal property taxes; and state, local, and foreign income, war profits, and excess profits taxes (see internal revenue code section 164). Those taxes are generally deductible on your federal income tax return when you itemize, or list your eligible tax-deductible expenses, on your return instead of using the standard deduction.

However, in 2017, the US congress passed the “act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” also known as the Tax Cuts and Jobs Act of 2017. That act limited the federal income tax deduction of state and local taxes to $10,000 ($5,000 when you’re married and file a separate return). The limitation will apply beginning with your 2018 federal income tax return.

If you don’t usually itemize your deductions, or if you will choose not to itemize because the act increased your standard deduction, the limitation has no real effect on your tax return.

But the limitation does affect taxpayers who itemize and those who pay alternative minimum tax. In addition, the limitation has an impact on programs many states have in place that provide state or local tax credits in return for contributions to certain charities.

Wondering how these tax credit programs work, and how they relate to federal tax returns? Note that the $10,000 limitation only applies to state and local taxes. You can still deduct charitable contributions on your federal income tax return, generally in full (though your deduction may be limited by existing rules).

Charitable contributions include gifts to or for the use of a state or a US possession, or political subdivisions. The gift must made exclusively for public purposes such as schools or housing programs. (See internal revenue code section 170.)

When you live in a state with a tax credit program, you can make a payment to one of these charities and receive in return either a credit or a deduction against your state taxes. You can then take a federal income tax deduction for the charitable contribution.

Before the new $10,000 SALT limitation, whether you claimed a deduction for the charitable contribution or the state tax, the result was essentially the same on your federal return. You either paid the full amount of tax to the state and took a federal deduction for that amount, or you made a payment to a state charity, received a reduction of your state taxes in exchange, and claimed the entire charitable payment on your federal return. Since the reduction of your state taxes reduced the amount you could claim for those taxes on your federal income return, the two balanced out.

Now, some taxpayers have the opportunity to claim these payments as fully deductible charitable contributions on federal income tax returns, while using the same payments to satisfy or offset their state or local tax liabilities. In other words, these taxpayers could potentially take a deduction for state income taxes without regard to the $10,000 limitation.

In proposed regulation 112176-18, the IRS says the tax credits and deductions received in exchange for the charitable donations are benefits that reduce the amount taxpayers can claim as a charitable deduction.

As always, the rules have exceptions. In this case, two exceptions apply.

First, the charitable deduction is not reduced if the state tax credit is less than 15% of the payment (or the fair market value).

Second, the charitable deduction is not reduced if the taxpayer gets a state or local tax deduction in exchange for the contribution, and the state or local tax deduction exceeds the fair market value of the contribution.

Got the rules salted away? Ready to head to the salt mines? Here are three questions so you can prove you’re worth your salt.

1

An individual makes a payment of $1,000 to a qualified charitable entity and gets a state tax credit of 70% of the payment.

Does the taxpayer have to reduce the charitable contribution deduction claimed on her federal income tax return?

or

 

2

An individual transfers a painting to a qualified charitable entity. At the time of the transfer, the painting has a fair market value of $100,000. In exchange for the painting, the individual gets a state tax credit equal to 10% of the fair market value of the painting.

Does the taxpayer have to reduce the charitable contribution deduction claimed on her federal income tax return?

or

 

3

An individual makes a payment of $1,000 to a qualified charitable entity. In exchange for the payment, the individual gets a state tax deduction equal to the amount paid.

Does the taxpayer have to reduce the charitable contribution deduction claimed on her federal income tax return?

or

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Right answer!

The charitable contribution deduction is reduced by $700 (70% x $1,000).

This reduction occurs regardless of whether the taxpayer is able to claim the state tax credit in that year.

Thus, the charitable contribution deduction for the $1,000 payment may not exceed $300.

Sorry, wrong answer :(
Sorry, wrong answer :(
Right answer!

The taxpayer is not required to apply the general rule because the amount of the tax credit received does not exceed 15% of the fair market value of the property transferred.

Accordingly, the amount of the charitable contribution deduction for the transfer of the painting is not reduced.

Sorry, wrong answer :(
Right answer!

The taxpayer is not required to reduce the charitable contribution deduction under section 170(a) on account of the state tax deduction. Editorial Note: The individual in this example received a deduction, not a credit. See exception 2 above.

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