SECTION 2. 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, including 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 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. Section 164(b)(6), as added by section 11042(a) of “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (“the Act”), Pub. L. 115-97, provides that deductions for foreign real property taxes are not allowable under section 164(a)(1) and limits an individual’s deduction to $10,000 ($5,000 in the case of a married individual filing a separate return) for the aggregate amount of the following state and local taxes paid during the calendar year: (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 and incurred in carrying on a trade or business or an activity described in section 212. Section 164(b)(2) provides that for purposes of section 164,

a “state or local tax” includes only a tax imposed by a state, a United States territory, or a political subdivision of any of the foregoing, or by the District of Columbia.

Due to the potential for taxpayers to use state or local tax credit programs to avoid the limitation on the deductibility of state and local taxes, the Treasury Department and the IRS have issued guidance on the federal income tax treatment of transfers to entities described in section 170(c) when the taxpayer receives or expects to receive a state or local tax credit in return. On June 11, 2018, the Treasury Department and the IRS issued Notice 2018-54, 2018-24 I.R.B. 750, announcing the intention to propose regulations addressing the federal income tax treatment of transfers pursuant to state and local tax credit programs. On August 27, 2018, proposed regulations under sections 170 and 642(c) were published in the Federal Register (83 FR 43563). The proposed regulations generally state that if a taxpayer makes a payment or transfers property to or for the use of an entity described in section 170(c), and the taxpayer receives or expects to receive a state or local tax credit in return for such payment, the tax credit constitutes a return benefit, or quid pro quo, to the taxpayer and reduces the taxpayer’s charitable contribution deduction under section 170(a). On December 28, 2018, the Treasury Department and the IRS issued Rev. Proc. 2019-12, 2019-04 I.R.B. 401, providing a safe harbor under section 162 for certain payments made by C corporations and specified passthrough entities to or for the use of an organization described in section 170(c) if the C corporation or specified passthrough entity receives or expects to receive a state or local tax credit in return for such payment. On June 11, 2019, the Treasury Department and the IRS published T.D. 9864, Contributions in Exchange for State or Local Tax Credits, 2019-27 I.R.B. 6 (effective August 12, 2019 and applicable to amounts paid or property transferred by a taxpayer after August 27, 2018), providing rules governing the availability of charitable contribution deductions under section 170 when a

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taxpayer receives or expects to receive a corresponding state or local tax credit, as well as providing similar rules under section 642(c) for payments made by a trust or decedent’s estate.

In the Special Analyses section of the proposed regulations, the Treasury Department and the IRS explained that the proposed regulations “will leave charitable giving incentives entirely unchanged for the vast majority of taxpayers.” The Treasury Department and the IRS acknowledged, however, that a small fraction of taxpayers could see a reduction in their financial incentives to donate to state and local tax credit programs compared to their pre-Act incentives and requested comments on this important consideration. After the publication of the proposed regulations, stakeholders expressed concern, through comments and through testimony at the public hearing, that the proposed regulations would create unfair consequences for certain individuals who receive state or local tax credits in return for payments to section 170(c) entities. Specifically, donors to such tax credit programs who itemize deductions for federal income tax purposes and have total state and local tax liability for the year under $10,000 would be precluded from taking charitable contribution deductions for payments to section 170(c) entities to the extent the donors receive state or local tax credits even though the donors would have been able to deduct equivalent payments of state and local taxes offset by such credits. As a result of the proposed regulations, if these individuals chose to make a payment to a section 170(c) entity instead of paying tax to the state or local government, they would lose a deduction to which they would otherwise have been entitled.

These state tax credit programs effectively offer taxpayers a choice of paying tax to the state or local government or making a payment to a section 170(c) entity and receiving a tax credit that offsets the taxpayer’s state or local tax liability. This situation can be analogized to situations in which a party 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 party entitled to receive payment. Cf. 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); Rev. Rul. 86-14, 1986-1 C.B. 304 (same).