IRS Releases Regulations Affecting Contributions to State Tax Credit Programs

By Rob Stroud, Senior Tax Manager, and Keith Little, Senior Tax Associate

For several years, various programs have been popular with Georgia taxpayers due to the tax credits available to offset Georgia income tax. Especially popular were the Rural Hospital Tax Credit Program and Qualified Education Expense Tax Credit programs, which allowed for a Georgia tax credit for the amount of the contribution to the program, as well as a federal charitable deduction.

The IRS issued proposed regulations in June 2018 (1.170A-1) to deal with these types of programs, as their popularity in other states increased with the $10,000 limit to state & local tax deduction for individuals that itemize their deductions on a personal tax return. The proposed regulations applied to any contributions made after Aug. 27, 2018 and stated that no charitable deduction would be allowed for any payment a taxpayer makes wherein the taxpayer expects to receive a state or local tax credit in return for such payment. According to the proposed regulations, the tax credit constitutes a return benefit, or quid pro quo, to the taxpayer, a position that lines up with longstanding regulations and case law.

The finalized regulations were released on June 11, 2019 along with Notice 2019-12, with no change to the IRS stance from the proposed regulations. In essence, the position of the IRS is that prior to these regulations, taxpayers could have used the state or local tax credit programs to avoid the limitation on the deductibility of state and local taxes.

What’s next for these programs and for taxpayers?

The IRS regulations make it clear that individual contributions to the Rural Hospital Tax Credit Program and Qualified Education Expense Tax Credit programs will no longer enjoy the tax benefits they once did. Individuals can still get a dollar-for-dollar Georgia tax credit for contributions made to these programs, thereby redirecting tax dollars to an organization of their choosing, within the programs.

The regulations did, however, provide a possible benefit for taxpayers that contribute to these programs who otherwise do not meet the $10,000 itemized deduction limitation for state and local taxes. In such a case, the payment made to the program will be treated as if it was a state tax payment, thereby increasing the taxpayer’s itemized deduction amount, though not to exceed $10,000.

For C corporations and flow-through entities engaged in a trade or business, there are planning opportunities still available. The IRS noted in the regulations that payments made to state credit programs could be deducted by the entity if they are ordinary and necessary expenses under Code Section 162. Revenue Procedure 2019-12 specifically states that for a C corp, payments to these organizations would be deemed to meet the requirements of an ordinary & necessary business expense, and therefore deductible by the C corp. There are safe harbors for flow-through entities as well. Absent future guidance from the IRS, it would be advisable to contact your Aprio tax advisor to discuss your particular situation.