Rev. Proc. 2019-12: Safe harbors, business taxpayer payments to charity for state, local tax credits
December 28, 2018
The IRS today released an advance version of Rev. Proc. 2019-12 that provides safe harbors under section 162 for certain payments made by C corporations or passthrough entities to (or for the use of) a charitable organization (that is, one described by section 170(c)) if the C corporations or passthrough entities receive or expect to receive a state or local tax credit in return for these payments made to the charitable organization.
Read Rev. Proc. 2019-12 [PDF 173 KB]
Background
The new tax law in the United States (Pub. L. No. 115-97) limits an individual’s deduction to $10,000 ($5,000 for married individuals filing separate returns) for the aggregate amount of state and local taxes paid during the calendar year including: (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 tax years beginning after December 31, 2017, but does not apply to taxes paid and incurred in carrying on a trade or business.
Since enactment of the new tax law, the IRS found some taxpayers were looking for ways to avoid the new limitation on the deductibility of their state and local taxes. To address this, the IRS and Treasury in August 2018 issued proposed regulations that generally apply to charitable contributions made after August 27, 2018, and require a taxpayer to reduce its charitable contribution deduction by the amount of a state or local tax credit received or expected to be received as a result of the contribution. This rule would apply to individual and corporate taxpayers under section 170 and to trusts and estates under section 642(c).
Following the release of the proposed regulations, the IRS and Treasury Department received questions from taxpayers and others regarding application of the proposed regulations to business entities that make payments to charitable organizations pursuant to state and local tax credit programs. These questions related to the application of section 162 to these payments—that is, whether a business entity may deduct these payments under section 162 as ordinary and necessary business expenses incurred in carrying on a trade or business. To answer these questions, the IRS in September 2018 released a “frequently asked question” (FAQ) document stating that the proposed regulations do not affect the availability of an ordinary and necessary business expense deduction under section 162. Thus, a business taxpayer making a payment to a charitable or government entity generally would be permitted to deduct the payment as an ordinary and necessary business expense under section 162 if the payment was made with a business purpose. The FAQ also notes that the rules permitting an ordinary and necessary business expense deduction under section 162 apply to a taxpayer engaged in carrying on a trade or business regardless of the form of the business.
With today’s release, the IRS explained that since the issuance of the FAQ, the IRS and Treasury have continued to receive questions regarding the application of the proposed regulations and sections 162 and 164 to taxpayers engaged in trades or businesses.
Rev. Proc. 2019-12
In providing safe harbors, Rev. Proc. 2019-12 states that to the extent a C corporation receives or expects to receive a state or local tax credit in return for a payment to a section 170(c) organization:
…it is reasonable to conclude that there is a direct benefit to the C corporation’s business in the form of a reduction in the state or local taxes the C corporation would otherwise have to pay and, therefore, to the extent of the amount of the credit received or expected to be received, there is a reasonable expectation of financial return to the C corporation commensurate with the amount of the transfer.
The safe harbor for C corporations provides that if a C corporation makes a payment to or for the use of a section 170(c) organization and receives or expects to receive a tax credit that reduces a state or local tax imposed on the C corporation in return for such payment, 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 credit received or expected to be received. Examples illustrating the safe harbor are provided.
Rev. Proc. 2019-12 further provides that for a business entity other than a C corporation that is regarded as separate from its owner for all federal tax purposes—i.e., a passthrough entity—to the extent the credit received in return for a payment can reduce the passthrough entity’s tax liability:
…it is reasonable to conclude that there is a direct benefit to the pass-through entity in the form of a reduction in the state or local taxes the entity would otherwise have to pay. However…the deductibility of the payment must be determined at the level of the individual owners of the entity if the credit received or expected to be received will reduce a state or local income tax subject to the limitations in section 164(b)(6).
The safe harbor for certain passthrough entities provides that if a passthrough entity (as defined by the revenue procedure) makes a payment to or for the use of a section 170(c) organization and receives or expects to receive a tax credit that the entity applies or expects to apply to offset a state or local tax other than a state or local income tax, the passthrough entity 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 credit received or expected to be received. Examples illustrating this safe harbor are provided.
