Be Careful on Making "State" Contributions

Published on: 12:34PM May 24, 2018

The IRS released a notice yesterday that indicates further guidance is coming regarding the deductibility of payments made to certain "state" charities.  Under the new tax law, individuals are only allowed to deduct state and local income, sales or property taxes up to $10,000.  Several states have either passed new laws or are in the process of passing laws to allow taxpayers to "contribute" funds to certain state sponsored charities.

After making these contributions, the state will then allow you to offset your state income tax or property tax liability (perhaps not in full).  The IRS is taking a very dim view of these proposals and it is likely that they will disallow these deductions in full.  This could be bad news for a taxpayer and could be good news for the state.  Here is an example.

A farm couple in New York has a good year.  They have taxable income of $1 million and owe $100,000 of tax to New York State.  In addition, they incur $25,000 of property tax.  The total allowed deduction on their Schedule A is only $10,000, whereas, the old law allowed them to deduct $125,000 (although AMT may have limited the benefit).  Instead of paying the income tax directly, they contribute $100,000 to a state sponsored charity.  This allows them to offset $85,000 of the state income tax (appears that these are not dollar-for-dollar).  They pay the additional $15,000 of state income tax and deduct a total of $10,000 on their federal return.  A year goes by and the IRS audits their return and disallows the charity contribution, leading to an extra $31,450 of tax plus likely a $6,300 penalty plus interest.  Plus the couple had to pay an extra $15,000 to the state.

The IRS views these state sponsored charities as being abusive.  It will likely head to court to get final determination.  However, many states already allow taxpayers to offset their state income taxes by making charitable donations to certain charities that are not "state sponsored".  My concern right now is that the IRS will also lump these charities in with the "abusive" ones and disallow those deductions as well.

We will keep you posted when we get final guidance.

Also, remember that property tax payments on farm property remain fully deductible.  It is only personal property taxes that have a limit.