Second Circuit Upholds Charitable Contribution Deduction State Tax Credit Quid Pro Quo Regs

Yesterday the U.S. Court of Appeals for the Second Circuit issued an opinion concluding that the IRS did not exceed its statutory authority when it issued a regulation requiring taxpayers who claim a charitable contribution deduction to reduce the deduction “by the amount of any state or local tax credit that the taxpayer receives or expects to receive in consideration for the taxpayer’s payment or transfer.” The plaintiff governments had created state tax credits in an attempt to help residents offset to some extent the effect off the federal cap on the state and local tax (SALT) deduction. The opinion in State of New Jersey v. Bessent is notable in part because it applied the post-Chevron, Loper Bright standard for reviewing agency regulations.

Important holdings of the case include the following:

• The court found (p. 30) that there is “an important quid pro quo principle underpinning the meaning and objective of [Internal Revenue Code section] 170,” which provides for the federal charitable contribution deduction. It also elaborated on the details of this principle, based on prior case law.

• It rejected arguments that a tax credit cannot be a quid pro quo because tax deductions are not quid pro quos, that the quid pro quo principle only applies to “good or services” provided in return for the contribution as opposed to any “substantial benefit in return” and that a tax credit is not a good or service, that only return benefits constituting taxable income qualify as quid pro quos, and that Congress had acquiesced in the previous IRS practice of not requiring taxpayers to reduce charitable contribution deductions because of state tax credits.

• While the above holdings were based on a review of the IRS’ interpretation of section 170 without giving the agency any deference, as required by Loper Bright, the court in rejecting the plaintiffs final argument that the IRS’ action was arbitrary and capricious noted that for purposes of the arbitrary and capricious review it deferred to the IRS.

Coverage: Bloomberg LawLaw360 (subscription required).

Lloyd Mayer