Blue State Attorneys General Continue Fight Against Proposed Anti-Workaround Regs
We have previously blogged on the pros and cons of the Treasury Department’s Proposed Charitable Contribution deduction regulations, designed to prevent residents of high tax states from increasing charitable contributions as a way of “working around” the recently enacted $10,000 limitation on state and local tax deductions. We blogged on it again here. My own view is that if a charitable contribution is to be reduced by the receipt or expectation of return benefit, a whole ‘lotta corporate charitable contributions should be in jeopardy. A corporate charitable contribution is not a “detached and disinterested” transfer like a a 104 gift. Anyway, AGs from California, Connecticut, New Jersey and New York have sharply criticized the proposed regulations in what could be a preview of arguments made in pending or future lawsuits. As a reminder, here is how Treasury summarizes the proposed regulation’s effect (Proposed Reg. 1.170A-1(h)(3) (August 27, 2018):
After reviewing the issue, and in light of the longstanding principles of the cases and tax regulations discussed above, the Treasury Department and the IRS believe that when a taxpayer receives or expects to receive a state or local tax credit in return for a payment or transfer to an entity listed in section 170(c), the receipt of this tax benefit constitutes a quid pro quo that may preclude a full deduction under section 170(a). In applying section 170 and the quid pro quo doctrine, the Treasury Department and the IRS do not believe it is appropriate to categorically exempt state or local tax benefits from the normal rules that apply to other benefits received by a taxpayer in exchange for a contribution. Thus, the Treasury Department and the IRS believe that the amount otherwise deductible as a charitable contribution must generally be reduced by the amount of the state or local tax credit received or expected to be received, just as it is reduced for many other benefits. Accordingly, the Treasury Department and the IRS propose regulations proposing to amend existing regulations under section 170 to clarify this general requirement, to provide for a de minimis exception from the general rule, and to make other conforming amendments.
Compelling policy considerations reinforce the interpretation and application of section 170 in this context. Disregarding the value of all state tax benefits received or expected to be received in return for charitable contributions would precipitate significant revenue losses that would undermine and be inconsistent with the limitation on the deduction for state and local taxes adopted by Congress in section 164(b)(6). Such an approach would incentivize and enable taxpayers to characterize payments as fully deductible for federal income tax purposes, while using the same payments to satisfy or offset their state or local tax liabilities. Disregarding the tax benefit would also undermine the intent of Congress in enacting section 170, that is, to provide a deduction for taxpayers’ gratuitous payments to qualifying entities, not for transfers that result in economic returns. The Treasury Department and the IRS believe that appropriate application of the quid pro quo doctrine to substantial state or local tax benefits is consistent with the Code and sound tax administration.
In their 12 page letter, dated yesterday, the AGs, without actually saying so, decry tax policy by political payback. But that conclusion, I’ll admit, is in the eye of the beholder. Here is part of the AGs’ more formal argument:
Critically, case law and the IRS’s own administrative guidance have uniformly held that the expectation of a tax benefit does not give rise to a quid pro quo that would negate charitable intent or reduce the amount of a charitable deduction. See, e.g., Browning v. Comm’r., 109 T.C. 303, 325 (1997) (rejecting as “untenable” the argument that a taxpayer “may be entitled to a charitable contribution deduction of some lesser amount on account of the economic value of the deduction”); McLennan v. United States, 24 Cl. Ct. 102, 106 n.8 (1991) (noting that “a donation . . . for the exclusive purpose of receiving a tax deduction does not vitiate the charitable nature of the contribution”), aff’d 994 F.2d 839 (Fed. Cir. 1993); Transamerica Corp. v. United States, 15 Cl. Ct. 420, 465 (1988) (stating that “[e]ven where the donation is made solely for the purpose of obtaining a tax benefit, the taxpayer is entitled to the deduction”); Skripak v. Comm’r., 84 T.C. 285, 319 (1985) (averring that “a taxpayer’s desire to avoid or eliminate taxes . . . cannot be used as a basis for disallowing the deduction for that charitable contribution”).
Simply put, existing authority uniformly suggests that tax benefits do not constitute either “consideration,” see Am. Bar Endowment, 477 U.S. at 118, or a “good[] or service[]” that gives rise to a quid pro quo, see Treas. Reg. § 1.170A-1(h)(2). Rather, courts and the IRS have treated tax benefits as a simple reduction in tax liability, not as consideration reflecting a bargained-for exchange. In a memorandum released on February 4, 2011, the IRS’s Office of Chief Counsel addressed the deductibility of charitable contributions that trigger SALT credits. See IRS CCA 201105010. Drawing on the precedents cited above, and noting that “[t]he tax benefit of a federal or state charitable contribution deduction is not regarded as a return benefit that negates charitable intent, reducing or eliminating the deduction,” the Chief Counsel expressly approved of charitable tax credit programs, advising taxpayers that they could still deduct the full amount of their charitable donations without subtracting the value of SALT credits. Id. at 2-5. In so doing, the Chief Counsel squarely confronted the question of whether “a tax benefit in the form of a state tax credit . . . is distinguishable from the benefit of a state tax deduction.” Id. at 4. The Chief Counsel’s answer was clear. “[W]e see no reason,” the Chief Counsel concluded, “to distinguish the value of a state tax deduction, and the value of a state tax credit, or to draw a bright-line distinction based on the amount of the tax benefit in question.” Id. at 5. The Chief Counsel correctly rejected this formalistic distinction. Indeed, the effect of a tax credit is the same as that of a tax deduction—both reduce the beneficiary’s tax liability and incentivize particular kinds of behavior. As the Chief Counsel recognized, therefore, a rule treating credits as evidence of a quid pro quo while discounting the value of deductions would be incongruous. Significantly, the Tax Court subsequently agreed with the Chief Counsel.
In Tempel v. Commissioner, the court observed that “[s]ome commentators have suggested a State’s grant of State income tax credits to taxpayers who make charitable donations . . . should be treated as a transaction that is in part a sale and in part a gift.” 136 T.C. 341, 351 n.17 (2011). Citing IRS CCA 201105010, and noting that “[t]he Commissioner has eschewed this approach,” the court “discern[ed] no reason to disturb this practice.” Ibid. “A reduced tax,” the court went on, should not diminish the amount of a charitable deduction. Ibid. With the proposed rules, however, the IRS has abandoned this longstanding approach by creating one regime for tax credits and another for tax deductions. See Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944) (identifying “consistency with earlier . . . pronouncements” as a factor in evaluating agency action). In so doing, the IRS has elevated form over substance and engaged in arbitrary and capricious rulemaking. The difference between a tax deduction and a tax credit is typically a difference of degree of economic benefit; it is not a different kind of benefit. But the IRS has now chosen to ignore the tax benefits flowing to a taxpayer from deductions, while accounting for the tax benefits that result from credits. This is a creature of the IRS’s own imagination, and not an interpretation of anything found in Section 170 of the Tax Code.
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Worst of all, the IRS’s approach is a far cry from the statutory language it’s supposed to be implementing. Section 170 “allow[s] as a deduction any charitable contribution . . . made within the taxable year.” I.R.C. § 170(a)(1). Nothing in Section 170 provides a basis for a rule requiring taxpayers to subtract the value of tax benefits—whether in the form of credits or deductions— from their charitable deductions. Indeed, the very purpose of Section 170 is to encourage charitable giving through the provision of tax benefits. As a consequence, as noted above, judicial precedent and administrative guidance have unanimously affirmed the principle that the expectation of a tax benefit does not give rise to a quid pro quo that would negate charitable intent or reduce the amount of a charitable deduction. See, e.g., Browning, 109 T.C. at 325; McLennan, 24 Cl. Ct. at 106 n.8; Transamerica, 15 Cl. Ct. at 465; Skripak, 84 T.C. at 319; IRS CCA 201105010.
Had Congress wished to revise the Code so as to reverse this longstanding precedent, it would have done so in clear terms. It has not done so, including in the most recent federal tax overhaul. Rather, members sponsoring that overhaul legislation repeatedly stressed that the legislation kept the charitable deduction under Section 170 in place. As House Speaker Paul Ryan explained: “[T]he Tax Cuts & Jobs Act preserves the deduction for charitable giving.” House Ways & Means Committee Chairman Kevin Brady (R-Tex.) likewise stressed: “Preserving and expanding the charitable deduction will continue to encourage and reward Americans who give back to their local church, charity, or other cause they believe in.” Senate Finance Committee Chairman Orrin Hatch (R-Utah) likewise stressed that the bill “preserves . . . the deduction for charitable contributions.” See also, e.g., 163 Cong. Rec. S7873 (Statement of Sen. Hoeven (RND))(“We continue the deductibility of charitable contributions.”). The bill did make some changes to Section 170, e.g., increasing the percentage of a taxpayer’s income that can be deductible under Section 170 for cash donations and preventing taxpayers from claiming amounts paid for college athletic event seating rights. Pub. L. No. 115-97, §§ 11023, 13704; H.R. Rep. 115-466 (Conference Report), at 273. These changes reinforce that Congress knew how to modify Section 170—even to account for value received in exchange for certain kinds of donations. But Congress did not change Section 170 to establish that receipt of a state or local tax benefit would constitute a quid pro quo negating charitable intent. It is not within the IRS’s rulemaking power to usurp Congressional authority and overrule a tax law principle that has been unquestioned for more than 100 years. See, e.g., Commodity Futures Trading Comm’n v. Schor, 478 U.S. 833, 846 (1986) (“It is well established that when Congress revisits a statute giving rise to a longstanding administrative interpretation without pertinent change, the ‘congressional failure to revise or repeal the agency’s interpretation is persuasive evidence that the interpretation is the one intended by Congress.’”).
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