Business-Entity Charitable Workarounds

Abstract

In 2017 Congress enacted a controversial $10,000 cap on individual deductions for state and local taxes. States initially responded by enacting charitable workarounds which invited individual taxpayers to convert capped § 164 deductions for state income taxes into uncapped § 170 deductions for contributions to charitable organizations in exchange for state income tax credits that reduced or eliminated state tax liability. Final regulations under § 170 shut down the tax shelter by treating state tax credits received in exchange for charitable payments as a quid pro quo, reducing or eliminating any charitable deduction. In 2020, acceding to pressure from business groups and school choice advocates, the outgoing Trump administration blessed a functionally equivalent business-entity charitable workaround which circumvents the SALT cap by exploiting discontinuities under §§ 162, 164 and 170. Passthrough owners obtain an ordinary § 162 business deduction for entity-level payments to § 170 organizations, coupled with passthrough of state tax credits that reduce or eliminate the owners’ state income tax liability. The Treasury can and should close this loophole by requiring a separate statement, subject to the § 164(b)(6) limit, of entity-level deductions attributable to payments to charitable organizations that generate state ncome tax credits. Whether or not Congress retains the SALT cap, passthrough owners should not be permitted to convert nondeductible individual state income taxes into fully deductible business expenses.