IRS To New York, New Jersey, and California: We Weren’t Kidding

Today the IRS issued rules and guidance on charitable contributions as a workaround to the new limits on state and local taxes. Unsurprisingly, the IRS said exactly what I thought they would: both substance over form and quid pro quo apply.

There’s a fundamental rule in tax: The substance of a transaction determines how it’s taxed, not what it’s labeled. Suppose I pay you to perform services for me, but I send you a Form 1099-INT (for interest income). What I pay you is service income, not interest income, no matter how it’s labeled. Consider state taxes. Suppose a state (say, New York) offers you the ability to contribute to the “Support New York Fund” instead of state taxes. Well, the substance is that you’re paying state taxes by contributing to that fund.

Another issue is “quid pro quo;” that’s Latin for ‘something for something.’ And if you get something for a charitable contribution, that portion isn’t charity. Consider a donation to some foundation for $50 and you receive a blanket worth $10; your charitable contribution (that you can take) is $40. This rule has been around for some time. It applies to these workarounds, too.

Put bluntly, the IRS isn’t amused with the workarounds. The Tax Code is law; until Congress changes it, federal deductions for state and local taxes are limited.

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