57-18 Exhibit - Urging State of New Jersey to Implement Charitable Trust in Lieu of Local Taxes Plan.pdf

Exhibit “A”

Federal  Income  Tax  Treatment  of  Charitable  Contributions   Entitling  Donor  to  a  State  Tax  Credit     Introduction     This   paper   summarizes   the   current   federal   income   tax   treatment   of   charitable   contributions  where  the  gift  entitles  the  donor  to  a  state  tax  credit.  Such  credits  are  very   common   and   are   used   by   the   states   to   encourage   private   donations   to   a   wide   range   of   activities,   including   natural   resource   preservation   through   conservation   easements, 1   private  school  tuition  scholarship  programs,2  financial  aid  for  college-­‐bound  children  from   low-­‐income   households,3  shelters   for   victims   of   domestic   violence,4  and   numerous   other   state-­‐supported   programs.   Under   these   programs,   taxpayers   receive   tax   credits   for   donations   to   governments,   government-­‐created   funds,   and   nonprofits.   Appendix   A   provides  a  partial  inventory  of  existing  state  charitable  tax  credits.     A  central  federal  income  tax  question  raised  by  these  donations  is  whether  the  donor   must  reduce  the  amount  of  the  charitable  contribution  deduction  claimed  on  her  federal   income  tax  return  by  the  value  of  state  tax  benefits  generated  by  the  gift.  Under   current   law,   expressed   through   both   court   opinions   and   rulings   from   the   Internal   Revenue   Service,   the  amount   of   the   donor’s   charitable   contribution   deduction   is  not   reduced   by   the   value   of   state   tax   benefits.  In  the  analysis  below,  we  refer  to  this  feature  of  current   law  as  the  “Full  Deduction  Rule.”  The  effect  of  the  Full  Deduction  Rule  is  that  a  taxpayer   can  reduce  her  state  tax  liability  by  making  a  charitable  contribution  that  is  deductible  on

 Full  Deduction  Rule  is  that  a  taxpayer   can  reduce  her  state  tax  liability  by  making  a  charitable  contribution  that  is  deductible  on   her  federal  income  tax  return.     In   a   tax   system   where   both   charitable   contributions   and   state/local   taxes   are   deductible,  the  ability  to  reduce  state  tax  liabilities  via  charitable  contributions  confers  no   particular  federal  tax  advantage.  However,  in  a  tax  system  where  charitable  contributions   are  deductible  but  state/local  taxes  are  not,  it  may  be  possible  for  states  to  provide  their   residents  a  means  of  preserving  the  effects  of  a  state/local  tax  deduction,  at  least  in  part,   by  granting  a  charitable  tax  credit  for  federally  deductible  gifts,  including  gifts  to  the  state   or   one   of   its   political   subdivisions.   Congress   first   introduced   differential   treatment   of   charitable   contributions   and   state/local   taxes   in   the   Tax   Reform   of   1986,   when   it   amended                                                                                                                           1  See   Jeffrey   O.   Sundberg,   State   Income   Tax   Credits   for   Conservation   Easements:   Do   Additional   Credits   Create   Additional   Value?,   Lincoln   Institute   of   Land   Policy   (2011)   (p.   26,  Table   1,   listing   state   tax  credits  as  of  2011)  (http://www.lincolninst.edu/publications/working-­‐papers/state-­‐income-­‐tax-­‐ credits-­‐conservation/easements).   2  See   Carl   Davis,   State   Tax   Subsidies   for   Private   K-­‐12   Education,   Institute   on   Taxation   and   Economic   Policy  (October  2016)  (https://itep.org/wp-­‐content/uploads/k12taxsubsidies.pdf).   3

Private   K-­‐12   Education,   Institute   on   Taxation   and   Economic   Policy  (October  2016)  (https://itep.org/wp-­‐content/uploads/k12taxsubsidies.pdf).   3  http://www.treasurer.ca.gov/cefa/catc/index.asp  (CA  College  Access  Tax  Credit).   4  https://dss.mo.gov/dfas/taxcredit/dvtaxcredit.htm  (MO  Domestic  Violence  Shelter  Tax  Credit).   Electronic copy available at: https://ssrn.com/abstract=3098291

FEDERAL  TAX  TREATMENT  OF  STATE  CHARITABLE  TAX  CREDITS     the  federal  alternative  minimum  tax  by  disallowing  the  deduction  for  state/local  taxes.5  As   a   result,   from   1987   onward,   taxpayers   subject   to   the   federal   AMT   have   found   it   advantageous   to   make   charitable   gifts   generating   state   tax   credits.6  These   gifts   had   the   felicitous   effect   of   increasing   the   taxpayer’s   (deductible)   charitable   contributions   while   simultaneously   reducing   her   (non-­‐deductible)   state   tax   obligations.   In   light   of   recent   federal   legislation   further   limiting   the   deductibility   of   state   and   local   taxes,7  states   may   expand   their   use   of   charitable   tax   credits   in   this   manner,   focusing   new   attention   on   the   legal  underpinnings  of  the  Full  Deduction  Rule.     The  Full  Deduction  Rule  has  been  applied  to  credits  that  completely  offset  the  pre-­‐tax   cost  of  the  contribution.    In  most  cases,  however,  the  state  credits  offset  less  than  100%  of   the   cost.     We   believe   that,   at   least   in   this   latter   and   more   typical   set   of   cases,   the   Full   Deduction   Rule   represents   a   correct   and   long-­‐standing   trans-­‐substantive   principle   of   federal   tax   law.     According   to   judicial   and   administrative   pronouncements   issued   over   several   decades,   nonrefundable   state   tax   credits   are   treated   as   a   reduction   or   potential   reduction   of   the   credit   recipient’s   state   tax   liability   rather   than   as   a   receipt   of   money,   property,   contribution   to   capital,   or   other   item   of   gross   income.     As   discussed   in   greater   detail  below,  the  Full  Deduction  Rule  is  supported  not  only  by  decades  of

r   item   of   gross   income.     As   discussed   in   greater   detail  below,  the  Full  Deduction  Rule  is  supported  not  only  by  decades  of  precedent  but  by   a   host   of   policy   considerations.     These   considerations   include   federal   respect   for   state   initiatives   and   allocation   of   tax   liabilities,   and   near-­‐insuperable   administrative   burdens   posed  by  alternative  rules.   The  combination  of  precedent  and  policy  justifications  suggests  that  the  Full  Deduction   Rule  should  survive  administrative  and  judicial  challenge.  We  believe  that  changes  to  the   Full   Deduction   Rule   would   require   legislation.   We   also   caution   Congress   that   a   legislative   override   of   the   Full   Deduction   Rule   would   raise   significant   administrability   concerns   and   would  implicate  important  federalism  values.  Congress  should  tread  carefully  if  it  seeks  to   alter  the  Full  Deduction  Rule  by  statute.   Background  on  the  Charitable  Contribution  Deduction     Availability  of  Deduction.  Section  170(a)  of  the  federal  Internal  Revenue  Code  provides   for   a   deduction   for   “charitable   contributions”   as   defined   in   section   170(c).   Deductible                                                                                                                           5  26  U.S.C.  56(b)(1)(A)(ii)  (enacted  as  part  of  the  Tax  Reform  Act  of  1986).   6  See,   e.g.,   Bryan   Strike,   Charitable   Donation   and   State   Tax   Credit!,   Kays   Financial   Advisory   Corporation,   Professional   Wealth   Management   Services   (September   20,   2016)   (describing   tax   advantages   for   AMT   taxpayers   to   make   deductible   gifts   to   Georgia’s   Student

anagement   Services   (September   20,   2016)   (describing   tax   advantages   for   AMT   taxpayers   to   make   deductible   gifts   to   Georgia’s   Student   Scholarship   Organizations,   which   entitle   donors   to   100%   state   tax   credit);   David   Slade,   ‘Donation’   Can   Make   You  a  Profit,  The  Post  and  Courier  (July  12,  2014)  (describing  benefit  to  AMT  taxpayers  of  making   deductible   gifts   to   South   Carolina’s   Exceptional   SC   fund,   which   entitle   donors   to   100%   state   tax   credit).       7  P.L.   115-­‐97,   An   act   to   provide   for   reconciliation   pursuant   to   titles   II   and   V   of   the   concurrent   resolution  on  the  budget  for  fiscal  year  2018.   2     Electronic copy available at: https://ssrn.com/abstract=3098291

FEDERAL  TAX  TREATMENT  OF  STATE  CHARITABLE  TAX  CREDITS     contributions  include  donations  not  only  to  familiar  non-­‐profit  organizations  such  as  those   qualifying  for  tax-­‐exempt  status  under  section  501(c)(3)  but  also  “a  State,  a  possession  of   the  United  States,  or  any  political  subdivision  of  any  of  the  foregoing,  or  the  United  States   or  the  District  of  Columbia,  but  only  if  the  contribution  or  gift  is  made  for  exclusively  public   purpose.”8  Donations  can  be  made  in  either  cash  or  property.     Amount  of  Deduction.  The  amount  of  the  deduction  is  generally  the  amount  of  cash  or   the   fair   market   value   (or   in   some   instances   the   basis)   of   property   contributed   to   the   qualifying  entity.  Treasury  Regulations  provide  that  the  amount  deductible  may  not  exceed   the  excess  of:   “(A)  The  amount  of  any  cash  paid  and  the  fair  market  value  of  any  property   (other  than  cash)  transferred  by  the  taxpayer  to  an  organization  described  in   section  170(c);  over     (B)  The  fair  market  value  of  the  goods  or  services  the  organization  provides   in  return.”   Treas.  Reg.  Sec.  170A-­‐1(h)(2)(i)   By  virtue  of  this  “quid  pro  quo”  provision,  a  taxpayer  who  makes  a  $100  gift  to  public  radio   and   receives   a   tote   bag   in   return   must   reduce   the   amount   of   the   deduction   by   the   fair   market  value  of  the  tote  bag.  For  example,  if  the  value  of  the  tote  bag  is  estimated  to  be   $20,  the  taxpayer  may  only  claim  a  deduction  of  $80.9  

 bag.  For  example,  if  the  value  of  the  tote  bag  is  estimated  to  be   $20,  the  taxpayer  may  only  claim  a  deduction  of  $80.9     Federal   Tax   Deduction   for   Charitable   Contributions.   The   basic   logic   underlying   the   quid   pro   quo   regulation   is   that   the   deduction   should   be   limited   to   the   actual   net   cost   of   the   gift   to  the  taxpayer  —  i.e.,  the  gross  amount  of  the  gift  minus  the  value  of  goods  or  services   received   in   exchange   for   the   gift.   While   this   “net   cost   to   the   taxpayer”   principle   makes   intuitive   sense,   it   bears   noting   that   federal   tax   law   ignores   (and   has   always   ignored)   the   value   of   the   federal   charitable   contribution   deduction   itself.   These   tax   savings   are   often   substantial.  For  a  taxpayer  subject  to  a  37  percent  marginal  tax  rate,  a  $100  gift  results  in  a   $100   deduction,   even   though   that   deduction   reduces   the   net   cost   of   the   gift   to   $63.   In   other   words,   in   making   the   quid   pro   quo   determination,   federal   tax   law   ignores   the   $37   of   tax   savings   arising   from   the   gift.   If   instead   of   cash   the   taxpayer   donates   $100   value   property  with  a  zero  basis,  she  not  only  secures  a  $100  deduction  but  also  avoids  federal   income  tax  on  the  $100  of  built-­‐in  gain,  saving  her  (assuming  the  property  is  a  capital  asset   held  for  more  than  a  year)  another  $20  in  federal  income  tax  liability.  In  this  case,  the  net   cost  of  the  gift  to  the  taxpayer—after  backing  out  the  federal  tax  savings—would  be  only                                                                  

g  out  the  federal  tax  savings—would  be  only                                                                                                                           8  26  U.S.C.  170(c)(1).   9  This   example   assumes   the   cost   of   the   tote   bag   exceeds   $10.90   and   thus   is   not   treated   as   an   “insubstantial  benefit”  within  the  meaning  of  Rev.  Proc.  90-­‐12  as  adjusted  for  inflation  under  Rev.   Proc.  2017-­‐58,  Section  2.30(2).   3