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

FEDERAL  TAX  TREATMENT  OF  STATE  CHARITABLE  TAX  CREDITS     investments   in   tangible   property,   could   be   claimed   against   income   tax   or   corporate   franchise   tax   and   the   taxpayer   could   carry   forward   any   unused   portion   or   receive   half   of   the   excess   as   a   refund.   Similarly,   the   EZ   Wage   Credit   was   first   used   to   reduce   corporate   franchise   or   income   tax   liability   with   any   excess   credit   either   carried   forward   or   partially   refunded,   at   the   taxpayer’s   election.   Finally,   the   QEZE   Real   Property   Tax   Credit   was   calculated   by   reference   to   real   property   taxes   previously   paid   by   the   qualifying   business   but  the  credit  was  claimed  by  the  taxpayers  on  their  individual  income  tax  return.   The  Tax  Court’s  holding  in  Maines  is  consistent  with  the  approach  outlined  in  Rev.  Rul.   79-­‐315,   discussed   above.   First,   where   a   credit   entitles   a   taxpayer   to   a   refund   of   a   prior   year’s  tax  liability,  the  taxability  of  the  refund  is  determined  under  the  tax  benefit  rule.  This   holding  applied  to  the  QEZE  Credit  for  Real  Property  Taxes  and  is  consistent  with  Holdings   (1)   and   (2)   of   Rev.   Rul.   79-­‐315.   Second,   where   a   credit   is   applied   to   reduce   the   current   year’s  tax  liability,  the  credit  is  not  taxable  or  otherwise  treated  as  an  item  of  income  but   rather  simply  reduces  a  tax  obligation.  This  holding  applied  to  the  nonrefundable  portions   of  the  EZ  Investment  Credit  and  the  EZ  Wage  Credit  and  is  consistent  with  Holding  (3)  of   Rev.   Rul.   79-­‐315.   Beyond   these   two   holdings,   the   court   also   concluded   that   the   taxpayer   must  include

 with  Holding  (3)  of   Rev.   Rul.   79-­‐315.   Beyond   these   two   holdings,   the   court   also   concluded   that   the   taxpayer   must  include  in  income  the  refundable  portion  of  the  credits.36  Thus,  the  holding  in  Maines   illustrates  an  important  limitation  on  the  principle  underlying  the  Full  Deduction  Rule.  If  a   state  charitable  tax  credit  is  refundable,  entitling  a  donor  not  only  to  reduce  her  state  tax   liability  but  also  secure  a  refund  to  the  extent  that  the  credit  exceeds  tax  owed,  then  it  is   possible   that   the   refundable   portion   of   the   credit   would   be   treated   as   a   payment   from   the   state  rather  than  a  mere  reduction,  or  potential  reduction  in  tax  liability.   Randall   v.   Loftsgaarden.   To   our   knowledge,   the   Supreme   Court   has   addressed   the   federal  income  tax  treatment  of  tax  credits  in  only  one  case:  Randall  v.  Loftsgaarden.37  The   petitioners   in   that   case   purchased   interests   in   a   limited   partnership   formed   by   the   respondent  to  build  and  operate  a  motel.  The  respondent  marketed  the  scheme  as  a  tax   shelter   and   promised   substantial   after-­‐tax   returns   for   investors   in   the   top   income   tax   brackets.   While   the   partnership   did   generate   tax   benefits   for   the   petitioners   in   its   early   years,  the  enterprise  ultimately  failed,  and  the  petitioners  successfully  sued  the  respondent   for  securities  fraud.  The  issue  before  the  Supreme  Court  concerned  the  damages  to  which   the  petitioners  were  entitled.  The  relevant  provision  of  the  Securities  Act  of  1933,  section   12(2),   provides   for   recovery   in   certain   cases   equal   to   “the   consideration   paid   for   such   security

curities  Act  of  1933,  section   12(2),   provides   for   recovery   in   certain   cases   equal   to   “the   consideration   paid   for   such   security   with   interest   thereon,   less   the   amount   of   any   income   received   thereon.”38  The                                                                                                                           36  Id.  (holding  that  the  “excess  portion  that  remains  after  first  reducing  state-­‐tax  liability  and  that   may   be   refunded   in   an   accession   to   the   Maineses’   wealth,   and   must   be   included   in   their   federal   gross  income  under  section  61.”)   37  478  U.S.  647  (1986).   38  15  U.S.C.  §  77l(a).   14

FEDERAL  TAX  TREATMENT  OF  STATE  CHARITABLE  TAX  CREDITS     question   for   the   Court   was   whether   the   petitioners’   damages   should   be   reduced   by   the   value  of  the  tax  benefits  they  received  from  their  investment.39   By  an  8-­‐1  vote,  the  Court  found  in  favor  of  the  petitioners.  According  to  the  Court,  “§   12(2)’s   offset   for   ‘income   received’   on   the   security   does   not   encompass   the   tax   benefits   received  by  defrauded  investors  by  virtue  of  their  ownership  of  the  security,  because  such   benefits   cannot,   under   any   reasonable   definition,   be   termed   ‘income.’”40  The   Court   went   on  to  say:   “[T]he  ‘receipt’  of  tax  deductions  or  credits  is  not  itself  a  taxable  event,  for  the   investor  has  received  no  money  or  other  ‘income’  within  the  meaning  of  the   Internal  Revenue  Code.  See  26  U.S.C.  §  61.  Thus,  we  would  require  compelling   evidence   before   imputing   to   Congress   an   intent   to   describe   the   tax   benefits   an   investor   derives   from   tax   deductions   or   credits   attributable   to   ownership   of  a  security  as  ‘income  received  thereon.’”41   Randall’s  holding  is  about  a  provision  of  securities  law  and  thus  this  passage  about  the   income   tax   treatment   of   credits   is   dicta.     Furthermore,   Randall   does   not   address   the   central  question  of  whether  a  tax  credit  should  be  treated  as  a  quid  pro  quo  return  benefit   for   purposes   of  

not   address   the   central  question  of  whether  a  tax  credit  should  be  treated  as  a  quid  pro  quo  return  benefit   for   purposes   of   section   170.   Nevertheless,   Randall   clearly   addresses—and   clearly   dismisses—the   possibility   that   the   amount   of   a   credit   should   be   includible   in   income   for   purposes  of  section  61.  In  this  respect,  the  case  provides  solid  support  for  the  conclusion   common   to   Rev.   Rul.   79-­‐315,   Snyder,   Tempel,   Maines,   and   the   2011   IRS   memo   that   tax   credits  are  not  an  item  of  income.  Put  another  way,  the  Court’s  statement  that  tax  benefits   “cannot,  under  any  reasonable  definition,  be  termed  ‘income’,”  though  dicta,  would  loom   large  over  any  effort  by  the  IRS  to  argue  otherwise.    As  we  explain  below,  there  are  good   reasons  for  so  many  authorities  to  reach  the  same  conclusion.    Arizona  Christian  School  Tuition  Organization  v.  Winn.42  One  additional  U.S.  Supreme   Court   decision   deserves   mention   because   of   its   extended   discussion   of   state   charitable   tax   credits.  Winn  involved  an  Establishment  Clause  challenge  to  Arizona’s  system  of  providing   100%  charitable  tax  credits  for  donations  to  School  Tuition  Organizations  (STOs)  that  fund   tuition   scholarships   to   private   schools,   including   religious   schools.   A   group   of   Arizona   taxpayers   challenged   the   constitutionality   of   this   program,   but   the   Supreme   Court   dismissed   their   challenge   on   the   basis   that   the   taxpayers   lacked   the   required   “standing”   under   Article   III   of   the   Constitution.   The   court’s   analysis   of   the   standing   issue   involved   considering  an  earlier  standing  case,  Flast  v.  Cohen.43  In  making

  Constitution.   The   court’s   analysis   of   the   standing   issue   involved   considering  an  earlier  standing  case,  Flast  v.  Cohen.43  In  making  their  argument  that  they                                                                                                                           39  Randall,  478  U.S.  at  649-­‐55.   40  Id.  at  656.   41  Id.   42  563  U.S.  125  (2011).   43  392  U.S.  83  (1968).   15

FEDERAL  TAX  TREATMENT  OF  STATE  CHARITABLE  TAX  CREDITS     had  standing  under  Flast,  the  respondents  in  Winn  alleged  that  Arizona’s  100%  tax  credits   were   “best   understood   as   a   governmental   expenditure”   and   that   by   making   donations   entitling  them  to  100%  state  income  tax  credits,  donors  to  STOs  were  “in  effect  …  paying   their  state  income  tax  to  STOs.”     In  his  opinion  for  the  majority,  Justice  Kennedy  rejected  both  of  these  arguments.  As   to  whether  state  tax  credits  should  be  understood  as  a  government  expenditure,  the  Court   noted  simply  “[t]hat  is  incorrect”  and  said  instead  that  tax  credits  are  an  instance  of  “the   government   declin[ing]   to   impose   a   tax…”   The   Court   did   not   characterize   the   granting   of   state   tax   credits   as   a   transfer   of   money   or   other   property   to   the   taxpayer   (the   essential   elements   of   a   quid   pro   quo   transfer).   Rather,   “[w]hen   Arizona   taxpayers   choose   to   contribute  to  STOs,  they  are  spending  their  own  money,  not  money  the  State  has  collected   from  respondents  or  from  other  taxpayers.”  The  Court  also  emphasized  that  donations  to   Arizona   STOs   were   fully   voluntary,   concluding   that   “respondents   and   other   Arizona   taxpayers   remain   free   to   pay   their   own   tax   bills,   without   contributing   to   an   STO”   or,   alternatively,  they  could  “contribute  to  an  STO  of  their  choice,  either  religious  or  secular”   [or]  “other  charitable  organizations,  in  which  case  respondents  may  become  eligible  for  a   tax  deduction  or  a  different  tax  credit.”  Significantly,  the  point  here  seems  to  be  that,  when   an   individual   makes   a   gift   to   an   STO,  

ion  or  a  different  tax  credit.”  Significantly,  the  point  here  seems  to  be  that,  when   an   individual   makes   a   gift   to   an   STO,   the   Supreme   Court   regards   that   act   as   a   wholly   voluntary   private   decision,   despite   the   fact   that   the   gift   generates   a   100%   tax   credit,   reducing  the  donor’s  tax  liability  on  a  dollar-­‐for-­‐dollar  basis.   The  second  element  of  the  Court’s  analysis  is  perhaps  even  more  relevant  to  the  Full   Deduction  Rule.  Recall  that  in  CCA  201105010,  when  the  IRS  embraced  the  Full  Deduction   Rule,   it   also   noted   that   “[t]here   may   be   unusual   circumstances   in   which   it   would   be   appropriate  to  recharacterize  a  payment  of  cash  or  property  that  was,  in  form,  a  charitable   contribution   as,   in   substance,   a   satisfaction   of   tax   liability.”   In   Winn,   the   Supreme   Court   appears   to   express   the   view   that   donations   generating   a   100%   state   tax   credit   are   not   one   of   those   circumstances:   “Like   contributions   that   lead   to   charitable   tax   deductions,   contributions  yielding  STO  tax  credits  are  not  owed  to  the  State  and,  in  fact,  pass  directly   from  taxpayers  to  private  organizations.  Respondents’  contrary  position  [that  a  tax  credit   donation  constitutes  a  satisfaction  of  a  tax  liability]  assumes  that  income  should  be  treated   as  if  it  were  government  property  even  if  it  has  not  come  into  the  tax  collector’s  hands.”44                                                                                                                           44 One   might   argue   that   the   court’s   characterization  

                                                      44 One   might   argue   that   the   court’s   characterization   of   STOs   as   “private   organizations”   is   an   essential   element   of   the   Court’s   analysis   here,   but   the   “private”   aspect   of   these   organizations   cannot   be   essential   to   the   holding.   First,   Congress   has   determined   that   both   public   and   private   organizations  are  entitled  to  receive  deductible  charitable  donations  (26  U.S.C.  170(c)).  There  is  no   favored   "private"   category.   Second,   treating   tax   credits   as   a   quid   pro   quo   only   in   the   case   of   donations   to   public   entities   (but   not   in   the   case   of   donations   to   private   organizations)   would   run   afoul  of  longstanding  precedent  that  the  “return  benefit”  in  quid  pro  quo  transfers  need  not  come   directly   from   the   donee   organization   but   can   also   consist   of   indirect   benefits   (see   e.g.,   Singer   16

FEDERAL  TAX  TREATMENT  OF  STATE  CHARITABLE  TAX  CREDITS     Thus,  Winn  confirms  two  essential  insights  regarding  the  fundamental  nature  of  state   charitable  tax  credits:  (1)  when  the  government  grants  charitable  tax  credits  to  a  donor,  it   is  not  transferring  money,  property,  or  anything  of  value  to  the  donor,  and  (2)  a  voluntary   donation   of   the   donor’s   resources   to   a   state-­‐designated   organization   does   not   constitute   the  “satisfaction  of  tax  liability”  even  where  the  donation  results  in  a  dollar-­‐for-­‐dollar  state   tax  credit.45  While  Winn  is  not  itself  a  tax  case,  it  should  be  clear  that  these  two  insights  are   in  full  accord  with  all  of  the  other  judicial  and  administrative  pronouncements  supporting   the  Full  Deduction  Rule.   State  Tax  Credits  as  a  “Lesser  Tax  Detriment”     Beyond  the  several  cases  discussed  above,  there  are  of  course  many  other  instances   where  a  taxpayer  is  entitled  to  a  state  tax  credit  for  one  reason  or  another.    In  all  of  these   instances,  it  is  necessary  to  determine  the  federal  income  tax  consequences  of  a  taxpayer’s   receipt   of   the   state   tax   credit.   Because   the   situations   are   so   numerous   and   varied,   it   is   not   possible   to   describe   them   here.   It   bears   noting,   however,   that   in   each   of   these   instances   the  IRS  has  relied  upon  the  exact  same  principle  underpinning  the  Full  Deduction  Rule—i.e.,   the   principle   that   nonrefundable   tax   credits   should   be   regarded   merely   as   conferring   a   “lesser  tax  detriment”  rather  than  as  a  payment  from  the  state.     For  example,  the  IRS  concluded  that  the  nonrefundable  portion  of  a