South Carolina released Revenue Ruling 21-4, which helpfully explains the impact of some federal regulations on taxpayers that make a charitable contribution and expect to receive a state tax credit in exchange for the contribution.
The IRS has issued Treasury Regulation 1.170A-1(h)(3)1, which may affect a taxpayer’s charitable contribution deduction amount, and also Treasury Regulations 1.162-15(a) and 1.164-3(j), which address when a payment otherwise qualifying as a charitable contribution can be treated as an ordinary and necessary business expense under IRC Sec. 162 or a payment of state and local taxes under IRC Sec. 164.
South Carolina adopts IRC Sections 170, 162, and 164 and, accordingly, will apply these regulations in calculating South Carolina taxable income.
Reduced Charitable Contribution Deduction
Under Treasury Regulation 1.170A-1(h)(3), if a taxpayer makes a payment or transfers property to a charitable organization and receives a state or local tax credit for the contribution, the taxpayer’s charitable contribution deduction for federal income tax purposes is reduced by the amount of the tax credit received.
However, there is an exception. The charitable contribution deduction is not reduced if the amount of the state or local tax credit does not exceed 15% of the taxpayer’s payment, or 15% of the fair market value of the property transferred by the taxpayer. Also, if the taxpayer receives a state or local tax deduction (rather than a credit) that does not exceed the amount of payment or the fair market value of the property transferred, then the taxpayer is not required to reduce its federal charitable deduction because of the state or local tax deduction.
Treating Contribution as Deductible Business Expense
Under Treasury Regulation 1.162-15(a)(1) and (2), a taxpayer operating a trade or business can deduct a payment or transfer made to a charitable organization as a business expense under IRC Sec. 162, rather than a charitable deduction under IRC Sec. 170, provided that the payment or transfer: (1) has a direct relationship to the taxpayer’s trade or business, and (2) is made with a reasonable expectation of financial return (other than the state or local tax credit itself) commensurate with the amount of the payment or transfer.
However, the regulation provides a safe harbor exception, under which a C corporation that makes a payment of cash or a cash equivalent to or for the use of a charitable organization, and in return receives a state or local tax credit that reduces a tax imposed on it, may deduct an amount equal to the credit as a business expense.
A safe harbor is also provided for pass through entities if the credit will not reduce a state or local income tax, and the entity: (1) is regarded as an entity separate from its owners and (2) is subject to a state or local tax incurred in carrying on its trade or business that is imposed directly on the entity.
Treating Disallowed Contribution as Deductible Tax Payment
Under Treasury Regulation 1.164-3(j), an individual who itemizes deductions can treat the portion of a charitable contribution disallowed under Treasury Regulation 1.170A-1(h)(3), and made in cash or a cash equivalent, as a state or local tax payment under IRC Sec. 164, subject to the $10,000 limit under IRC Sec. 164(b)(6).
How South Carolina Taxpayers Are Affected
Any reduction in a taxpayer’s federal charitable contribution deduction required under Treasury Regulation 1.170A1(h)(3) will also reduce the taxpayer’s South Carolina charitable contribution deduction.
Affected South Carolina credits include:
- conservation credit
- community development credit
- industry partnership fund credit
- exceptional needs children’s fund credit
In addition to reducing a charitable contribution deduction when a taxpayer receives a South Carolina tax credit, effects of the federal regulations can include:
- treating the contribution as a business expense deduction
- treating the disallowed portion of a contribution as an itemized deduction for state and local taxes
- requiring the taxpayer to add back the deduction for South Carolina income tax purposes
This requirement can apply whether the deduction is a charitable contribution deduction, a business expense deduction, or an itemized deduction for state and local taxes. Code Section 12-6-3790(D)(2)(c) (Exceptional Needs Children’s Fund credit) and Code Section 12-6- 3585(I) (Industry Partnership Fund credit) both require this addback on the South Carolina income tax return.
Further, the South Carolina deduction for taxes is computed in the same manner as provided in IRC Sec. 164, except that no deduction is allowed for state and local income taxes. Therefore, an individual who deducts a disallowed charitable contribution as a state and local income tax may have to add back some or all of the deduction for South Carolina income tax purposes.
The Revenue Ruling includes examples that illustrate how some of these provisions works for South Carolina taxpayers under both the corporate and personal income taxes.
By Brian Plunkett, J.D.
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