Failed Charity: Taking State Tax Benefits into Account for Purposes of the Charitable Deduction

The Tax Cuts and Jobs Act (TCJA) substantially limited the ability of individuals to deduct state and local taxes (SALT) on their federal income tax returns. Some states are advancing schemes to allow taxpayers a state tax credit for contributions to a charity controlled by the state. The issue is whether state tax benefits are deductible as a charitable contribution for purposes of the federal income tax. Under a general rule of prior law—the full deduction rule—state tax benefits were ignored for purposes of the charitable deduction. If the full deduction rule is applied to the state workaround schemes, then the SALT limitation can successfully be avoided. This Article explains that after the TCJA, the legal basis for the full deduction rule is undermined. The IRS articulated the full deduction rule given the longstanding baseline of deductible state tax payments. Thus, to allow a charitable deduction for state tax benefits under prior law was simply to allow a deduction for an otherwise deductible expense. After the TCJA, this symmetry with the SALT deduction is gone and the full deduction rule is of questionable applicability. A charitable deduction for state tax benefits would allow taxpayers to deduct amounts not spent and even to profit from charitable transfers. The charitable deduction is intended to encourage giving, not tax avoidance. Thus, the Treasury Department and the courts should apply a longstanding principle of charitable contribution law that measures a contribution by the amount of taxpayer sacrifice. After the TCJA, a contribution should be reduced by the value of state tax benefits, whether the benefits take the form of a credit or a deduction. The reasoning applies both to state workaround credits (and deductions) and to existing state tax benefits that previously have been deducted as charitable. Further, denying a charitable deduction for previously deductible expenses is in fact consistent with the status quo prior to the TCJA, in that, given the loss of a SALT deduction, the charitable deduction was an offset that did not provide a meaningful benefit to taxpayers