Proposed IRS Regulations Could Affect Federal Income Tax Deduction for Charitable Donations that Receive a State Income Tax Credit

By: Lynn S. Clarke, Emily R. Lambright and Melody A. Simpson
Benefits e-Alert
August 27, 2018

For charities that rely on West Virginia Neighborhood Investment Program (“NIP”) credits – or other similar state tax credit programs – as an incentive for donors each year, the IRS has proposed new regulations that affect the impact of the credits on donors’ federal (but not state) income taxes.

If NIP credits are awarded to the charity, donors who gift $500 or more in a single donation can be given some of the credits by the charity, up to half of the donated amount. For example, if a charity has $20,000 in credits, and a donor who wants the credits makes a $1,000 donation, the donor can be given a $500 NIP credit which will reduce the donor’s West Virginia state tax bill, dollar for dollar, by $500.

In the past, the full $1,000 could also be taken as a deduction on the donor’s federal income tax return if the requirements for a federal income tax charitable deduction were otherwise met. Under the 2018 Tax Reform Act, the deduction for state income taxes on federal returns was cut back. In response, some states enacted new credits, similar to the NIP credits West Virginia has offered for many years, so that taxpayers who were ‘losing’ federal tax deductions for state and local taxes could get some benefit back on the state level through charitable donation credits.

Unfortunately, the IRS has just issued proposed regulations that would reduce, by the amount of the state tax credit, the donation amount that could qualify for a federal income tax deduction (with a de minimus exception for certain small state tax credits), whether or not the state credit program is new or, like West Virginia’s NIP program, has been in place for years.

For example, and with respect to the $1,000 donation mentioned above that resulted in a $500 NIP credit for the donor, the NIP credit would still reduce the donor’s West Virginia income taxes by $500, but only $500 of the donation (instead of the full $1,000) would be eligible for a possible federal income tax deduction for the donor. The regulations likely won’t be finalized for several months, but if they do become final the proposed effective date is for donations made on or after August 27, 2018.

West Virginia NIP credits will still be valuable to donors in terms of reducing their state income taxes while helping the charities they want to support, but the new regulations may reduce the potential federal income tax deduction benefit of the donation.

If you have questions, or would like additional information about this issue, please contact any member of the Bowles Rice Benefits Team.