BREAKING: IRS Limits Some 2018 Corporate Deductions for State Tax Credit Contributions

As you may remember, in August, the IRS issued proposed regulations removing a deduction for federal taxes for charitable contributions made by individuals after August 27, 2018 if the contribution also results in a state tax credit. Final regulations have not been issued on this subject, but the IRS released additional guidance on December 28, 2018 that applies to businesses and corporations.
 
In general, the guidance means good news for C-Corporations but bad news for pass-through entities like S-Corporations, and the rules are retroactive to amounts paid on or after January 1, 2018. A brief summary of the rules follows.
 
C-Corporations that make state tax credit contributions can consider their contributions to STOs as meeting the requirements of an ordinary and necessary business expense to the extent of the state tax credit received. Therefore, the contribution may be deductible for federal taxes in addition to providing a state tax credit benefit.
 
S-Corporations (and other pass-through entities) can only deduct as ordinary and necessary business expenses contributions that provide for credits against taxes that are imposed directly on the entity. Since Arizona’s income tax is assessed at the shareholder level, not the corporate level, S-Corporations cannot consider their contributions to STOs as deductible ordinary and necessary business expenses for federal tax purposes.
 
Since the rules are retroactive to the start of 2018, they may affect many S-Corporations that contributed to STOs this past summer. As an STO, you should consider revising any literature you provide to potential corporate contributors taking into account these new rules.
 
As always, each business should consult their tax advisor before engaging in any transaction. If you would like more information about these new rules, please give us a call.