By Daniel Pessar*Daniel Pessar (email@example.com) is a J.D. candidate at Harvard Law School (class of 2020). The author would like to thank Leigh Youngblood, Executive Director of the Mount Grace Land Conservation Trust and Tom Anderson, Program Coordinator for the Massachusetts Conservation Land Tax Credit Program, for providing key insights that facilitated this piece. As well, the author would like to thank the fantastic editorial team of the Harvard Environmental Law Review, including Alex Kontopoulos, Grant Glovin, and Ross Gitlin.
“Florida’s Sunshine and Tax Benefits Beckon Billionaires” read the headline of a 2019 Wall Street Journal article that listed several billionaires who recently moved from the New York area to Florida.1Juliet Chung & Joseph De Avila, Florida’s Sunshine and Tax Benefits Beckon Billionaires; Trump is Joining the Tradition of Wealthy People Abandoning New York, New Jersey and Connecticut, Wall St. J. (Nov. 11, 2019), https://perma.cc/ZK49-MKCC. Among the reasons credited for the moves are changes to the state and local tax (“SALT”) deduction rules that have left high earners in high tax states paying more federal income tax.2Id. Deductions reduce a taxpayer’s taxable income. For example, instead of a business paying taxes on its revenues, it might be allowed to take a deduction for all of its expenses so that it is taxed only on profits. See, e.g., 26 U.S.C. § 162 (2018). But these changes to the tax code implicate more than just wealthy taxpayers’ state and local tax deductions. The SALT rule changes also reduce certain benefits available to donors receiving state tax credits for supporting environmental conservation efforts.3For a list of states offering tax credit programs for conservation donations, see State Land Conservation Tax Incentives as of April, 2019, Land Trust Alliance (2019), https://perma.cc/H5PK-U8CN. While many observers worried that the reduction in benefits available to conservation donors could dampen state and local conservation efforts, initial signs suggest that such concerns may have been unwarranted.
The 2017 Tax Cuts and Jobs Act amended the tax code to cap deductions for state and local taxes at $10,000 for taxable years 2018 through 2025,4See 26 U.S.C. § 164(b)(6)(B). making it more expensive for high earners to live in high tax states. This alarmed policymakers in many state capitals who worried that increasing numbers of taxpayers would move to lower tax jurisdictions. In response, several states passed or proposed statutory solutions to help their taxpayers achieve tax deductions indirectly, circumventing the deduction cap. New York, for example, created a charitable fund that accepted donations which could be claimed “as deductions on [donors’] federal and state tax returns. Any taxpayer making a donation [to these charities] may also claim a state tax credit equal to 85 percent of the donation amount for the tax year after the donation is made.”5Press Release, Governor Andrew M. Cuomo, Governor Cuomo Signs Bill to Protect New York Taxpayers from Federal Tax Increases on Tax Day (Apr. 17, 2018), https://perma.cc/59R9-YF7T. Even though IRS regulations foreclosed these workaround attempts, some states are still attempting legislative workarounds. For example, a New Jersey bill signed into law on January 13, 2020 establishes a “pass-through entity business alternative income tax” to allow certain businesses to take advantage of SALT deductions even as individuals continue to face the cap. John Herzfeld, N.J. Governor Signs SALT Workaround, Vetoes Property Tax Bill, Bloomberg Daily Tax Report (Jan. 14, 2020), https://perma.cc/2C5A-U7RT. Taxpayers were encouraged to donate to this newly-formed charity in order to enjoy the tax benefits that were once available to them before the Tax Cuts and Jobs Act: qualifying for federal tax deductions while paying off their state tax liability.6To understand how this works, consider an example. A taxpayer not subject to the alternative minimum tax—and therefore able to take SALT deductions—who used to pay $100,000 in state taxes could enjoy $100,000 in federal tax deductions as a result. The net cost of state taxes was only $76,000 as a result ($100,000 paid to the state minus $24,000 in federal income tax savings). Now, after the Tax Cuts and Jobs Act, the taxpayer is capped at $10,000 in deductions. See 26 U.S.C. § 164(b)(6). The new net cost to the same taxpayer is $97,600 ($100,000 paid to the state minus $2,400 in federal income tax savings). Moreover, if the taxpayer has already reached the SALT cap because of other state and local taxes, the effective cost of the state tax liability will be the full $100,000. New York’s approach was to encourage the taxpayer to donate $100,000 to a state charity, qualifying the taxpayer for $100,000 in federal tax deductions, just like the taxpayer used to receive. In exchange, New York would grant the taxpayer a state tax credit of 85%, or $85,000. Thus, in order to satisfy the entire state tax liability, the taxpayer would have to pay $117,640 ($100,000/0.85) to the charity, resulting in an effective cost of $89,406.40 ($117,640 paid to the charity minus $28,233.60 in federal income tax savings) to satisfy the $100,000 state tax obligation. Although the result involves more tax than the taxpayers faced before the SALT deduction laws changed, it represents a significant savings as compared to the tax liability without the workaround.
In response, the IRS issued regulations preventing this workaround.726 C.F.R. § 1.170A-1(h)(3)(i) (2019) (“[T]he amount of the taxpayer’s charitable contribution deduction under section 170(a) is reduced by the amount of any state or local tax credit that the taxpayer receives or expects to receive in consideration for the taxpayer’s payment or transfer.”) However, there is an exception for cases in which the “credits received or expected to be received by the taxpayer [constitute] 15 percent or less of the taxpayer’s payment.” Id. § 1.170A-1(h)(3)(vi). The agency’s justification for closing the scheme is based on the concept that donations given in exchange for benefits should fall outside the scope of the charitable contribution deduction. The charitable deduction regulations provide that a taxpayer may only deduct the value of a donation as reduced by the “fair market value of the goods or services the organization provides in return.”8Id. § 1.170A-1(h)(2). For example, a taxpayer who makes a $100 donation to a local charity and receives $40 worth of concert tickets in return would be eligible to take only a $60 federal tax deduction for the donation. The new IRS regulations apply this same principal to tax credits received for donations.9Id. Thus, the new regulations reduced or eliminated the federal tax deductions previously available to taxpayers receiving state or local tax credits for charitable donations, regardless of whether those donations were made in order to circumvent the deduction cap.
For example, the new regulations implicate tax credits provided to taxpayers making donations to certain environmental projects. Donations of complete or partial interests in land that qualify for state tax credits no longer qualify for federal tax deductions corresponding to the full value of the donation. The value must be reduced to the extent of any tax credit received for the donation. It is still the case that a taxpayer facing a 24% marginal federal tax rate who makes a qualifying property donation worth $100 would receive $24 in federal tax liability reduction from the federal tax deduction. However, prior to the new regulations, a generous state tax credit—$50, for example—could be enjoyed in addition to the federal tax deduction, for a total of $74 in benefit.10For a list of these state tax credits as of April 2019, see Land Trust Alliance, supra note 3. Now, with the change, the taxpayer will only qualify for a $50 federal tax deduction ($100 reduced by the $50 in tax credit benefit received) providing a value of only $12 at the federal level to add to the $50 state tax credit, for a total of $62 in benefit.11“Thus, the final regulations adopt the rule that the amount otherwise deductible as a charitable contribution under section 170 must generally be reduced by the total amount of state and local tax credits received or expected to be received.” Contributions in Exchange for State or Local Tax Credits, 84 Fed. Reg. 27,513, 27,515 (June 13, 2019) (to be codified at 26 C.F.R. pt. 1). Because financial considerations are important to a taxpayer’s decision to donate, this change makes it less attractive for donors of conservation property to make those contributions.
Before the tax regulations were finalized, conservation groups alerted the IRS to the negative effect that the new tax regulations would have on conservation donors. Of particular worry was the effect on conservation easements, a popular property interest that can be donated to conservation groups and government entities.12Known in the tax code as a “qualified conservation contribution” and discussed extensively in 26 U.S.C. § 170(h) and 26 C.F.R. § 1.170A-14, these contributions are perpetual restrictions—exclusively for conservation purposes—on the use or development of property. See Land Trust All., Using the Conservation Tax Incentive, 2 (2016), https://perma.cc/2DFB-SRH8. When these restrictions result in a reduction in property value, the landowner may take a deduction in the amount of that value reduction. Conservation easements are attractive to many conservation groups because they are much less expensive than a fee simple acquisition and can thus help conservation groups leverage their impact. Because the fee simple interest is retained by the landowner, however, there are incidents involving violations of the restrictive covenants and reductions in the anticipated conservation value. Some of the deduction rules also appear quite generous to landowners, such as the rule that conservation easements do not necessarily need to offer public access (or even complete visual access). See 26 C.F.R. § 1.170A-14(d)(4)(ii)(B). Environmental groups and conservation donors
recommended that donations of conservation easements should be exempted from the rules in the regulations. Commentators representing land trusts expressed concern that the regulations would reduce the number of donated conservation easements, thereby reducing the ability of the federal government, state and local governments, and land trusts to conserve in perpetuity significant natural lands, water, and habitats.13Contributions in Exchange for State or Local Tax Credits, 84 Fed. Reg. at 27,522.
The IRS held firm, explaining that the “final regulations apply longstanding principles regarding charitable intent and quid pro quo, and therefore treat all contributions to entities described in section 170(c) similarly. Those principles apply equally to all charitable contributions, regardless of the charitable purpose or type of donee.”14Id.
While the changes to the SALT rules certainly impact the benefits available to many donors of conservation property, the effect of the change on conservation efforts is not easy to determine. High property values nationwide can translate to relatively high tax benefits for taxpayers donating land or property interests, including conservation easements. Massachusetts’s Commonwealth Conservation Land Tax Credit (“CLTC”) Program,15The program awards a total of $2 million per year—up to $75,000 per donation—in tax credits to landowners who donate real property interests or “Conservation Restrictions.” Commonwealth Conservation Land Tax Credit (CLTC), Mass. Off. Energy & Envtl. Aff., https://perma.cc/3S2K-ERX5. for example, finished approving applications for its entire 2020 and 2021 allocation by mid-January 2020, a signal of continued, significant demand for the tax credit program.16Email from Tom Anderson, Program Coordinator, Mass. Conservation Land Tax Credit Program, to author (Jan. 12, 2020) (on file with author). Because of the backlog, Massachusetts landowners interested in receiving the tax credit will need to apply, win approval, and then wait until January of 2022 before making the qualifying donation.17Id. This is not an entirely surprising state of affairs. Although the tax benefits available to donors of conservation property are less than they were before the charitable deduction regulations changed, the Massachusetts tax credits dramatically improve the economic benefits of making qualifying property donations. While financial considerations continue to be an important driver of conservation donations, the availability of federal tax deductions is only one factor influencing the decision to contribute.