Charitable Fund Tax Workaround Questioned by Tax Experts (1)

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

Gerald B. Silverman Albany, N.Y. Staff Correspondent Ryan C. Tuck Washington

By Gerald B. Silverman

Plans to create charitable funds as a workaround to the new federal tax law are raising concerns among tax attorneys who are questioning the legal soundness of the proposals.

Peter L. Faber, a partner at McDermott, Will & Emery LLP, questioned whether contributions to the funds will pass muster with the Internal Revenue Service.

Another tax attorney, Stanley C. Ruchelman of Ruchelman PLLC, questioned whether the credits could be considered by the IRS to be an abusive tax shelter.

If the creation of the funds doesn’t pass muster with the IRS, it would be a death blow to plans by New York, California, New Jersey, and other states to mitigate the impact of the new $10,000 cap on the federal deduction for taxes paid to state and local governments.

“It is absurd to suggest that a ‘voluntary’ contribution to a state to be used for functions that the state would pay for anyway, and that reduces the donor’s income tax liability dollar-for-dollar or close to that, would be treated as a deductible contribution under Section 170 of the Internal Revenue Code,” Faber told Bloomberg Tax in a March 20 email.

“It is a well-established principle of tax law that a transaction’s form will not be respected if its substance is otherwise, and the charitable deduction gambit represents a classic example of that principle,” he said.

In New York, Gov. Andrew M. Cuomo (D) has proposed creating two statewide charitable funds that would allow taxpayers to make contributions and get a federal tax deduction and receive a state tax credit. The funds would provide support for state education and health care programs.

Both houses of the Legislature have rejected the idea, but Cuomo will continue to push for it in budget negotiations with legislative leaders.

‘Rooted Firmly in Precedent’

Morris Peters, a spokesman for the New York State Division of the Budget, defended Cuomo’s plan in an email to Bloomberg Tax.

“Taxpayers have traditionally been able to reduce their income tax liability by taking deductions for contributions to charities and local governments, and the new federal tax law reinforced that ability by raising the limit on charitable deductions,” he said. “Our proposal builds on the expanded federal deduction by encouraging additional charitable giving. It’s not a new concept at all, it’s rooted firmly in precedent.”

Dennis J. Ventry Jr., a tax law professor at the UC Davis School of Law, said the charitable fund plans are “on totally firm ground.”

“It is absolutely legal under current court precedent, including the U.S. Supreme Court,” he told Bloomberg Tax. ''It’s also been endorsed by the IRS three different times in three different chief counsel advisory opinions.”

Ventry, who chairs the IRS Advisory Council, said there are about 100 existing charitable contribution programs in the states that result in a tax credit or tax deduction that have already passed muster with the IRS.

He said the charitable fund programs aren’t like the typical quid pro quo charitable deductions where taxpayers must net out the benefit from a contribution. “It is just the sovereign’s decision not to tax the individual for whatever the amount would have been in the absence of the contribution,” he said.

‘Flimsy’ Strategy

Faber said “there is a real question in my mind as to whether state legislators and governors should be encouraging their citizens to engage in a tax strategy that is so flimsy.”

“If the IRS successfully challenges the strategy, as seems likely, the state officials will seem ignorant at best and deliberately deceptive at worst,” he said.

Ruchelman told Bloomberg Tax that the charitable-funds idea would be “blown out of the water” for violating the IRS “economic substance” rule if it was proposed in the private sector.

Creation of the charitable funds is clearly a way to get around the 2017 tax act ( Pub. L. No. 115-97), which “tends to fall right into the definition of an abusive tax shelter,” Ruchelman said.

“Good politics doesn’t make good tax law,” he said. “I think this is simply a form of civil disobedience.”

If the credits are deemed “a transaction of interest” by the IRS, all of the related tax penalty and record-keeping rules would automatically apply, Ruchelman said.

To contact the reporter on this story: Gerald B. Silverman in Albany, N.Y., at

To contact the editor responsible for this story: Ryan C. Tuck at

Copyright © 2018 Tax Management Inc. All Rights Reserved.

Request Daily Tax Report: State