Too Good to Be True? How State Charitable Tax Credits Could Increase Federal Funding for California

Abstract

An IRS chief counsel memorandum published in 2010 found that a taxpayer was permitted to claim a charitable contribution deduction for the full amount of a gift, even thought a substantial portion of the gift was effectively refunded to the taxpayer through a charitable state tax credit. In this article, Blackman and Stark explain that the IRS memorandum permits states to adopt charitable tax credits that effectively enable taxpayers to convert state taxes to charitable gifts — a strategy that would be attractive to alternative minimum taxpayers. Those state charitable tax credits (some with extraordinarily high credit percentages) appear to be on the rise, perhaps in part because they effectively enable a transfer of revenue from the federal government to the states. The authors believe the memorandum should be repudiated (as a matter of appropriate federal tax policy), but if it is not, states should consider taking advantage of it. The article discusses how the strategy applies in the case of proposed California legislation that would permit a 60 percent tax credit for contributions to a state fund designed to increase financial support for low- and middle-income students to pursue secondary education.

Keywords: charitable contributions, state tax credit, state charitable tax credits, federal revenue, financial support for secondary education