NY Local Governments Sue IRS and Treasury Secretary Mnuchin Over Unfair and Unlawful Regulations on Contributions to Charitable Funds

This in from New York State Assemblywoman Amy Paulin:

A lawsuit in federal court seeks to challenge regulations that were recently finalized by the Internal Revenue Service (IRS) and the Treasury Department that would deny a full charitable deduction for donations to the charitable funds for which states authorize tax credits, including both long-standing charitable funds and those created after the federal government severely limited the state and local tax deduction (SALT).

The case, Village of Scarsdale v. Internal Revenue Service at al., asserts that the IRS’s regulations “usurp the lawmaking function and purport to unilaterally impose the current administration’s political will in violation of clear statutory limits.” In doing so, the regulations would cause charitable reserve funds explicitly authorized under New York State law to “suffer irreparable harm.” This includes the charitable reserve funds established by the Village of Scarsdale and the Town of Rye after the SALT deduction was limited by the passage of the Federal Tax Cuts and Jobs Act of 2017 (TCJA). If successful, the lawsuit would reverse the IRS’s regulations.

Both Scarsdale and the Town of Rye are members of the Coalition for the Charitable Contribution Deduction (3CD), which consists of Nassau, Suffolk, and Westchester Counties, 17 municipalities, 17 school districts, and eight state and countywide professional and advocacy organizations.

“Starting today, we will stand up for New Yorkers already reeling from the cap on the SALT deduction by making our case in court that these regulations are arbitrary, capricious, and invalid,” said New York State Assemblymember Amy Paulin, who took the lead role in developing New York’s charitable reserve fund legislation, coordinated the coalition, and had attended the IRS’s public hearing on the proposed regulations last October. “The denial of charitable deductions for donations to charitable reserve funds disproportionately hits communities like mine. In trying to satisfy the whims of this administration without running afoul of powerful interests, the IRS regulations strayed far from the law that they were supposed to interpret. These regulations will cause real harm for villages like Scarsdale and taxpayers across the country struggling to remain in the communities they fell in love with and to send their children to the same nurturing, high-quality schools.”

“The IRS and Treasury Department have clearly exceeded their authority with these regulations. As a previously practicing tax attorney, I have confidence in the merits of this case, which is important to so many New Yorkers,” said New York State Assemblyman David Buchwald. “I applaud the work of the Village of Scarsdale, the attorneys at Baker & McKenzie LLP and the municipalities that banded together as the Coalition for the Charitable Contribution Deduction for their hard work that shows how premature it is to believe that the SALT deduction question has already been decided.”

The lawsuit was filed today in the United States District Court for the Southern District of New York. It comes on the same day as the Attorneys General of Connecticut, New Jersey, and New York filed their own lawsuit challenging the same IRS/Treasury Department regulations.

Scarsdale and the coalition assert that in preventing individuals from receiving a full federal charitable deduction for making a contribution to a charity state or municipality when that donation has been encouraged at the state or local level with a tax credit, the IRS has broken “with judicial precedents, published guidance binding on the IRS and the Treasury Department, IRS administrative pronouncements and settled taxpayer expectations.” Prior to the IRS/Treasury Department issuing their regulations, 70 active programs across 24 states already encouraged charitable contributions to various public and private programs with tax credits at the state or local level – all of which will now be denied a full charitable contribution at the federal level.

The complaint also takes aim at the complex and confusing distinctions made by the regulations in order to create carve outs and “safe harbors” for various corporate entities who also benefit from federal deductions for charitable giving and business expenses encouraged at the state level with tax credits – distinctions which “result in divergent consequences for substantively identical circumstances without any statutory authority, let alone a reasoned explanation, for doing so.”

For example, as was originally stated by Treasury Secretary Steve Mnuchin in August and confirmed in the final regulations, the disallowance of a charitable contribution deduction for an individual under the reasoning that the state or local tax credit represents a quid pro quo would not apply to any business-related payments to charities or government entities, even though any so-called benefit received by the business would be identical and serve the same purpose of creating incentives to support charities. A separate safe harbor provision would also allow C corporations to claim an “ordinary and necessary business expense” federal deduction for contributions without state or local tax credits they receive being considered quid pro quo incentives.

Even more illogical are carve outs for a very narrow set of individuals. Under the regulations, a charitable contribution encouraged by a state or local tax credit is not considered a quid pro quo if the value of the credit is 15 percent or below the value of the contribution – with no explanation for why or why that specific percentage provided either in the regulations or in the TJCA. Additionally, individuals making contributions may still claim a federal charitable deduction to a charitable fund if the value of doing so doesn’t exceed the SALT cap – mixing the apples of charitable contribution deductions with the oranges of a SALT deduction without any obvious basis in law.

The local governments that comprise 3CD had previously stated their belief that the regulations are arbitrary and capricious, and therefore invalid. Under the Administrative Procedure Act, they now ask that the regulations be found unlawful and be set aside.

Members of the Coalition for the Charitable Contribution Deduction (3CD)

Association of School Business Officials of New York
Association of Towns of the State of New York
Lower Hudson Education Coalition
New York Conference of Mayors
New York State Association of Counties
New York State Council of School Superintendents
New York State School Boards Association
Westchester Putnam School Boards Association

Nassau County
Suffolk County
Westchester County

City of New Rochelle
City of White Plains
City of Yonkers
Town of Bedford
Town of Lewisboro
Town of Mamaroneck
Town of New Castle
Town of North Salem
Town of Ossining
Town of Pelham
Town of Rye
Village of Ardsley
Village of Hastings-on-Hudson
Village of Pelham
Village of Pelham Manor
Village of Scarsdale
Village of Upper Brookville

Ardsley Union Free School District
Brewster Central School District
Briarcliff Manor Union Free School District
Byram Hills Central School District
City School District of New Rochelle
Dobbs Ferry Union Free School District
Eastchester Union Free School District
Edgemont Union Free School District
Hastings-on-Hudson Union Free School District
Katonah-Lewisboro School District
Ossining Union Free School District
Pelham Public Schools
Pleasantville Union Free School District
Pocantico Hills Central School District
Public Schools of the Tarrytowns
Scarsdale Union Free School District of the Towns of Scarsdale and Mamaroneck
White Plains City School District