Each edition of Tax Matters consists of free-flowing responses by three tax practitioners to a question regarding a current issue in tax law and policy. This issue includes an additional response. Tax Matters commentaries provide insightful perspectives on a broad range of topics, making important contributions to the dialogue within the tax bar about cutting-edge issues. Although the commentaries are certainly of interest to the academic community, they are primarily directed toward tax professionals and their clients.Tax Treatment of Charitable Contributions & State Tax Credits
Like the federal government, most states offer tax incentives for charitable giving. These incentives typically take the form of an income tax deduction, though states sometimes provide more generous tax incentives in the form of tax credits for some subset of gifts. A review of state tax codes reveals over 100 state charitable tax credits in 33 states.
As an example, 18 states provide tax credits for donations to organizations authorized by state law to provide tuition scholarships to students who attend private schools, including sectarian schools. Because these credits substantially reduce (and in some cases eliminate) the net cost of the gift to the donor, a natural question is whether the donor may claim a charitable contribution deduction on her federal income tax return and, if so, what the amount of the deduction should be. Under current law, expressed in various administrative and judicial pronouncements over the years, taxpayers may claim a deduction for the full amount of a charitable contribution, undiminished by the value of tax savings generated by making the gift. In a recent paper, we refer to this feature of current law as the Full Deduction Rule.
The recently enacted $10,000 limit on the deductibility of state and local taxes (SALT) has drawn new attention to the legal underpinnings of the Full Deduction Rule. Some have expressed concern that this rule may allow taxpayers to circumvent the limits on SALT deductibility. For example, consider a taxpayer who makes a $10,000 gift that qualifies for a 30% state tax credit, reducing her SALT liability by $3,000. If she is allowed a $10,000 deduction for this gift on her federal return, she has managed to convert $3,000 of nondeductible taxes into a deductible gift. Of course the same might be said of the federal charitable contribution deduction itself. A donor who makes a $10,000 gift is ordinarily entitled to a federal deduction for the full $10,000, despite the fact that the gift reduces her nondeductible federal income tax liability by $3,700 (for a taxpayer in the top bracket). For better or worse, the law seems to have always countenanced this implicit conversion of nondeductible taxes into deductible gifts.
Taxpayers making donations to any of the existing 100+ programs referenced above are understandably interested in knowing the federal income tax consequences of their gifts. For example, consider the “Exceptional SC Fund,” the 501(c)(3) entity established by the South Carolina legislature to receive donations to fund private school tuition scholarships for children with special needs. Assume that taxpayer Jessamine expects to owe $60,000 in South Carolina state income taxes and would like to make a gift to the Exceptional SC Fund. Under South Carolina law, Jessamine could donate $50,000 to the state fund, entitling her to a nonrefundable tax credit in the same amount when filing her state income tax return. Assuming the Full Deduction Rule applies, Jessamine’s federal return would include a $10,000 deduction for SALT paid and a $50,000 charitable contribution deduction. Is Jessamine entitled to claim a $50,000 charitable contribution deduction for her donation to the Exceptional SC Fund? If not, what is the proper treatment of her $50,000 donation?
As an extension of the example above, assume that Connecticut establishes a Bridgeport School District Fiscal Support Fund and that donors to this fund will be entitled to an 80% nonrefundable state tax credit for their donations. Assume that taxpayer Laurel makes a $10,000 gift, entitling her to an $8,000 credit on her Connecticut income tax return. May Laurel deduct the full $10,000 as a charitable contribution on her federal return? Does the answer to that question depend on the amount of Laurel’s Connecticut income tax liability determined without regard to the credit? For example, what if Laurel’s pre-credit income tax liability is $5,000, such that the $8,000 credit will reduce her 2018 liability to zero, leaving $3,000 of unused credit to be carried over to her 2019 return.
If Jessamine and Laurel are required to reduce their charitable contribution deductions by the value of the state tax credits generated by making the gifts described above, must they also reduce their deductions by the value of the federal charitable contribution deduction itself? Like state and local taxes beyond the $10,000 limit, federal income taxes are nondeductible. If the Full Deduction Rule is to be rejected in the context of state/local charitable tax incentives (to prevent taxpayers from converting nondeductible SALT to deductible gifts), should it also be rejected in the context of the federal charitable tax incentive (to prevent taxpayers from converting nondeductible federal taxes to deductible gifts)? If so, how would this work?
Finally, if some sort of federal action is appropriate to clarify or modify the tax consequences of gifts to these programs, what form should that federal action take? Should the IRS issue a notice along the lines of its December 2017 notice regarding prepayment of property taxes? Given extant law and guidance, could the IRS change its position substantially via such a notice? Should the Treasury Department initiate notice and comment procedures to promulgate new regulations? And again, what changes are possible through regulation, given existing law? Should Congress change the law? If so, how?
By Kirk J. Stark, Barrall Family Professor of Tax Law and Policy, UCLA School of Law. The author would like to thank Darien Shanske for valuable comments on a prior version of this prompt.
 See Appendix A in Joseph Bankman et al., Federal Income Tax Treatment of Charitable Contributions Entitling Donor to a State Tax Credit 22-44 (UCLA Sch. of Law, Law-Econ. Research Paper Series No. 18-02, Feb. 26 2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3098291 [https://perma.cc/4JPG-R9GE].
 For a summary of these programs, see School Choice in America Dashboard, EdChoice (Jan. 18, 2016), https://www.edchoice.org/school-choice/school-choice-in-america/# [https://perma.cc/264D-8USJ]. Among the states that provide this type of tax credit, several provide donors with a 100% tax credit for qualifying gifts — including Alabama, Arizona, Georgia, and South Carolina. Other states offer somewhat less generous tuition scholarship tax credits—e.g., Oklahoma (75%), Virginia (65%), Iowa (65%), and Indiana (50%). Some of these school tuition tax credits feature per donor limits, while others do not.
 See Bankman et al., supra note 1.
 Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 11042, 131 Stat. 2054 (amending I.R.C. § 164(b) to limit deduction for state and local taxes for taxable years 2018-2025).
 Of course, the millions of taxpayers subject to the AMT before the passage of the new tax law were already in the situation where it would be advantageous to increase the deductible charitable contribution and reduce their non-deductible state and local taxes.
 The formal name of the Exceptional SC Fund is the South Carolina Educational Credits for Exceptional Needs Children Fund. The Fund is governed by five directors, two of whom are appointed by Chairman of the South Carolina House Ways and Means Committee, two by the Chairman of the South Carolina Senate Finance Committee, and one appointed by the Governor.
 According to the Education Law Center, Bridgeport School District in Connecticut is one of “the most fiscally disadvantaged districts in the country.” Bruce Baker et al., Is School Funding Fair? America’s Most Fiscally Disadvantaged School Districts 4 (2016)
 I.R.C. § 275(a)(1).
The Ways of Paradox: What Renders a Contribution Deductible?
In his prompt, Professor Stark serves up a most ingenious paradox: if a charitable contribution must be disinterested to qualify for the federal charitable deduction, which confers a tax benefit, does not the very act of claiming the deduction render the claimant ineligible for it? Groucho Marx did not care to belong to any club that would have him as a member; the charitable deduction, in turn, is transformed into the deduction which will not countenance any contribution it deems eligible.
Clearly, this is neither the intent nor the reality of the charitable deduction, nor does Professor Stark suppose it to be. But even nonsense can be suggestive, so might the seeming paradox aid us in unraveling the entwined threads of Internal Revenue Code provisions, Treasury regulations, case law, Internal Revenue Service (IRS) guidance, and actual practice? Might it help clarify whether state legislative proposals enabling taxpayers to recharacterize state tax payments as charitable contributions differ in essence or merely in magnitude from existing state tax credits, or indeed whether the current treatment of those incentivized contributions is legally justified?
Proponents of federal tax reform expressed optimism that changes to the tax code would spark innovation. If legislative innovation counts, the new law is already an unqualified success, with states actively pursuing multiple strategies to enable their residents to avoid the law’s $10,000 limit on the deductibility of state and local taxes (SALT). Under one approach developed by Professor Stark and others, taxpayers would be permitted to make voluntary charitable contributions to a governmental fund then take that amount as a credit against state taxes. State tax liability, nondeductible above the cap, is converted into a deductible charitable contribution, essentially preserving the full value of the deduction for eligible taxpayers.
Critics have dismissed this as little more than a recharacterization which would be regarded by the IRS as the satisfaction of tax liability, not charity. Against this, Professor Stark offers his paradox, along with the evidence of more than one hundred state tax credits for contributions to scholarship organizations, free clinics, food pantries, and other charities, all of which undeniably reduce (and occasionally even eliminate) the net cost of the gift to the donor, and none of which have been interpreted to limit the amount of the contribution eligible for the federal deduction. How can the aforementioned legal constraints be reconciled with the practice of countless taxpayers who have claimed the charitable deduction for contributions favored by state credits?II. General Requirements
Both private nonprofits and governmental entities are qualifying organizations for purposes of the charitable deduction, but contributions to government are only deductible if the contribution “is solely for public purposes (for example, a gift to reduce the public debt or maintain a public park).” The requirement that contributions have a charitable aspect creates an immediate obstacle to contribution-in-lieu-of-taxes proposals, as such contributions serve little or no public purpose (a 100% credit has no net effect on state revenue) and are primarily intended to benefit the donor, not the recipient.
U.S. Treasury regulations also prohibit claiming contributions from which the donor benefits, at least to the extent of that benefit. If one purchases a $250 ticket to a benefit dinner, and the fair market value of the dinner is $50, then only $200 can be deducted. In Professor Stark’s scenario, arguably the personal benefit of Laurel’s $10,000 contribution is the $8,000 credit she received against Connecticut tax liability, making $2,000 the most she could deduct for federal tax purposes, undermining the intent of the credit.
Furthermore, the Internal Revenue Code stipulates that if a liability is assumed by the recipient as the result of a charitable contribution, the deductible value of the charitable contribution is reduced by the amount of that liability. Even neglecting the limitations discussed above, the liability undertaken by the state—in the form of a tax credit—could provide the basis for disallowing the deduction.
Extant case law creates further barriers to such strategies. In Singer Company v. United States, the U.S. Court of Claims ruled that a payment of money generally cannot constitute a charitable contribution if the contributor expects a substantial benefit in return. Similarly, the U.S. Supreme Court has held that when a charitable contribution has a dual character, a “taxpayer… must at a minimum demonstrate that he purposely contributed money or property in excess of the value of any benefit he received in return” for any portion of the contribution to be deductible. These holdings could disallow Laurel’s entire deduction, not just limit it to $2,000.
Still worse for Laurel’s chances, IRS regulations in a matter regarding personal property taxes provide that “[a] tax may be considered to be imposed in respect of personal property even if in form it is imposed on the exercise of a privilege,” while an appellate case spells out the rule more generally: “whether a particular contribution or charge is to be regarded as a tax depends upon its real nature.” The IRS would be well within its authority to determine, consistent with the doctrine of substance over form, that the payment, though recharacterized as a charitable contribution, is nothing more than satisfaction of tax liability.III. The Charitable Tax Credit Conundrum
In Professor Stark’s other scenario, Jessamine contributes $50,000 to a scholarship organization, which funds private school tuition scholarships for children with special needs. She receives a dollar-for-dollar credit against her state income tax liability for this contribution, then claims a $50,000 deduction against federal tax liability, with the seemingly perverse result that her financial position is enhanced by her contribution. This anomalous outcome is consistent with the intent of SALT deduction avoidance proposals, in which contributions yield an increase in the donor’s after-tax income, and seems at odds with the legal determinants of a qualifying charitable contribution. Here, then, is another paradox.
Is the IRS’s current permissive treatment of Jessamine’s contribution mistaken, and can it be distinguished from the contributions-in-lieu-of-taxes proposals emerging in California, New Jersey, and other states?
Paradox has been defined as “truth standing on her head to attract attention,” and such an outcome succeeds by that measure. Most observers are likely to rankle at the notion that a financial transaction to one’s advantage is considered an act of charity; it fails to accord with what Professor Stark has termed “the common-sense notion that a charitable gift entails parting with something of value.” In 2013, he called attention to possible arbitrage opportunities, though their potential benefit was much attenuated prior to the limitation of the SALT deduction.
It is possible that the IRS has been too lenient with existing charitable credits and that the amount claimed for purposes of the federal tax deduction should be prorated based on the generosity of the state benefit. The IRS has diligently avoided issuing formal guidance on this matter, though full deductions have been permitted in practice. For our purposes, however, it is enough if these programs can be distinguished from those expressly designed to facilitate a reduction in the donor’s federal tax liability.
The existing tax credits to which proposed SALT deduction limitation avoidance credits are often analogized almost exclusively incentivize contributions made not to the state but to private charities. They do reduce state tax liability, often quite significantly, but they do so by leaving the state treasury worse off rather than making it whole. By contrast, contributions-in-lieu-of-taxes proposals are designed to leave governmental revenues unchanged. Contributions to 501(c)(3) organizations, however heavily subsidized by state governments, benefit the recipient, thus meeting one key test of a charitable contribution. Conversely, contributions to governmental entities that are offset by a corresponding tax credit do not benefit the recipient, or do so only at the margin (where the credit is less than 100%). The former involves the state forgoing revenue to promote a charitable cause; the latter involves only the recharacterization of a payment already being made.
Relatedly, when governments provide a tax credit for contributions to private charity, the liability (in the form of the credit), while substantial, is not incurred by the recipient (the charity). The same cannot be said when the government is also the recipient.
An IRS memorandum on state charitable tax credits notes that state tax benefits are generally treated as a reduction in state tax liability reflected in a reduced SALT deduction. This memo, while nonprecedential, is often cited by proponents of SALT deduction cap workarounds, as it tacitly permits many of the extant credit programs. However, the logic of the memo is predicated on the notion that recharacterization has little or no impact on federal liability, a supposition which no longer holds.
The memo also sets out several guardrails, noting that “[a] transfer is not made with charitable intent if the transferor expects a direct or indirect return benefit commensurate with the amount of the transfer,” and that “[i]f the benefits expected to be received by a donor are substantial (that is, greater than those incidental benefits that inure to the general public from transfers for charitable purposes), then the transferor has received a quid pro quo sufficient to remove the transfer from the realm of deductibility.” The memo even posits that “there may be unusual circumstances in which it would be appropriate to recharacterize a payment of cash or property that was, in form, a charitable contribution as, in substance, a satisfaction of tax liability.” If contributions-in-lieu-of-taxes do not constitute such circumstances, it is difficult to imagine what would.
Finally, while the act of claiming the federal deduction may be inherently in tension with the idea of a completely disinterested charitable contribution, this cannot allow the many limitations with which the deduction is fenced to become a dead letter. There can be no question that the deduction is intended to incentivize and reward charitable giving and that this tax preference does not sufficiently encumber the contribution as to render it ineligible. Perhaps it is this same line of thought which has kept the IRS from adopting more stringent rules about state tax credits incentivizing charitable activity. A measure of permissiveness does not require a total indifference to whether a contribution exhibits anything approaching a charitable aspect.IV. Conclusion
For the laws, regulations, and case law around eligible charitable contributions to have any meaning, they cannot countenance contributions expressly devised to reduce tax liability, with little or no benefit inuring to the recipient. To permit a deduction would not be to play at paradox but to make existing requirements a nonsense.
The Internal Revenue Code requires no such outcome. “A charitable contribution,” it specifies, “shall be allowable as a deduction only if verified under regulations prescribed by the Secretary.” Existing law, regulations, and case law provide ample grounds to disallow contributions so frankly proffered as tax avoidance schemes. Issuance of a notice clarifying these restrictions would be appropriate and consistent with current law and regulation. The federal government is under no obligation to affirm tax avoidance schemes which rely on an inversion of the plain meaning of charitable giving.
 Gilbert K. Chesterton, Two Kinds of Paradox, in The Collected Works of G. K. Chesterton XXIX (1911-1913), 51-54 (Lawrence J. Clipper ed., Ignatius Press 1988).
 See Joseph Bankman et al., Deduct This: How States Can Undo One of the Most Potentially Destructive Elements of the Republican Tax Law, Slate (Jan. 11, 2018), https://slate.com/news-and-politics/2018/01/how-states-can-undo-one-of-the-most-potentially-destructive-elements-of-the-new-tax-law.html.
 See Joseph Bankman et al., Federal Income Tax Treatment of Charitable Contributions Entitling Donor to a State Tax Credit (UCLA School of Law, Law-Econ. Research Paper No. 18-02, Feb. 26 2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3098291 [https://perma.cc/4JPG-R9GE].
 Specifically, those regulations stipulate that “[n]o part of a payment that a taxpayer makes to or for the use of an organization described in section 170(c) that is in consideration for … goods or services … is a contribution or gift within the meaning of section 170(c) unless the taxpayer — (i) Intends to make a payment in an amount that exceeds the fair market value of the goods or services; and (ii) Makes a payment in an amount that exceeds the fair market value of the goods or services.” Treas. Reg. §26 CFR 1.170A-1(h).
 I.R.C. § 170(f)(5).
 The Singer Co. v. U. S., 449 F.2d 413 (Ct. Cl. 1971).
 U. S. v. Am. Bar Endowment, 477 U.S. 105, 118 (1986).
 Treas. Reg. § 1.164-3(a)(3).
 Campbell v. Davenport, 362 F.2d 624, 628 (5th Cir. 1966).
 Gregory v. Helvering, 293 U.S. 465 (1935).
 For further discussion, see Jared Walczak, State Strategies to Preserve SALT Deductions for High-Income Taxpayers: Will They Work?, Tax Found. (Jan. 5, 2018), https://taxfoundation.org/state-strategies-preserve-state-and-local-tax-deduction/[https://perma.cc/85P6-K2KY].
 G.K. Chesterton, The Paradoxes of Mr Pond 41 (House of Stratus 2008).
 I.R.S. Chief Counsel Advice, 2011-05-010 (released Feb. 4, 2011), https://www.irs.gov/pub/irs-wd/1105010.pdf [https://perma.cc/9UAE-UEXG] (“In both instances we did not resolve the issue, but instead suggested that the issue could be addressed in official published guidance. At this time, published guidance on the issue is not contemplated.”).
 I.R.C. § 170(a).
Comment on Professor Stark’s Prompt
Professor Stark and other economists and academics have drafted a long paper arguing that the charitable contribution/credit mechanism would get around the disallowance of a deduction for state and local taxes. I disagree, and I suspect that the Treasury Department disagrees as well.
The authors rely on an IRS Chief Counsel Advice from 2011, but that memorandum is not precedential and does not necessarily state the IRS’s official position. Indeed, the CCA specifically indicates that the Service did not contemplate issuing published guidance and it acknowledges that there may be circumstances in which a contribution to a state that is creditable against the state income tax may be viewed as a payment of tax and not as a charitable contribution.
Could anyone, including Professor Stark and the other authors of the paper, seriously contend that a direct payment to a state’s general fund that reduced the person’s state income tax liability dollar-for-dollar could be viewed as anything other than an advance payment of tax? It would not be “voluntary” in any sense of the word and it is well-established that a contribution to a charity must be voluntary to be deductible. Making the credit less than 100% would not make the contribution more voluntary, and thus would not change the result. Bills using this approach have been introduced in California and Illinois. They won’t work.
Professor Stark’s “Full Deduction Rule” does not help the situation. It is well-established that the fact that a voluntary charitable deduction produces tax benefits does not make it less of a voluntary contribution. That is not the same as saying that a “contribution” to, or for the benefit of, a government agency that reduces one’s personal income tax liability dollar-for-dollar (or close to that) should be treated as a voluntary contribution. In the latter situation, the taxpayer has paid an amount to finance a state function and would be in exactly the same position as he or she would be in if the amount was paid as taxes for which the taxpayer would otherwise have been liable.
Would a payment to a special state fund that was used to finance a specific state function that depended for its funding on similar contributions be viewed as a payment of tax? If a state fund was established to pay the salaries of state legislators and the state made up the difference if contributions to the fund were not sufficient to pay all of the salaries, I could not imagine that this would be viewed as anything other than a payment of tax. Money is fungible and the state is going to spend the same amount of money on the salaries of its legislators regardless of whether part of the money is provided by contributions from the public and the state makes up any deficit in its obligation to the legislators from its general funds.
The technique might work if contributions were made to a special fund for a particular purpose and that purpose was financed entirely by such contributions, or with a contribution from state funds that was equal to a percentage of the contributions received from the public, so that the ability of the state to carry out that function would be limited by the extent to which the public contributed to the special fund. That might conceivably work, but this is not what Professor Stark discusses. He is talking about using “voluntary” contributions to finance functions that the state would perform regardless of whether it received such contributions and that the state would finance by making up any deficit if the contributions were not sufficient to finance the function. For example, if New York State set up a special fund to finance the creation of a public park in the City of Rochester and the creation of the park was financed entirely by contributions and would not happen if the contributions to the fund were insufficient to pay for the project, contributions to the fund might be viewed as charitable contributions. But if New York State decided to create the park and would make up any deficit in the funds if voluntary contributions were insufficient to pay for the project, this would not work.
It is true that many programs designed to support private schools and other non-governmental activities that credit contributions against state income tax have received non-precedential IRS approval in private letter rulings, but these situations are different from those in which the “contributions” are made to support essential government functions. The South Carolina program discussed by Professor Stark seems to fall into the category of a fund that is used to finance projects that the state would not itself finance. Such a program is not the same thing as a program designed to pay the salaries of teachers in the public schools. I have not surveyed all of the programs that have received favorable private letter rulings from the Internal Revenue Service but I suspect that most, and, perhaps, all of them are similar in that they are not used to provide funding for programs that the states would fund in full absent private support. Moreover, the IRS rulings were not issued in the context of a systematic attack by a number of states against a clearly prescribed Congressional policy. The IRS might well take a different view in 2018.
The 2011 Chief Counsel Advice memorandum on which Professor Stark’s paper relies is not precedential and it does not discuss the facts presented in any detail. Revenue Ruling 79-315, also cited in the paper as authority for the Full Deduction Rule, involved an income tax rebate that was not paid in consideration for contributions or any other activity. It simply represented a state tax reduction.
It is unlikely that contributions to a separate 501(c)(3) organization that was required to turn the money over to the state (or that it was understood by all to be expected to do that) would be treated differently; the organization would be treated as a conduit which would be ignored, or as an agent of the state.
Practically speaking, I doubt that the IRS would endorse the contribution credit concept proposed in Professor Stark’s prompt. The few authorities that exist do not involve a systematic effort by many states to evade a federal policy that is reflected in an unambiguous statute. I sympathize with the people who are trying to assist the states in mitigating the effects of the federal disallowance of SALT deductions, and, in fact, I have been working with the tax authorities in New York State, New York City, and New Jersey on a pro bono basis toward that end. In addition, I am chairing an American Bar Association Tax Section task force that will be providing guidance to state revenue departments and legislatures about responses to the Tax Cuts and Jobs Act. But the law is what it is and any attempt to mitigate its effects must pass muster under established principles of the common law of taxation.
Professor Stark and his colleagues have made a valuable contribution to the discussion and I do not mean to be critical of them, but the position for which they advocate flies in the face of the well-accepted doctrine in tax law that the substance of an arrangement prevails over its form, and I do not think that their arguments will carry the day with the IRS or the courts.
 Joseph Bankman et al., Federal Income Tax Treatment of Charitable Contributions Entitling Donor to a State Tax Credit (UCLA Sch. of Law, Law & Econ. Research Paper Series No. 18-02, 2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3098291 [https://perma.cc/4JPG-R9GE].
 I.R.S. Chief Counsel Advice, 2011-05-010 (released Feb. 4, 2011), https://www.irs.gov/pub/irs-wd/1105010.pdf [https://perma.cc/9UAE-UEXG].
 Rev. Rul. 79-315, 1979-2 CB 27.
 Gregory v. Helvering, 293 U.S. 465 (1935).