IRS Provides Additional Clarity Regarding Donations to Scholarship Granting Organizations

SALT Alert: Alabama Edition

Client Alert

Author(s) , Jack H. Pouchert (Law Clerk)

On December 16, the Internal Revenue Service (IRS) and the Treasury Department issued proposed regulations (available here) that provide some good news and needed clarification for C corporations, individuals, and S corporations and other pass-through entities classified as partnerships (PTEs) that made or are considering a year-end donation to a qualified scholarship granting organization (SGO) or other exempt organization that results in both a deductible payment and a tax credit. These proposed regulations are the latest in the ongoing tug-of-war between the IRS and certain congressmen and state lawmakers, as described in our previous SALT Alerts on the topic (available here and here). Generally, the proposed regulations confirm the helpful guidance offered by the IRS in Revenue Procedure 2019-12 and Notice 2019-12, issued December 28, 2018.  The “codification” of this guidance in regulations, with strong reliance language, will provide a higher level of assurance that C corporations, PTEs, and certain individuals are permitted to take federal income tax deductions for certain contributions to SGOs such as our client, the Alabama Opportunity Scholarship Fund (AOSF), despite the receipt of a state tax credit in return for the donation.  The proposed regulations also provide needed clarity regarding the availability of a deduction for donations by PTEs that are not “specified” PTEs.

Safe Harbor for C Corporations and “Specified” PTEs:

The proposed regulations include safe harbors for donations by C corporations and “specified” PTEs, in largely the same manner the safe harbors were announced in Rev. Proc. 2019-12.  These safe harbors provide that the receipt of a state or local tax credit that reduces a state or local tax imposed directly on the entity may be treated as meeting the requirements of an ordinary and necessary business expense for purposes of IRC Section 162 to the extent of the credit received or expected to be received. In other words, for payments falling within the safe harbor, the receipt of the tax credit is itself the “business reason” for the payment for purposes of Section 162. For donations by C corporations, this provides a readily available safe harbor for deductions in connection with payments to SGOs that also result in the receipt of a state income tax credit.

For PTEs, however, the safe harbor was and will only be useful in limited circumstances. The proposed regulations include requirements for a PTE to be a “specified” PTE, most notably that the entity itself must be subject to a state or local tax incurred in carrying on its trade or business, and the credit received by the entity must offset that tax (e.g., an excise, sales or ad valorem property tax). Additionally, the safe harbor doesn’t apply if the credit received or expected to be received reduces a state or local income tax. Because of these restrictions, the safe harbor was and is of limited benefit for PTEs, and in the case of Alabama and a number of other states, that grant only an income tax credit for donations to SGOs or similar organizations, not helpful at all to the individual owners of the PTE. 

Deduction by PTEs Outside the Safe Harbor:

For payments by businesses that don’t meet the requirements of the safe harbor (for example, PTE donors in states such as Alabama), the proposed regulations offer an additional path. In order to claim a Section 162 business expense for the donation, the proposed regulations impose a somewhat stricter requirement that the payment “bears a direct relationship to the taxpayer’s trade or business and [is] made with a reasonable expectation of financial return commensurate with the amount of the payment or transfer.”   

The proposed regulations provide a helpful example that demonstrates how this requirement may be met.  Example 2 of § 1.162-15(a)(2) of the proposed regulations, describes a situation in which a partnership may take a deduction under Section 162 without meeting the safe harbor.  The example describes a scenario in which the partnership “P” operates a chain of supermarkets and sponsors a program in which it donates a percentage of its annual sales to local charities. P advertises the program and reasonably believes that the program will generate a significant degree of name recognition and goodwill in the communities where it operates (thereby increasing its revenue). The example provides that the partnership may treat its payments to such charities as an expense of carrying on a trade or business under Section 162, even if the partnership expects to receive an income tax credit that it will, in turn, pass through to its partners.

In contrast to the safe harbor for “specified” PTEs, Example 2 shows that partnerships, LLCs and other PTEs may be able to claim a federal tax deduction under Section 162 despite the receipt of a state income tax credit in connection with the payment. This example provides a reasonable basis for PTEs and their advisors to develop new planning ideas with respect to donations to SGOs or similar organizations and should encourage PTEs, and indirectly their partners to make qualifying donations to SGOs before year-end.

These year-end donations are much needed by Alabama’s SGOs, as described by Julie Emory-Johnson, Executive Director of Alabama Opportunity Scholarship Fund:

“Alabama Opportunity Scholarship Fund provides scholarships for over 1,400 students across Alabama who otherwise wouldn’t have the opportunity to go to the school that best meets their needs. Unfortunately, due to the delay in clarity of the tax regulations, tax-credit donations have been stunted, putting these children’s scholarships at risk. There is a critical need to raise these funds before the 2019 window to reserve credits closes on December 31st. Hopefully, getting the word out about the clarified regulations that expand benefits to PTE will help us meet our goal.”

Alabama Opportunity Scholarship Fund will be hosting a conference call on Friday, December 20th at 11:00am Central time to discuss the new regulations with Alabama taxpayers and their advisors. To listen to this call, please let Brian Robbins know that you would like to join the call by emailing


Though the proposed regulations are not finalized, they provide that taxpayers may nevertheless rely on them for payments and transfers to certain exempt organizations made on or after January 1, 2018, and up to the date the regs are finalized and published in the Federal Register.  Of course, there are limitations on the amount of the tax credit that can be claimed by the owners, and prospective donors and their owners should consult their own tax advisors first.

If you have any questions regarding this Alert, feel free to contact Bruce Ely ( or Brian Robbins ( and feel free to share this Alert with your own tax adviser. Thanks to our law clerk, Jack Pouchert, a 3L at Cumberland School of Law here in Birmingham and a member of its Law Review Editorial Board, for his assistance in preparing this newsletter.