Partnerships and S Corporations May Not Deduct Certain Charitable Contributions

The IRS recently issued proposed regulations regarding the “Disallowance Rule” for partnerships and S corporations making qualified conservation contributions (“QCC”) after December 29, 2022. Under the Disallowance Rule, a partnership and an S corporation making a QCC cannot claim a charitable contribution deduction if it exceeds 2.5 times the sum of each partner’s or shareholder’s relevant basis. Partnerships and S corporations planning to make a QCC in the future should pay close attention to these regulations to determine whether their contributions will be deductible for federal income tax purposes. In addition, the proposed regulations update the substantiation and reporting rules for certain charitable contributions.

Background

A QCC is a charitable donation of a qualified real property interest to an eligible organization exclusively for conservation purposes. A donor who makes a QCC can claim a charitable contribution deduction for the property’s fair market value transferred to the charity. Some promoters of conservative contributions see this as an opportunity to obtain a significant tax deduction by grossly inflating the value of the contributed property. In an abusive arrangement, investors can claim charitable contribution deductions that significantly exceed the amount of their investments. For this reason, the IRS has identified these types of deductions as having a high potential for abuse, especially in the complex structure of partnerships and S corporations. Congress responded by passing a new law that limits the amount of deduction for conservation contributions made by a partnership or S corporation. If the contribution amount exceeds 2.5 times the sum of each partner’s relevant basis in the partnership or shareholder’s relevant basis in the S corporation, then the deduction is not allowed. This new law is known as the “Disallowance Rule” for partnerships and S corporations.

Key Highlights

1. The Disallowance Rule does not apply to:
   1. Family partnerships and S corporations
   2. Contribution made outside a three-year holding period
   3. Contribution having a principal purpose of preserving a certified historic building
2. The proposed regulations introduce new modified basis calculations for contributing partnerships and S corporations, the upper tier entity, and the ultimate person receiving the allocation of such contribution.
3. The Disallowance Rule is applied to each tier unless and until the test is failed (ex., the contribution exceeds 2.5 times the relevant basis). When a tier fails the test, that tier and all subsequent upper tiers (including the individual partners or shareholders) are deemed to fail.
4. For certain qualified conservation contributions made by a partnership or an S corporation, the sum of each ultimate member’s relevant bases must be reported on Form 8283 (Section B). In addition:
   1. An upper-tier partnership’s or S corporation’s separate Form 8283 must include the sum of each of its ultimate member’s relevant bases.
   2. The ultimate partners or shareholders receiving the allocation of such contribution must also file a separate Form 8283 to report their relevant basis with respect to the contribution.
5. For Form 8283, phrases like “available upon request,” “provided upon request,” and any other nonresponsive information other than the information requested is not permitted. If a taxpayer is asked to provide an amount, they must include the number in the designated box or provide an explanation as to why they cannot do so.
6. The partner or shareholder must attach its separate Form 8283 to the return on which the contribution is claimed in addition to the copy of the donor’s Form 8283 as well as other Form 8283s that the partner or shareholder received. This new requirement would apply to all noncash charitable contributions over $500 made by a partnership or an S corporation, not just those for conservation easements.
7. A QCC (both disallowed and allowed) is an extraordinary item that must be reported separately on the k1.

The IRS is seeking comments on the proposed regulations, and a public hearing is scheduled for Jan. 3, 2024. Marcum will closely monitor this matter. If you have questions, please contact your Marcum advisor today.