The Post-Chevron Quid-Pro-Quo Doctrine: Second Circuit Affirms IRS Power to Net State Tax Credits against § 170 Charitable Deductions

Introduction

The consolidated appeal New Jersey v. Bessent; Village of Scarsdale v. IRS, decided by the U.S. Court of Appeals for the Second Circuit on 13 August 2025, squarely confronted a high-stakes clash between state efforts to blunt the 2017 federal cap on state-and-local-tax (“SALT”) deductions and the Internal Revenue Service’s (“IRS”) attempt to prevent what it regarded as a circumvention of congressional intent.

Three states (New Jersey, New York, Connecticut) and one locality (the Village of Scarsdale, NY) created “work-around” charitable funds: residents could donate to the funds, receive an 85-95 % state or local tax credit, and then claim the entire transfer as a federal charitable deduction under 26 U.S.C. § 170. The IRS responded with a 2019 regulation (“the Final Rule”) requiring taxpayers to reduce any federal § 170 deduction by the amount of any state or local tax credit that the donor “receives or expects to receive.”

After the district court upheld the rule (relying on Chevron deference), the Supreme Court’s 2024 decision in Loper Bright Enterprises v. Raimondo overruled Chevron, forcing the Second Circuit to revisit the regulation without agency deference. The court ultimately affirmed the IRS, establishing the first published appellate application of Loper Bright to a tax regulation and cementing a modern, judicially driven “quid-pro-quo” doctrine under § 170.

Summary of the Judgment

Standing: New York and Scarsdale had Article III standing because the Final Rule demonstrably reduced contributions (and therefore revenue) to their charitable funds. One plaintiff’s standing sufficed for all appellants.
Anti-Injunction Act (“AIA”): The suit was not barred. Under South Carolina v. Regan and New York v. Yellen, states lacking any alternative remedial pathway may seek injunctive relief despite § 7421(a).
Merits – Statutory Authority: Applying Loper Bright, the court independently construed § 170. Relying on a long-standing “quid pro quo” principle, it held the IRS correctly treated state tax credits as a return benefit that must net against the federal deduction. The court distinguished credits (a dollar-for-dollar benefit) from deductions (benefit depends on marginal rate) and upheld the 15 % de minimis exception.
Merits – Arbitrary & Capricious: The rule survived APA review: the IRS explained the credit/deduction distinction, revenue impact, and administrative feasibility; justified the 15 % cliff; and adequately acknowledged departure from a non-precedential 2010 Chief Counsel Advice.
Disposition: Judgment of the Southern District of New York affirmed.

Analysis

1. Precedents Cited and Their Influence

Loper Bright Enterprises v. Raimondo (2024): Abolished Chevron deference. The Second Circuit became one of the first courts to operationalise the new directive: courts must use “every interpretive tool” and owe no legal deference to agency statutory constructions.
Chevron U.S.A. Inc. v. NRDC (1984): Former two-step deference test repudiated. The district court had relied on it; the Circuit could not.
South Carolina v. Regan (1984) & New York v. Yellen (2d Cir. 2021): Established the “no alternative remedy” exception to the AIA. Crucial for justiciability here.
Quid-pro-quo line of cases:
- United States v. American Bar Endowment (1986)
- Hernandez v. Commissioner (1989)
- Scheidelman v. Commissioner (2d Cir. 2012)
- Rolfs v. Commissioner (7th Cir. 2012)
These decisions articulate that a § 170 “charitable contribution” must be unrequited; any substantial benefit to the donor negates deductibility except to the extent the gift exceeds the quid pro quo. The Second Circuit extended the doctrine to government-granted tax credits.
Encino Motorcars v. Navarro (2016): Agency must acknowledge policy change and give good reasons – cited in the arbitrary-and-capricious analysis.

2. Court’s Legal Reasoning

Textual Baseline: § 170(c)(1) permits deductions for gifts “to or for the use of a State…if made for exclusively public purposes.” The statute does not define “contribution” or “gift,” so the court looked to judicial gloss.
Quid-Pro-Quo Lens: Earlier cases require that payments ≠ deductible gifts when the donor receives a “specific, measurable return.” A state tax credit, unlike an ordinary deduction, is dollar-for-dollar and therefore a “substantial benefit.”
Differentiating Credits from Deductions:
- Credits reduce liability directly; deductions reduce income and have variable value.
- Congress allows donors to claim both state and federal deductions without nullifying the gift (otherwise § 170(c)(1) itself would be internally contradictory).
- No analogous statutory signal exists for credits; therefore the quid-pro-quo bar applies.
15 % Safe Harbour: IRS pegged the threshold to the highest combined state and local marginal tax rates (~15 %). Below that, credits mirror the tax value of an ordinary deduction; above it, credits confer outsized, quid-pro-quo value.
Policy-Change Justification: The IRS candidly rejected its 2010 Chief Counsel Advice because it pre-dated the SALT cap and failed to address credit-driven circumvention. Acknowledgment satisfied Encino.

3. Likely Impact

State SALT Workarounds: Any program that pairs large state tax credits with “charitable” transfers is effectively neutralised. States must redesign incentives (e.g., pure deductions or low-percentage credits).
Administrative Law: The case illustrates that post-Loper Bright courts will often reach the same substantive outcome but through independent interpretation. Agencies must now fortify regulations with deep textual and historical analysis rather than rely on Chevron.
Tax Planning & Non-profits: Donors seeking federal deductibility must scrutinise any state or local benefit they obtain. Universities, hospitals, and foundations administering state-incentivised giving programs may need to warn donors about federal limitations.
Potential Supreme Court Review: Because the decision cements an expansive reading of the quid-pro-quo doctrine and applies the brand-new Loper Bright regime, other Circuits may diverge, setting the stage for further high-court clarification.
Revenue Effects: The ruling protects federal revenue by ensuring the SALT cap cannot be sidestepped via charitable-credit schemes. States lose a potential fiscal tool but keep flexibility to offer smaller credits or deductions.

Complex Concepts Simplified

Tax Credit vs. Tax Deduction: A credit directly reduces the amount of tax owed ($1 credit = $1 less tax). A deduction reduces taxable income; its value equals the deduction multiplied by one’s marginal rate.
Quid Pro Quo Principle: Under § 170, a contribution is not deductible to the extent the donor receives something of substantial value in return. You may deduct only the part that exceeds what you got back.
Chevron Deference: Former doctrine requiring courts to defer to reasonable agency interpretations of ambiguous statutes. Overruled in 2024 (Loper Bright).
Loper Bright Standard: Courts now decide statutory meaning de novo. Agency reasoning may persuade (Skidmore weight) but never controls.
Anti-Injunction Act (26 U.S.C. § 7421(a)): Bars suits to restrain assessment or collection of tax. Exception: a plaintiff with no alternative legal avenue (Regan) may sue.
Arbitrary and Capricious Review: APA standard asking whether the agency examined relevant data and articulated a rational connection between facts and decision. Deferential: courts cannot substitute their policy judgment.

Conclusion

The Second Circuit’s decision marks a pivotal post-Chevron moment in tax and administrative law. By independently construing § 170 through the lens of the longstanding quid-pro-quo doctrine, the court validated the IRS’s effort to stop SALT-cap end-runs while providing a roadmap for future statutory interpretation without deference. States must recalibrate charitable-credit programs, and agencies must prepare for searching judicial scrutiny of their statutory readings. Ultimately, New Jersey v. Bessent exemplifies continuity amid doctrinal change: even as Chevron falls, principled, text-focused analysis can still sustain robust federal regulation.