By: Ashley Menders
As if the Tax Cuts and Jobs Act (TCJA) changes to state and local taxes were not enough, the IRS further sought to reduce tax benefits from new and existing workarounds by focusing on charitable contributions that qualify to receive state or local tax credits. Pennsylvania’s popular pre-TCJA program, the Educational Improvement Tax Credit (EITC), is affected by this new IRS regulation. Despite this, many support the program as it still provides cash flow and tax planning benefits in your charitable planning. Today, we discuss what to consider when deciding if you should participate in the PA EITC program.
The PA EITC program, established in 2001, offers businesses and individuals a credit to lower their tax liability through donations to K-12 private schools, scholarship organizations, pre-K programs, and other educational enrichment initiatives. When it launched in 2001, it had an original budget of $30 million. In 2019 the budget grew to $185 million.
Those approved by the program can receive a credit of up to 75 percent of the contribution made in a one-year commitment or up to 90 percent of the contributions made in a two-year commitment. For example, if a business is approved to make a $100,000 donation for two consecutive years, it could receive a $90,000 credit for each of those years.
What did the IRS change?
The definition of a charitable contribution was interpreted by the Supreme Court in 1986 as a transfer of money or property without the expectation of quid pro quo. More recently, the IRS dissected charitable contributions made in exchange for state and local tax benefits and believes programs like the EITC are, indeed, a quid pro quo arrangement. Federal Regulation §1.170A-1(h)(3) provides a contribution made on or after August 27, 2018, must reduce your federal charitable contribution deduction by the amount awarded in the state tax credit.
To illustrate, based on our earlier example, before the regulation was finalized, the business that donates $100,000 would receive a $90,000 credit on its PA return and could claim the full $100,000 charitable contribution deduction on their federal return. Whereas after August 27, 2018, if the business contributed the same amount, it would receive the $90,000 credit on their PA return, but they can only claim a $10,000 charitable contribution deduction on their federal return ($100,000 donation less the $90,000 credit allowance). This assumes they had enough taxable income to fully utilize the credit.
Why should taxpayers still consider donating to the PA EITC?
Below, we compare a $10,000 donation for someone with an AGI of $300,000, assuming they are in the highest tax bracket for federal purposes, to demonstrate how tax savings may still exist.
$10,000 charitable donation directly to XYZ charity
Total Tax Due = $116,510
$10,000 donation through the PA EITC program
Total Tax Due = $110,840
A taxpayer receives an additional benefit of over $5,600 if you donate through the PA EITC. ($116,510 - $110,840)
Also, with this example, the $10,000 contribution only costs the taxpayer approximately $630 out of pocket. The $10,000 contribution at a 90% credit on PA’s return results in a $9,000 benefit to cover taxes that would have been paid anyway, assuming the taxpayer has at least a $9,000 liability. The remaining $1,000 results in a federal benefit of 37% or $370. The benefits for a $10,000 contribution, result in it only costing $630 to contribute ($10,000 - $9,000 - $370).
When first reading the regulations, many assumed the IRS eliminated all tax benefits for donations made to the PA ETIC program. However, when you run the numbers, it is still possible to receive some benefit, even if it is less than prior to the regulations. At the end of the day, any donations made are supporting good causes but donating to the PA EITC program can also provide incremental tax savings. Call on The Tax Warriors® at Drucker & Scaccetti to help you determine just how beneficial a PA EITC donation could be for you.