Pennsylvania EITC and the New 2018 Federal Tax Law

Major tax reform was approved by Congress in the Tax Cuts and Job Act (TCJA) on December 22, 2017.  In a landmark change, the new tax law put a cap on deductions for state and local taxes, or SALT. Previously these deductions were unlimited for individuals, though many people who owed the alternative minimum tax lost the benefit of some or all of these write-offs.

The state and local tax (SALT) deduction permits taxpayers who itemize deductions on their federal income tax to deduct certain taxes paid to state and local governments from their gross income for federal income tax liability purposes. Taxpayers may deduct their property taxes plus either their state and local income or sales taxes, but not both.  Under the newly implemented tax law, the deduction is now capped at $10,000 per year. A significantly higher standard deduction is also likely to reduce the number of filers who itemize from 30 percent to about 10 percent.  The state and local tax deduction disproportionately favors high-income taxpayers, particularly those in high-tax states. This was even more true prior to this year, under an uncapped deduction, when more than 88 percent of the benefit flowed to filers with incomes in excess of $100,000.  The deduction reduces the cost of state and local government expenditures, particularly in high-income areas, with lower-income states and regions subsidizing higher-income, higher-tax jurisdictions. A $10,000 cap, however, will limit the impact of those transfers.

Pennsylvania Education Improvement Tax Credit (EITC) has been a program since 2001 that allows business taxpayers to redirect their state taxes to a donation for scholarships for K-12 private schools in Pennsylvania.  Special Purpose Entities (SPE's) were created in 2014 to allow individuals who own a business or work for a business to contribute to EITC scholarships and receive a tax credit of 90% of their contribution as a participant in an SPE.  

The new federal Tax Cuts and Job Act (TCJA) change how Pennsylvania EITC impact federal tax deductions for an individual donor.  For lower income donors the new standard deduction means the 90% state tax credit is the only benefit available.  Conversely since all donations won't exceed the standard deduction a tax strategy would be to maximize Pa EITC donations and minimize regular donations.  Receiving a 90% tax credit for a donation versus no tax benefits for an annual fund contribution is a tax efficient way to give more while costing less.

For high income individuals the cap on federal state tax deductions clearly result in most EITC donors transferring non deductible Pennsylvania tax payments to deductible EITC donation.   This results in both a Pennsylvania tax benefit of 90% and a federal benefit of 22% to 37% depending on the donors top federal tax rate.  The initial donation requires a large upfront donation investment typically in the fall.  The tax refund the following year repays the initial donation investment.  The donor is without their funds for less than a year but provides scholarships to local low and middle income families to attend the K-12 school of their choice.