For many years Pennsylvania businesses and their owners have enjoyed significant PA and Federal tax benefits by using credits generated under the Pennsylvania Educational Improvement Tax Credit (EITC) program. These credits not only reduced various PA taxes dollar for dollar but also provided a Federal tax deduction. Historically if you were not an owner of a Pennsylvania pass-through entity (S-Corporation, partnership, etc.), you could not share in these benefits. Now through a little-known provision known as a Special Purpose Entity (SPE), most Pennsylvania residents paying PA individual income taxes can also share in the savings.
First a little background and education on the credit. Administered by the PA Department of Community and Economic Development (DCED), the EITC is designed to provide funding to organizations that provide and promote learning throughout the state.
Organizations who offer these services may complete an online application to become recognized as an eligible EITC recipient. The organizations are divided into three categories – Scholarship Organizations, Educational Improvement Organizations, and Pre-Kindergarten Scholarship Organizations. Visit DCED’s website for a comprehensive list of qualifying organizations.
Businesses wishing to participate must complete an online application beginning on July 1 of each year. Within the application, they state their requested contribution level and which program(s) they wish to support. They do not need to name their intended recipient organization(s) with the application. Businesses making a two-year commitment to the program can submit their second year and subsequent applications beginning on May 15 of each year. DCED reviews these applications and makes award grants based on funds made available each year by Pennsylvania’s budget. Receiving businesses are sent award letters in the 4th quarter each year stating the amount of their grant. The company has sixty days from the date of the award letter to make contributions to qualifying organizations and 90 days to provide documentation of the contributions to DCED. Upon receipt, DCED responds with a letter confirming the credits earned. You may then use the credit vs. any PA entity-level taxes or pass-through to their owners for use against their PA individual income tax liability. Companies who are not granted credits in the initial offering are put on a waiting list and may be offered credits if the first group of awardees does not fulfill their commitments.
The amount of the credit ranges from 75-100% of the amount contributed depending upon which program you select and whether you are making a one- or two-year commitment. Take care in determining the amount of your request, as credits cannot be carried over from year-to-year nor can they be sold like some other PA credits. In addition to offsetting PA taxes dollar for dollar and supporting your favorite charities, the program has also spun off Federal tax benefits. The contribution has historically been deductible at the individual level as a charitable contribution for those taxpayers who itemize deductions. For an individual taxpayer who was not subject to the Federal Alternative Minimum Tax (AMT), the Federal benefit was comparatively minimal since the PA taxes saved by the use of the credit reduced Federal itemized deductions by a similar amount. Those individuals subject to the AMT received a potentially significant benefit by trading the state tax deduction for a charitable contribution deduction because state and local taxes are not deductible vs. the AMT, but charitable contributions are deductible.
Special Purpose Entity Concept
As noted these benefits were historically limited to persons who had ownership in PA businesses. A relatively under the radar law change in late 2014, opened the door for other individuals to share in the benefits. PA Act 194 of 2014 was put into law on October 31, 2014. This act gave new definitions to the terms “business firm” and “pass-through entity.” A concept known as a Special Purpose Entity (SPE) was introduced as a vehicle for non-business owners to share in the EITC benefits. The SPE is an LLC set up to aggregate the contributions of individuals and as a group apply for the EITC benefits. Essentially, the individual makes a financial commitment to the SPE who in turn applies for EITC credits. Pennsylvania recognizes the SPE as a business firm eligible to participate in the program. The SPE treats the individual’s payment as a capital contribution directly to the SPE. Upon being granted credits by PA, the SPE makes an aggregate contribution to the qualifying organizations and then at year-end allocates the credits and deductions back to the individuals. The individuals can then share in the same benefits of those who have traditionally gained credits.
Some of the state’s largest charities have taken advantage of the new rules to set up their own SPE’s with the funds being channeled directly to their charities. Smaller qualifying organizations who do not have the means to operate their own SPE can benefit through organizations who aggregate contributions and distribute to qualifying schools. One such SPE is the Central Pennsylvania Scholarship Fund (CPSF) headquartered in Tyrone, PA. Like most SPEs, CPSF has a set of participation requirements. Participants must be PA residents where at least one spouse is employed or has an ownership interest in a PA for-profit business. The minimum donation is $3,500 with a maximum of $500,000. Interested participants complete a Joinder agreement to become a member of one of the organization’s SPEs. Upon the SPE being granted their awards, participants fulfill their obligation by writing a check to CPSF who in turn distributes the monies to schools whom the participant designated. An eligible school would be any PA pre-school or K-12 school that charges tuition and operates an accredited education program. CPSF can research a school’s eligibility and provide the guidelines for the resulting scholarships. 100% of participant contributions are distributed to the schools.
The program could potentially be even more attractive moving forward as the Federal Tax Cuts and Jobs Act passed in December 2017 has introduced some very restrictive limits on an individual’s ability to deduct state and local taxes on their Federal returns. By saving these taxes via the PA EITC program and converting your payments to charitable contributions, Federal tax deductions can be enhanced. The Department of the Treasury released temporary regulations addressing state credit programs and their impact on Federal taxes in August 2018. These regulations could limit the Federal benefits if final regulations follow the provisions in the temporary regulations. There is some indication that existing programs such as the PA EITC program will get a reprieve in the new regulations, but even if they do not, most taxpayers will still benefit by contributing via the EITC program rather than direct contributions to the charities of their choice.
The tax professionals at Stambaugh Ness are happy to discuss this tax savings opportunity with you in greater detail and provide you with forecasts of your potential savings. Contact us today to start the conversation.