Bypassing the $10K State and Local Tax Deduction Limitation

March 26, 2018  |  

Bypassing the $10K State and Local Tax Deduction Limitation

Our friends at Drucker and Scaccetti recently wrote a great blog regarding the new tax law and state/local tax deduction.  It is well worth the read, please let us know if you have any questions.

With just a couple of lines, the Tax Cuts and Jobs Act of 2017 sent state governments into a frenzy by limiting the state and local tax deduction to $10,000 for individual taxpayers in 2018 and after.  States with especially high income or real estate taxes were scrambling to provide their residents with some relief.  Luckily for Pennsylvania taxpayers, there is a credit that reduces your state tax liability and allows a federal deduction.

The Pennsylvania Educational Improvement Tax Credit (“EITC”) allows you to contribute to an eligible scholarship and educational improvement organizations and receive two tax benefits:

  1. Gives a credit against PA income tax and creates a federal charitable deduction. You must apply for this credit.  Pennsylvania Department of Community & Economic Development approves the credit on a first-come, first-served basis until the annual maximum amount of credits is awarded. 
  2. The tax credit is equal to 75% of the contribution or 90% of the contribution for a two-year commitment.

Many charitable organizations set up special-purpose entities to allow you to take advantage of this credit.  The charitable organizations handle the application process and provide the documents necessary to claim the tax benefits.

For example, if you contribute $10,000 to an eligible scholarship and educational improvement organization, you receive a $9,000 credit against your Pennsylvania income tax and you can deduct $10,000 as your charitable contribution on your federal tax return (assuming you will itemize).  Essentially, a taxpayer ‘converts’ their state income tax liability into a charitable deduction and bypasses the $10,000 state tax limitation.  CAUTION:  Your Pennsylvania state liability should not exceed the credit since it is not refundable.  In our example, the taxpayer should have at least $9,000 in PA tax liability net of any other state credits (i.e., credit for taxes paid to other states).  Most taxpayers considering this option work with their tax advisors to prepare a projection of their estimated PA tax due before participating in the EITC program.

Most states, especially those with high-income tax rates, do not allow such tax benefits.  California taxpayers, however, can contribute to the College Access Tax Credit Fund and receive a credit of 50% of the taxpayers’ contribution. This credit works the same as the PA EITC.  Californians can claim a charitable donation for the contribution to the fund and get a 50% credit against their CA tax liability.  This contribution must be added back to compute California taxable income so as not to allow a deduction and a credit for the same contribution. This version of the credit was scheduled to expire in 2017 but was extended until January 1, 2023. Unfortunately, Delaware, New Jersey, and New York do not provide similar credits at this time.

Adviser does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party.  Adviser is not licensed to provide and does not provide legal or accounting advice to clients.  Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.

About Patrick Runyen

As a Wealth Manager at Independence Advisors, Patrick Runyen, CPA/PFS, CFP® works closely with clients to implement wealth management solutions. He leverages his technical financial planning and consulting experience to assist clients with investment counseling, retirement planning, estate planning, wealth enhancement, asset protection, tax planning, and other personally significant financial decisions. CLICK HERE TO ASK PAT.
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