With the stroke of a pen, the federal government virtually eliminated the state and local tax deduction and sent states scrambling to introduce legislation to minimize the tax impact. As part of the federal tax reform that was enacted at the end of 2017, the state and local tax itemized deduction was limited to $10,000. The limitation applies to both state income taxes and real estate taxes.
Even in a state with a relatively low income tax rate, many Pennsylvania residents will find that the $10,000 limited deduction will not come close to covering their state and local tax burden. Fortunately, PA has been a pioneer in the area of creating an alternative structure for the payment of tax liabilities through the implementation of the EITC program.
For several years, business owners in PA have taken advantage of the EITC program to shift their tax dollars to private educational and other non-profit institutions that qualify to receive donor contributions. In exchange for the contribution to a qualified organization, the donor receives either a 75 percent credit for a one year commitment or a 90 percent credit for a two year commitment. The credit is applied against the donor’s total PA personal income tax liability, not just the tax resulting from trade or business income, and also qualifies as a charitable contribution for federal income tax purposes.
In order to broaden the base of individuals who can benefit from the program, PA amended the original legislation to allow for the creation of special purpose entities to qualify as eligible participants in the program. The reason for the change in the legislation is due to the fact that individuals cannot participate in the program directly. Applications to participate in the program must be filed by a business enterprise. Pass-through entities such as S corporations, partnerships, and limited liability companies are permitted to pass unused credits through to their shareholders, partners, and/or members. However, the credit can only be passed through one level.
While the EITC is a program that offers PA taxpayers the opportunity to offset state income taxes with a self-directed donation to a qualified charitable organization, it is not without its limitations. For example, the credit does not apply to local income or property taxes and it has to be passed out to shareholders, partners, and/or members on a pro rata basis. It cannot be carried forward to future years, and it can only be passed out one level above the donating organization. PA taxpayers who are non-residents, and only subject to PA personal income tax on PA source income, can find themselves with credits that they may never be able to utilize.
Still, the EITC can be a useful tool for PA taxpayers and may just achieve an unintended benefit resulting from the recent federal tax reform. Taxpayers who discounted the benefit of the program may want to reevaluate their decision. It is possible that, now more than ever, participation in the EITC program would be a prudent decision.
If you have any questions about this information or would like to discuss this subject further, please do not hesitate to contact a member of Kreischer Miller’s State and Local Tax group at 215.441.4600.
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