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Each year I write about Georgia’s QEE Credit program that allows state citizens to donate to a qualified school in return for a credit against state income taxes. (See this year’s article here). There has never been a huge tax advantage to this program unless you owed Alternative Minimum Tax (AMT) for the year.
This year the Qualified Rural Hospital (QRH) credit was improved and, with the change in state and local tax (SALT) deductions on the federal return, became potentially powerful. (See article here). In that article I discussed that the state was allowing taxpayers a 90% crediting rate, which could still yield powerful tax savings if you itemized your deductions and are over the new $10,000 SALT deduction limit on your federal return.
Changes to the Credits
There have not been any changes to the Scholarship credit, which provides taxpayers with a 100% credit against state taxes for contributions made.
The QRH credit was increased from a crediting rate of 90% to 100%[i], which makes the potential tax savings even more amplified than previously thought.
IRS Proposed Regulations
The IRS has previously blessed these transactions with Chief Counsel Advice 201105010, allowing taxpayers a charitable deduction and the state tax credit. However, there was some grumbling on Capital Hill since this could now result in significant tax savings. As I had mentioned in my previous article on the QRH credit:
Unfortunately, the federal government is aware of this strategy. States are pushing these programs hard because of the tax advantages, which cost the states nothing. In fact, the IRS has specifically put states on notice that they are not pleased with this work around strategy. Notice 2018-54 has indicated that regulations on the treatment of these “donations” are forthcoming.
Well, those regulations have now been proposed.[ii] Proposed regulations are not yet in effect and are open for taxpayer feedback and comment. However, they do give us a pretty good guide as to what will be in the final regulations.
The new rules state that if the state credit is 15% or less, taxpayers are permitted a full charitable contribution on their federal income tax return. If the credit is above 15%, taxpayers are only permitted a charitable deduction to the extent they do not receive a credit. Lastly, if the state provides a deduction, rather than a credit, taxpayers are permitted a full charitable contribution on their federal income tax return.
Example 1: Tom donates $5,000 to a QRH and receives a 100% state income tax credit in return. Tom will report the $5,000 as a credit against his state income taxes and no charitable deduction on his federal return.
Example 2: Sally donates $5,000 to a qualified program recipient and receives a 70% state income tax credit in return. Sally will report $3,500 as a state income tax credit (that is 70% * $5,000) and a $1,500 federal charitable deduction.
Example 3: Billy donates $5,000 to a qualified program recipient and receives a 100% state income tax deduction in return. Billy will report the $5,000 as a deduction against income for state income tax purposes and a $5,000 federal charitable deduction.
The really bad news is the proposed regulations will NOT grandfather older state programs. This means the Scholarship credit program, which credits at 100%, will be lumped in with any new programs that were created specifically to skirt the SALT limitation.
Any gifts made to a qualified school or qualified rural hospital under these state credit programs will still permit the donor a 100% state income tax credit. You will, however, not receive a federal charitable deduction, so no tax savings there. Since you will no longer get a charitable deduction on the federal return, there is nothing to add back to income on the state tax return. Everything simplifies to you paid your state income taxes to a school or hospital rather than directly to the state government. Nothing is lost, but nothing is gained. Since these regulations are merely proposed, I will update you should something different become finalized.
[i] GA Chapter 560-7-8-.57 Qualified Rural Hospital Organization Expense Tax Credit
[ii] 26 CFR Part 1 [Reg-112176-18] RIN 1545-BO89
Bryan Strike, MS, MTx, CFP®, CFA, CPA, PFS, CIPM is a Senior Financial Advisor at Kays Financial Advisory Corporation. He can be reached at (770) 951-9001 or at email@example.com.
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