The Internal Revenue Service is currently looking at a tax loophole that was made much broader by the so-called Trump tax cut bill last year. The bill put a $10,000 limit on federal deductions for state and local taxes (commonly referred to as SALT). This sent some people scurrying for other ways to cut their tax liability.
In the case of Alabama, donations to scholarship granting organizations, did the trick for some. This is because an SGO donation is considered a “charitable” donation by the IRS, when it fact it isn’t because the state of Alabama reimburses the donor dollar for dollar through a tax credit.
Maggie Garrett is a Washington-based attorney (who once lived in Montgomery) recently wrote an excellent article detailing what is going on. With her permission, here it is:
“Private school voucher proponents are up in arms because the IRS has proposed closing a federal tax loophole that allows individuals who donate to voucher programs to make money off their donations. Vouchers are already troubling because they reduce the total funds available for public schools, waste taxpayer money on programs that are proven ineffective, lack transparency and provide no accountability to the taxpayer. A new wrinkle, however, is voucher proponents are pushing voucher programs as a way for individuals to cash in personally and line their own pockets with your tax dollars.
How does this loophole work?
Several states have adopted voucher programs called tuition tax credits (TTCs). Under this scheme, the government doesn’t give money directly to the student to attend private school. Instead, individuals or corporations “donate” money to an intermediary organization, often called a scholarship organization, and the scholarship organization writes a check for tuition to a private school. The state then fully reimburses the donor through a dollar-for-dollar tax credit.
These “donors” aren’t charitable; in fact, they really aren’t spending a dime because the government fully repays them. Normally, when you donate to charity, the government doesn’t just turn around and give you all your money back. But here, the state has set up a shell game. All the money for the private school voucher still comes from the public treasury – money that’s sent to private schools rather than used for public schools or other public services.
But the federal tax loophole creates a whole other level of fiscal irresponsibility. In six states, after the “donor” is fully reimbursed on their state taxes, the taxpayer can also take a federal tax deduction off the same “donation.” This allows the donor to make money off their donation to the voucher program.
For example, imagine that a wealthy South Carolinian who is in the top tax bracket gives $1 million to a “scholarship organization” that funds the state’s private school voucher program. South Carolina will reimburse that donor $1 million – this means the donor hasn’t spent anything. Nonetheless, the federal government considers that $1 million a charitable donation and therefore not taxable. At the top federal income tax bracket of 37 percent, the donor saves $370,000 on their federal taxes. But because the donor was reimbursed by the state for every dollar of their $1 million donation, that extra $370,000 savings is pure profit. It’s outrageous.
The biggest loser in this scheme is the public schools. All $1.37 million in state and federal tax breaks could have been used to fund our public schools; instead, it is used to fund private, mostly religious schools and wealthy individuals.”
As evidence that this loophole is beneficial to Alabama SGOs, donations to them reached their annual cap of $30 million back in March. That had never happened in prior years.