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Tax Loophole for Private Schools

MacMain, Connell & Leinhauser report on the Tax Loophole for Private Schools that Pennsylvania businesses can donate to and participate in tax credit programs.The new federal tax code contains a loophole that could affect private schools. An analysis by the non-profit Institute on Taxation and Economic Policy (ITEP) found that with the new tax laws, donations to private schools may help businesses make money by paying less in state income tax.

In Pennsylvania, businesses that donate to educational non-profits or a private school scholarship organization can receive up to 90 percent of the donation back when they donate through a tax credit program like the Opportunity Scholarships Tax Credit (OSTC) or Educational Improvement Tax Credit (EITC). Nine other states have similar education tax credits.

Under the education tax credit program, a $10,000 scholarship donation can save a business $9,000 in state taxes. The donation is tax deductible at the federal level at the full amount.

Previously there was no real incentive to exploit this loophole because there was no cap on state tax deductions. The federal government allowed for unlimited deductions based on how much individuals or businesses paid in state taxes. For participants of OSTC and EITC, lower state taxes meant higher federal taxes.

That is no longer the case under the new federal law, which caps state tax deductions at $10,000. Without any incentive to pay state taxes past a certain point, more businesses may want to take advantage of the loophole and participate in tax credit programs.

Carl Davis, research director at ITEP, expects that some states will see a flood of new private school donations. However, in Pennsylvania tax credits are limited with demand already exceeding the amount of money available. The OSTC program has $50 million while the EITC is funded with $135 million.

The limited funds likely mean competition for tax credits will be stiff. Recipients of Pennsylvania tax credits are determined by a lottery system. Some preference is given to participants who have received credits in the last two years. Not all of the donations go to private schools. The EITC program also includes educational improvement organizations whose missions vary widely. There are entities that distribute the money to traditional public schools and charters. Some run after-school programs, and others provide extracurricular science education. There are many choices besides private schools for businesses who want to earn tax credits.

It stands to reason that demand for tax credits will continue to increase leading state law makers to expand the programs. Governor Wolf has already increased the caps on the OSTC and EITC programs at the behest of Republican leaders.