Benefit Local Charities and Reduce Your Overall Taxes with Pennsylvania Credits
Pennsylvania offers two unique tax credits that provide direct support to local charities, the Educational Improvement Tax Credit ("EITC") and the Community-Based Service Credit ("CBSC"). These credits for eligible businesses reduce Pennsylvania and federal income taxes for the business (or the business's owners) and provide the local community with support.
The EITC provides qualifying businesses with a Pennsylvania tax credit equal to 75 percent of eligible contributions made to Pennsylvania educational organizations. The EITC benefit can be increased to 90 percent if the business makes equal sized contributions for two consecutive years (i.e., if a business agrees to make a $10,000 contribution in two consecutive years, it would receive a $9,000 tax credit each year as opposed to a $7,500 credit for a one-time contribution).
The CBSC provides qualifying businesses with a Pennsylvania tax credit equal to 50 percent of its eligible contributions to Pennsylvania charities that provide community-based services for individuals with intellectual disabilities and/or mental illness. The CBSC can be increased to 75 percent in the second and following years that a qualifying business makes an eligible contribution.
Federal Tax Benefits associated with Pennsylvania Credit
In addition to providing a credit against Pennsylvania tax liability, an EITC or CBSC contribution also provides federal tax benefits. This double tax benefit is especially true for the owners of a "flow-through" entity (i.e., S Corp, Partnership, or LLC). The EITC or CBSC contribution made by a business qualifies as a charitable contribution for federal income tax purposes. In a flow-through entity, the contribution passes out to the business's owners and may be deducted Itemized Deduction on the owner's Individual Income Tax Returns, thereby reducing the owner's federal taxable income.
Alternative Minimum Tax Benefit
The EITC or CBSC also provides a benefit against the Alternative Minimum Tax ("AMT"). Essentially, the AMT re-computes taxable income ("AMT Taxable Income") by disallowing certain deductions that are allowed in computing regular taxable income to insure each taxpayer pays a "minimum" level of tax. Although deductible for regular taxable income, state income taxes paid are NOT a permissible deduction in calculating AMT Taxable Income, whereas charitable contributions ARE deductible for AMT tax purposes. By investing in the EITC or CBSC, a taxpayer is converting an AMT on-deductible state income tax payment to a deductible charitable contribution, potentially saving substantial AMT tax.
What Does This Mean for Your Business?
To help illustrate the tax benefits of these credits, assume ABC, LLC ("ABC") is owned by two individuals: Y and Z. In 2013, ABC has income of $100,000 that is passed out to Y and Z equally. Y and Z would each owe $1,535 in Pennsylvania tax on this income ($50,000 x 3.07-percent tax rate). Now, let's assume ABC is accepted into the EITC program for two years and agrees to make a $3,000 contribution each year to a qualifying charity. ABC would receive a $2,700 Pennsylvania Tax Credit ($3,000 x 90 percent) both years which passes out equally to Y and Z ($1,350 to each) thereby reducing each of their Pennsylvania tax liabilities by $1,350.
In addition to the Pennsylvania tax benefit, ABC's $3,000 contribution passes out to Y and Z and would be claimed as a charitable deduction on Y's and Z's respective U.S. Income Tax Returns ($1,500 by each of them).
If Y or Z was subject to the AMT, the EITC contribution has the effect of lowering the owner's AMT Taxable Income (because charitable contributions are deductible for AMT purposes whereas the state income tax that would have been paid is not).
Every business owner should consult his or tax advisers about the substantial Pennsylvania and federal tax benefits to be gained by applying for the EITC and CBSC credits, especially if the business or its owners are subject to the AMT.
To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this article is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. If you would like to discuss this information with one of our attorneys, please call our office at 814-870-7600 or complete this form on our website.