More of South Carolina's richest taxpayers soon can pad their pockets by donating to the state's scholarship fund for special-needs students.
It's a complicated and little discussed result of the federal tax rewrite that President Donald Trump signed last month.
Under the new law, some wealthy South Carolinians may actually make a 37 percent profit, risk-free, by making charitable contributions to Exceptional SC, a nonprofit fund created by the state Legislature to administer scholarships to students with disabilities attending private schools.
That's according to a recent report by the nonpartisan Institute on Taxation and Economic Policy.
South Carolina has been one of 10 states — including Alabama, Arizona, Georgia, Kansas, Montana, Oklahoma, Pennsylvania, Rhode Island and Virginia — where this new loophole has opened up.
In South Carolina, those donating to Exceptional SC can get a 100 percent credit toward their state income tax payment. In past years, this donation has not led to an additional federal income tax break because while they could claim their gift to Exceptional SC as a deduction, it also lowered their amount of state tax they they could deduct — so no net profit.
But the rewriting of the federal tax code effectively expands this shelter by capping the state and local income tax deduction, the report said.
"The provision in the new federal law that just took effect, on its face, doesn't have anything to do with private schools or the charitable deduction even," explained Carl Davis, the researcher who wrote the report.
"It's all about the cutting back of the state income tax deduction."
Previously, only a few wealthy South Carolinians have been able to take advantage: those who paid the federal Alternative Minimum Tax, a special tax designed to ensure the wealthy still pay some federal taxes. These taxpayers are rich — in 2015, most had incomes between $200,000 and $1 million — but not the very richest, as Davis' report explains.
"Under the law as of last year, the pool of taxpayers able to participate in this tax shelter was limited by the state income tax deduction," Davis said.
Now, with the new tax law capping deductions of state and local income taxes at $10,000, a large donation that generates both a 100 percent state tax credit and a federal charitable income tax deduction is even more appealing.
"It's pushing the tax shelter further up the income scale," Davis said.
By Davis' calculations, among the top 1 percent of earners, the number of taxpayers who could benefit by donating to tuition voucher programs would double, from about 36 percent of 82 percent. Exceptional SC is the only such program in South Carolina.
Exceptional SC provides students with disabilities up to $11,000 each in grants to help pay for their private school tuition, textbooks and transportation fees. Taxpayers who donate to the fund can claim dollar-for-dollar credits on their state income tax liability. State tax credits are currently limited to $11 million annually and are awarded on a first-come, first-served basis.
The report cites the hypothetical example of a South Carolina multimillionaire who donates $1 million to the Exceptional SC scholarship fund. Under the new rules, that taxpayer would receive not only $1 million in state tax credits but also a federal charitable deduction worth $370,000, based on the new top federal income tax rate of 37 percent.
In other words, by donating $1 million, he or she would save $1.37 million on their combined state and federal taxes.
"The profit that’s being earned there, that’s ending up in the pocket of the donor. That doesn’t make its way into a private school. It doesn't make its way into a public school," Davis said. "It’s abuse of the charitable giving deduction. It's taking advantage of something that is supposed to encourage people to be generous with their own money."
In the future, Davis expects a very small number of extremely wealthy donors will rush to snatch all $11 million of the state's tax credits in a matter of days or even hours now that the new tax code makes donating to Exceptional SC so attractive.
This has already happened in other states with large programs and aggressive marketing, such as Georgia, where all $58 million in scholarship credits were claimed on Jan. 1, 2016, or in Arizona, where $67 million in credits in 2016 were taken in just a few hours. Last year, the scholarship tax credits were still available in South Carolina until late December, five months after they were made available.
One of the report's predictions — that wealthy donors' enthusiasm for state tax credits will convince lawmakers to expand these tuition voucher programs to keep up with demand — may soon come to fruition.
As South Carolina's General Assembly reconvenes this month, Thomas E. Persons, chairman of the Exceptional SC board of directors, said the board will ask lawmakers to increase the amount of state tax credits to at least $15 million.
It's possible, Persons said, that smaller donors may be squeezed out by a surge of larger donors if the program's popularity rises.
"I do think it's going to have an impact on some of the smaller ones (donors), the donors who are in the $1,000, $10,000, $15,000, maybe $20,000 range," Persons said. "We have looked at it, and we are studying it."