Tuition Donation Credit Program vulnerable to exploitation with recent federal tax changes

A little-used state tax credit program designed to benefit low-income students could balloon into a profitable tax shelter for Louisiana’s wealthiest citizens thanks to the recent federal tax cut law. If high-income taxpayers are allowed to exploit the program, the cost of the credit to the state could explode in the years to come as wealthy taxpayers rush to take advantage.

The program in question is the Tuition Donation Credit Program, which provides a dollar-for-dollar state tax credit for donations made to nonprofit organizations that provide students from low-income families with scholarship to private schools. The Legislature created the Tuition Donation Rebate Program in 2012 to allow taxpayers to receive a rebate in return for donating funds to a Student Tuition Organization (STO).

In 2017 the Legislature converted the program from a rebate to a nonrefundable tax credit with Act 377. With the change, lawmakers sought to limit the cost of the program to the state. But they could not have foreseen that future federal tax changes would turn the program into a highly lucrative tax loophole. They also did not know that the fiscal analysis they were given—of just a few million dollars per year—would become outdated in just a matter of months.

Even high-income people who may not be particularly interested in donating to STOs could begin doing so because their tax accountants advise them that making a “donation” will allow them to turn a profit—receiving more back in state and federal tax cuts than they donated in the first place.

Eighteen states have created similar tuition donation programs, but Louisiana is the only state that doesn’t have a cap on the total amount of tax credits that can be paid out by the state in any given year. According to Legislative Fiscal Office staff, there were 62 donors who donated to three STOs last year, giving a total of $5.4 million under the program. These numbers are likely to be much, much higher in the years to come.

The Tuition Donation Credit Program is prone to being exploited this year and in future years because the federal Tax Cuts and Jobs Act placed a $10,000 cap on state and local tax (SALT) deductions without placing a similar cap on the amount of charitable contributions that can be deducted for federal income tax purposes. As a workaround for the SALT cap, accountants and tax planners are encouraging individuals who are now unable to deduct their full state and local taxes on their federal income tax return to donate to state tuition credit programs. The taxpayer can then claim the donation as a charitable donation for federal tax purposes and receive a state income tax credit as well.

Many high-income donors stand to make a profit off this arrangement because the two tax breaks can add up to more than the original donation amount. (In the past, the benefits of a higher charitable deduction would have been offset by a reduced SALT deduction because the taxpayer received a Louisiana tax credit. But now that the SALT deduction is capped at $10,000, many high-income taxpayers participating in this program will see no change in their SALT deduction.Already this year, a very similar credit program in Alabama has reduced state revenues by $30 million – the maximum amount allowed by law. Alabama’s tax credits were claimed more quickly this year than ever before because accountants and private schools aggressively marketed the tax credit as a tool that allowed donors to convert their previous state and local tax deduction (capped at $10,000) to a charitable deduction (uncapped) by giving to the tuition credit program. Similar tax sheltering advice has begun to surface in states such as Georgia and Pennsylvania. Once Louisiana accountants begin advising their clients to make use of this strategy, the cost to the state’s budget could grow exponentially beginning next fiscal year.

The Legislature must act swiftly to cap the total amount in state tax credits that can be given in exchange for donations to STOs. An overall cap will ensure that the STO program will maintain its intended purpose while limiting both the state’s exposure to a major revenue loss and the ability of opportunistic taxpayers to exploit the program for its lucrative state and federal tax benefits.