Can your Arizona S Corp help you beat the IRS’s new $10,000 state and local tax cap?

Under new federal tax law taking effect January 1^st, 2018 the IRS will begin capping the deduction for state and local taxes (SALT) on Schedule A. So, if the total amount of state income taxes, property taxes, vehicle license taxes and sales tax tops more than $10,000 on your federal tax return, the excess is no longer deductible on your federal income taxes.

Example

So, if your SALT taxes total $25,000 in 2018 you’ll be limited to just a $10,000 deduction. As an example, if you’re in the 32% tax bracket that amounts in $4,800 of additional tax!

Back in 2015, the Arizona legislature passed a law allowing S Corporations to make contributions to low income or disabled children to Student Tuition Organizations (STO). Those contributions can be used by shareholders to reduce their Arizona tax liability dollar for dollar. The minimum contribution is $5,000 and there is no maximum contribution. In addition the contributions qualify as a charitable contribution on the shareholder federal tax return.

The shareholder potentially gets a dollar for dollar reduction of their Arizona tax liability and a federal tax deduction. Effectively the loss of the $15,000 SALT deduction is replaced by the Arizona charitable contribution deduction.

The shareholder could receive a greater tax benefit than the amount contributed. The eligible tax credit is passed through to each shareholder based on their ownership percentage at the end of the year.

Example continued

Continuing the example from above, if you’re a sole owner of an S Corporation and you donate $15,000 under the Arizona S Corporation program, you’ll receive an Arizona tax credit of $15,000 plus a reduction of your federal income tax of $4,800 (the $15,000 excess X the tax rate of 32%). That’s a tax benefit of $19,800 on a contribution of $15,000.

So, what’s the catch?

• Arizona limits total contributions to the program to $94 million for 2018. The tax credits are available on a first come first served basis. So, when the $94 million is used up the credit goes away, until next year.
• The tax donations must be made thru an Arizona STO. Your corporation must apply for pre-approval to an eligible STO.
• The cap is expected to be met shortly after the application process opens which this year is on July 2^nd. So, if you want to get in on the program, you’ll need to get the pre-approval process moving quickly.
• The IRS issued notice 2018-54 explaining that it was studying tax credit programs that appear to circumvent the new IRS caps. The Arizona program is different than newly adopted plans in New York and California (among others) so it remains to be seen how the IRS study will ultimately effect the Arizona tax credit program. Even if the IRS doesn’t allow the cap limitation you still end up with a dollar for dollar reduction of your Arizona individual income tax.

This program does not interfere with the Arizona individual tax credit programs for public school, private school STO’’s, foster or qualified public charities already in place. So, you can continue with those programs while participating in the S Corporation tax credit pass thru program as well.

The details are important so, as always, we advise that you speak with your tax advisor prior to implementing this or any other tax planning strategy to be sure that it fits within your overall plan.