Earlier this month, the Internal Revenue Service finalized a new rule helping to narrow a tax loophole that had been abused here in Virginia.

The rule prevents people or corporations from “double-dipping” when making donations to private or religious schools. This loophole had allowed some private school donors to turn a profit from their “charity” by claiming state and federal charitable giving deductions on top of Virginia’s already generous tax credit called the Education Improvement Scholarship Tax Credit.

Virginia is one of 18 states that has a state tax credit (sometimes referred to as a neo-voucher) as a tax incentive for people donating to private K-12 schools. Prior to the IRS ruling, the tax benefits in Virginia actually exceeded the size of the donations for some high-income earners.

Most of the state’s tax credit money goes to households with $500,000 or more in federal adjusted gross income, and over a third of the credits are claimed by those reporting more than $2 million in federal adjusted gross income. People claiming these credits are more likely to be white than black or Latinx, due to the under-representation of black and Latinx filers in the state’s highest income groups, a result of Virginia’s long history of racial discrimination.

While the new ruling does not change the benefits of the state credit, it does mean people can no longer claim charitable giving deductions on top of the state tax credit. For example, if somebody gives $100,000 to a private K-12 school in Virginia and claims the state’s EISTC (valued at 65% of the contribution), then that individual will be able to claim charitable giving for only $35,000 of that donation — that is, the portion not reimbursed with a state tax credit.

The ruling is an important improvement, but does come with some limitations.

First, people and businesses making stock contributions, rather than cash, may still be able to profit from their donations through avoidance of capital gains taxes. A fix suggested by the Institute on Taxation and Economic Policy is to require taxpayers to pay capital gains tax if they receive a large state tax credit as compensation for their gift of stock or property to a private school.

Second, the IRS indicated that additional guidance will be needed to deal with a variety of lingering issues, and it remains to be seen what that guidance will entail and when it will be released.

This is important news for tax fairness and for ending a loophole that is often abused by wealthy donors and private and religious schools here in Virginia. During this past legislative session, Gov. Northam and the legislature expanded the eligibility and benefits for Virginia’s EISTC (SB1015 and SB1365), despite the “double dipping” permitted under federal law at the time. While the EISTC remains a flawed policy, this new rule is a welcome way to rein in some of its worst abuses

Get Breaking News Alerts

* I understand and agree that registration on or use of this site constitutes agreement to its user agreement and privacy policy.

Chris Duncombe is policy director of the Richmond-based Commonwealth Institute for Fiscal Analysis, which provides analyses of fiscal and economic issues with particular attention to the impacts on low- and moderate-income persons.

This commentary first appeared on the institute’s blog and is reprinted here with permission.

Load comments