Changes Suggested for Regs on Payments to Charitable Entities

Internal Revenue Service
CC:PA:LPD:PR (REG-107431-19)

BACKGROUND

The following comments represent the view of EdChoice, recommending modifications to the proposed rule regarding Treatment of Payments to Charitable Entities in Return for Consideration (REG-107431-19) as outlined in the Notice of Proposed Rulemaking printed in the Federal Register on December 17, 2019.

EdChoice is a national 501(c)(3) nonprofit, nonpartisan organization originally established in 1996 by Nobel Prize winning economist Dr. Milton Friedman as the Milton and Rose D. Friedman Foundation, for the purpose of promoting the opportunity for parents to choose the schools their children attend. EdChoice, the nation's oldest and most successful parental choice organization, provides educational resources in all states, and is driven by the shared mission to advance a K–12 education system where all families, regardless of race, origin or family income, are free to choose a learning environment — public or private, near or far, religious or secular — that works best for their children. Our vision is to advance educational freedom and choice for all as a pathway to successful lives and a stronger society.

EdChoice recognizes that the proposed rule is designed to update and clarify the availability of charitable contribution deductions under sections 162, 164 and 170 of the Internal Revenue Code when the taxpayer receives or expects to receive a corresponding state or local tax credit. We acknowledge the underlying goal as preserving anticipated revenue from a cap limiting the federal state and local tax deduction, revenue presumed necessary to preserve certain tax cuts advanced in the 2017 Tax Cuts and Jobs Act.

EdChoice is not a tax advocacy organization. We are focused on the education of our Nation's youth. But EdChoice's founder, Milton Friedman, was quoted: “The power to do good is also the power to do harm.” In this case, an attempt to “prevent charitable contributions from being used to circumvent the new limitation on state and local tax deductions” will result in significant harm to the educational opportunities available to our Nation's most vulnerable youth.

Currently, there are 23 tax credit scholarship programs operating in 18 states. These programs currently benefit more than 299,000 children nationwide.¹ While income eligibility levels and scholarship award amounts vary significantly among the states, all of the programs leverage individual donations, business donations, or both, to fund elementary and secondary school choice scholarships that allow children who might not otherwise be able to attend the school of their choice due to financial constraints the opportunity to seek the educational environment which best suits their needs. The donations funding the scholarships receive a widely varying level of favorable tax treatment.²

It is important to note that these donations are voluntary, are not received by governmental entities, and do not take the place of any tax assessed for the provision of public education by the states.

UNINTENDED CONSEQUENCES

The most important question regarding consequences of the proposed rule can be answered in part, at this time. The question is, “Will donors to school choice tax credit scholarship programs stop donating to scholarship granting organizations or greatly diminish the size of their donations if the rule is adopted as proposed?” A 1989 study by the National Bureau of Economic Research (NBER) which evaluated the impact of the 1986 Tax Code on charitable contributions confirms that contributions will fall in those taxpayer sectors where the cost of giving rises most.

While initial reports from scholarship granting organizations (SGOs) confirm NBER's analysis regarding negative impact on contributions attributable to the cost of giving, SGOs also report a high level of donor disaffection based on considerable confusion and mistrust generated by the reason for the new regulations, the piecemeal roll-out of the regulations, and an underlying lack of understanding by financial analysts and donors as to the necessity of the proposed rule. As a result, many donors have diminished the size of their contributions or opted out altogether because they lack trust in the motivation behind the rule and its reliability as good tax law going forward. We expect to see a substantial decrease in contributions with a resulting loss of scholarships for children who can ill afford to lose those scholarships.

NBER also determined that there is more to charitable giving than economic factors. It is not reasonable to believe that predictions about giving will be accurate; educated guessing is the best any of us, including Treasury, can do. This is little solace to the families of over 299,000 children who are relying on scholarship funding, many of whom will have no option to remain in their schools if contributions to SGOs drop. This is a problem. As many recent parent surveys have shown, many of these children left their assigned schools due to bullying; when this problem was acknowledged in Florida, the legislature enacted a separate tax credit scholarship program specifically to help children escape bullying situations. Most children in tax credit scholarship programs left their assigned schools because they were failing to thrive; this does not necessarily mean that their assigned schools were troubled schools, but it most definitely means that the schools were the wrong fit for those children and they needed another option.

Treasury estimates that only 5% of taxpayers may be affected by the proposed rule and of that percentage of taxpayers, only those giving to programs entitling them to state tax credits greater than 15% will feel a sting from the new rule. Of course, because every tax credit scholarship program in the nation offers state tax credits over 15%, every donor to SGOs in Treasury's estimated 5% bracket will be impacted.

Furthermore, Treasury also believes that most donors in the estimated 5% bracket have never been donors to tax credit scholarship programs; this is no doubt true, but not persuasive. As of December 29, 2019, the IRS had received 155,798,000 individual income tax returns; 5% of those returns would be 7,789,900 taxpayer returns from taxpayers potentially impacted by the proposed rule. (Filing Season Statistics for Week Ending December 27, 2019 https://www.irs.gov/newsroom/filing-season-statistics-for-week-ending-december-27-2019) According to GAO, there are over 173,642 donors to individual donor only and individual plus business donor programs, which is only 2.2% of the number of tax filers Treasury believes may be impacted, and we do not know how many of those 173,642 donors would meet Treasury's definition of potentially impacted taxpayers (itemizers not subject to the SALT cap).³

A state policymaker's decision about whether to tax an SGO donor less than other taxpayers for contributing to an SGO will vary according to policy norms, community needs, and generally followed patterns of giving in the state. Donors receive a state tax credit equal to 100% of their contribution to an SGO in 12 programs, while two programs offer state tax credits equal to 50% of contributions. Program caps on state tax credits range from $1.5 million in Rhode Island to a current cap of $873.6 million in Florida.

Critically, contributions received by SGOs go directly to parents who decide where to use the money to pay tuition for their children. These are privately funded scholarship programs, independently operated to be closest to the people they serve.

Although the number of donors to SGOs is small compared to the nationwide number of tax filers, the children receiving what in many cases are life-saving or life-changing scholarships are not small – they are the next generation of our Nation's leaders, many of whom may one day hold leadership positions at Treasury and the IRS. There are 108,949 children receiving scholarships from the small number of tax filers Treasury believes will be impacted by the proposed rule.

Admittedly, whether a child receives a suitable education, learns well, and becomes a successful, contributing member of society has virtually nothing to do with the dollars and cents of tax policy; but no government agency stands alone. State education departments, Secretary DeVos at the U.S. Department of Education, and parents across this country dedicate their work to the improvement of education offerings for our children. Many forces work against them on a daily basis, not the least of which are poverty, despair, and apathy. Treasury's proposed rule can be added to that list. This is wrong for families, and wrong for public policy that seeks to be equitable and sustainable. The consequences of the proposed rule are most assuredly unintended, especially considering the President and Vice President's sincere support for educational freedom; yet, those consequences will be severe for each child who will lose a scholarship that has been a lifeline to a better life.

COMMENTS ON PROPOSED REGULATION

As proposed the pending IRS regulation will severely impair the viability of school choice scholarship programs serving hundreds of thousands of vulnerable youth. We believe the Department of the Treasury underestimates the negative impact of the proposed regulation.

Treasury has indicated that combined state and federal tax benefits favor contributions to charities for which the donor may receive a state tax credit, creating an economic distortion. What Treasury considers to be a distortion, state lawmakers consider serving the public good in their states. State tax credits are used as leverage to encourage private investment to further specific policy goals. For example, in Georgia, lawmakers saw a need to provide different educational options for children and they also saw a need to support hospitals in rural areas of the state; donors to both programs are taxed less, through receipt of state tax credits. This may look like an economic distortion from the viewpoint of federal tax law, but at the state level, it is a public benefit.

It is simply incorrect to view a state tax credit as a quid pro quo from the government. In the proposed rule, it states, “The quid pro quo principle is thus equally applicable regardless of whether the donor expects to receive the benefit from the donee or from a third party.” While this may have merit in some cases, when the third party is a state government, the logic fails. Treasury references benefits such as a $15 radio, future sales of sewing machines, increased land valuation from new road construction. In everyday donor contributions to charities, the benefit a donor may normally receive is a steak dinner, a hat, a mug, a book. The value of these benefits is deducted from the total value of the charitable contribution.

However, to consider a reduction in the amount of taxes owed to the state to be the same as a $15 radio or a steak dinner is not only illogical, it fails to respect the intent of state legislatures that incentivize citizens to provide charitable contributions to particular programs advancing the public good, as determined by duly elected state officials.

As 501(c)(3) organizations, SGO's are private entities who solicit donations aimed at a specific policy goal. The SGO's determine the recipients of scholarship based upon a variety of factors under the guidance of state law and IRS regulation, but they are not government entities. The donations they receive do not come into government coffers, do not take the place of general government revenues, are not administered by the government, and have a longstanding history of charitable intent. Their policy case has been examined by a significant number of states, and tax credit scholarship programs have been enacted which view the policy purpose as laudable enough to merit a reduction in state tax revenue via the issuance of state tax credits. It is worth noting that programs are expanded on a regular basis. In short, scholarship tax credits demonstrate value to contributors, government and students.

Also, we request clarification as to whether a business entity may deduct payments to SGOs under section 162 as ordinary and necessary business expenses incurred in carrying on a trade or business. In many cases, the purpose of a business entity contribution, especially pass-through businesses, is to help build the educational attainment and academic achievement level of students who will enter the workforce. For example, it is imperative for entry level employees to know enough math to complete invoices and to have skills necessary to read and comprehend an instruction manual. Finding employment candidates with requisite skills, particularly in low population areas, can be a challenge. Business contributions to SGOs to help students attain their highest level of academic achievement should naturally qualify as section 162 expenses.

We have learned from SGOs that donors are receiving tax advice discouraging donations. People are concerned that donations to SGOs may become red flags on tax returns that could trigger tax audits. The fear is not the audit per se; the fear is that, if, as a consequence of making a contribution, there is a reasonable probability of being audited, then the cost of that contribution will increase ten-fold. This may have a real chilling effect on potential donors. Others do not have confidence that the new rule is reliable, as it seems to be unwarranted and a major change in normal tax practice.

We also believe that grandfathering charities that were in existence prior to enactment of the rule would be equitable.

We appreciate the opportunity to comment, and request modification of the proposed rule that will allow Scholarship Granting Organizations to continue serving the educational needs of children across the nation by empowering parents with the financial option, and freedom, to choose educational opportunities for their children that families believe is the best fit.

If you have any questions regarding this submission, please contact Leslie Hiner, Vice President of Legal Affairs, at leslie@edchoice.org or 317-681-0745.

Respectfully submitted,

Robert C. Enlow
President and CEO, EdChoice, Inc.

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REQUEST TO SPEAK REGARDING REG-107431-19

EdChoice requests the opportunity to speak at the public hearing scheduled for February 20, 2020.

Our topic will be modifications to the proposed rule to mitigate the impact on school choice scholarship donations which are incentivized by state tax benefits.

Contact: Leslie Hiner
leslie@edchoice.org
317-681-0745

Speaker: Leslie Hiner, EdChoice, Inc.