TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, December 29, 2009

Arizona Tuition Tax Credit Program May Violate Federal Tax Law

Arizona Republic, Ariz. Tuition-Credit Practices May Violate Federal Tax Laws:

This month, as the tax year nears an end, thousands of Arizonans are expected to donate money to private-school tuition groups and claim a tax credit that reduces what they owe the state.

Many taxpayers will recommend that their money go to specific students as scholarships; many tuition groups will honor those wishes.

But these taxpayers, and the school tuition organizations that give out the scholarships, may be running afoul of federal tax law.

The legal do's and don'ts are not entirely clear because the IRS has not ruled specifically on tax-credit donations targeted to particular students. But disputes run deep among private-school and tuition-group operators and tax experts over the legality of recommending that specific students get the scholarships.

A typical scenario illustrates how such legal concerns arise:

  • A married couple decide to make a maximum $1,000 donation using the tax credit. They send a check to a tuition group and indicate they want the money to go to the husband's nephew.
  • The tuition organization honors the recommendation and allocates a roughly $1,000 tuition scholarship to the nephew.
  • Come tax time, the couple file an Arizona income-tax return claiming the $1,000 tax credit. Their tax bill is reduced by that amount. At the same time, they claim a $1,000 charitable deduction on their federal tax return because the donation went to a non-profit, tax-exempt tuition group. Their taxable income is reduced by $1,000. Without that deduction, the couple's federal tax bill would increase because the donated $1,000 would still be considered taxable income.
  • In a common variation, the couple also have a child in private school. State law bars them from making a donation to a tuition organization to directly benefit their own child. But the couple have friends whose child attends the same school. The two couples strike a deal to make $1,000 tax-credit donations for each other's children, a practice called "swapping." Both claim the state tax credit and the federal deduction.

Tax preparers and attorneys say this scenario raises three key legal questions:

  1. Are taxpayers allowed to claim a charitable deduction on their federal tax forms for a donation intended for a specific student?
  2. Is it legal for taxpayers to claim that same deduction when they swap donations with other parents?
  3. Are non-profit tuition organizations, which are 501(c)(3) charities under tax law, allowed to accept and honor requests from donors that the money go to particular students?
(Hat Tip: Joel Michael.)

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Great insight on an issue that isn't completely covered and specific, that can only lead to loop holes.

Posted by: The tax Club | Dec 29, 2009 10:38:44 AM