Since the original writing of this article, Treasury Decision 9864 clarified the relationship between state and local tax credits and the federal tax rules for charitable contribution deductions. The IRS released a press release that summarizes these changes, indicating that a taxpayer must reduce the federal charitable contribution deduction by the amount of any state or local tax credit that the taxpayer receives or expects to receive in return. The analysis described in the article has been updated to reflect this change. As was written in the original article, the analysis is general in nature, and the contents should not be relied upon for legal or tax advice, especially since there can always be new changes to tax law or the NAP program. To analyze and understand your specific situation, please consult your CPA or other professional for advice.
If you are a Virginian, there is a little-known program that can create massive tax breaks for you while also supporting nonprofits that provide neighborhood social services such as health care, education, housing, job training and food for impoverished populations.
The program is called the Virginia Neighborhood Assistance Program (NAP). To encourage support for charitable organizations servicing low-income communities, NAP provides a 65% Virginia state tax credit in exchange for charitable gifts to approved NAP nonprofit organizations.
In fact, if you are a high-income earner, you may receive back more tax benefits than you gave to the charity in the first place, akin to an instant positive return on investment. What’s more, the recent passing of the Tax Cuts and Jobs Act of 2017 could have made this program even more attractive to certain taxpayers.
You can also combine the tax benefits of the NAP program with avoidance of capital gains taxes by gifting appreciated securities (such as stocks and mutual funds) to make the whole transaction even more attractive. As described in the detailed analysis in this article, a person in the top tax bracket gifting highly appreciated stock could be receiving roughy $1 of tax benefits for every $1 gifted.
While this program and its substantial financial attractiveness are not widely known, many savvy taxpayers and their advisors are aware of this opportunity so the program is in high demand. As such, you should research which NAP charity or charities you would like to support and develop a relationship with their development office so that you can access some of their allocated credits each year. In this article, an illustrative example is analyzed to describe how the program works and how the various tax credits and deductions really add up.
Please note that the following information has been compiled by the author from various sources, the analysis is general in nature, and the contents should not be relied upon for legal or tax advice. To analyze and understand your specific situation, please consult your CPA or other professional for advice.
Virginia Neighborhood Assistance Program Overview
In 1981, the Virginia General Assembly established a program within the tax code to encourage individuals, businesses, and trusts to donate to charitable organizations serving low-income communities. These charities provide a range of social and educational services such as health care, education, housing, job training and food to impoverished populations living in Virginia.
The program provides a total of $17 million in tax credits each year. $8 million are allocated for the Virginia Department of Social Services (VDSS) to administer for General Human Services organizations and $9 million are allocated for the Department of Education (DOE) to administer for Education organizations. There are also similar programs in several other states including Pennsylvania, Indiana, and Missouri.
Due to changes in the Virginia tax code in 2013 you get in return a 65% Virginia state tax credit for the amount donated, which is then applied to your state income tax liability. As will be discussed later, when including federal and state deductions you receive for charitable gifts, depending on your tax bracket, you could receive tax benefits close to the actual gift.
What Charities are Eligible for the Virginia Neighborhood Assistance Program?
501(c)(3) non-profits must apply each year for an allocation of credits under the NAP program which they can then allocate to their donors. To be eligible for NAP, the non-profit must:
- Have 501(c) (3) status
- Have provided neighborhood assistance for low-income persons or an eligible student with a disability for at least 1 year
- Have no significant areas of concern for the ongoing operation of the organization
- Have an audit or compilation performed by an independent certified public accountant.
- Have at least 75% of total revenue received spent on support each year for ongoing programs
- Have at least 50% of the total revenue spent and people served are low-income.
Organizations must reapply each year for the July 1 to July 30 program cycle. Approved charities under the Virginia Department of Social Services can be found here and approved charities under the Department of Education can be found here.
To be eligible for the 65% Virginia credit, individuals must contribute a minimum of $500 and maximum of $125,000 per year in the form of cash or marketable securities.
Businesses must contribute a minimum of $616 (no maximum) in the form of cash, merchandise, rent/lease facility, professional services, pharmaceutical services, and physician specialist services. Business entities must be authorized to do business in the Commonwealth of Virginia.
Licensed professionals such as physicians, dentists, nurses, nurse practitioners, professional counselors, clinical social workers, clinical psychologists, and marriage and family therapists who donate their services for an approved clinic may also be eligible for credits.
Tax credits are non-refundable; however, Neighborhood Assistance Tax Credits that exceed the donor’s total Virginia State tax liability may be carried forward for up to five years. The tax credit for the current year is utilized first, prior to using the credit that has been carried forward from a preceding taxable year.
Basic Tax Benefits to the Donor
A 65% state tax credit is a powerful incentive for donors. Right off the bat, you get $0.65 back for every $1 you contribute to an approved charity.
If you itemize deductions on your federal tax return, you also get a charitable deduction for your charity as well, which then also flows through to your tax return in the form of a lower taxable income. Per Treasury Decision 9864, a taxpayer must reduce the federal charitable contribution deduction by the amount of any state or local tax credit that the taxpayer receives or expects to receive in return.
You must also consider, however, that state taxes are a federal deduction (although all state and local taxes are now subject to a maximum deduction of $10,000 under the Tax Cuts and Jobs Act of 2017, which I will address in a bit). If you were going to deduct your state taxes and now your state taxes are lower because of the tax credit, you must subtract the loss of deduction from the equation.
Nerd note: The calculation to do this is state tax rate (5.75%) plus state tax credit (65%), all multiplied by your federal marginal tax rate. For example, for a middle bracket family (24% in 2018), for every $1 of charitable contributions, federal deductions would be lower by $0.16 ($1 X (5.75%*(1-65%)+65%) X 24%). Therefore, when considering the positive tax benefits of the NAP gift (65% state tax credit, 24% of 35% of charitable deduction for federal taxes, and 5.75% of 35% of charitable deduction for state taxes which all add up to 75%), you must subtract 16% to get the actual after-tax benefit.
All told, a middle-bracket family (24% in 2018) gets total tax relief of $0.59 for each $1 of charitable contributions under this program.
More Tax Benefits Due to Tax Cuts and Jobs Act 2017
As mentioned in the previous section, the tax benefits of the NAP donation are dampened by the fact that lower state taxes results in a decrease in state tax deductions. However, under the Tax Cuts and Jobs Act 2017, deductions for state and local taxes (SALT) are now limited to $10,000. This means that if the sum of your state tax, real estate taxes, and personal property taxes are over $10,000, the decrease in state taxes from the NAP donation may not result in a decrease in SALT deductions.
Nerd Note: For example, let’s say you have around $200,000 taxable income in 2018 with approximately $11,500 in associated state taxes. You also have $8,000 in real estate taxes and $1,000 in personal property tax. Your SALT is $20,500. However, you can only deduct $10,000. If you make a $1,000 NAP donation, your state taxes goes down by $670 ($1000 x 65% tax credit plus 5.75% of 35% for the deduction). Your total SALT is now $19,830, but you still can only deduct $10,000 so the NAP donation had no impact on your SALT deduction.
In these situations, the NAP donation tax benefit is a lot more powerful. The same middle bracket family (24% marginal tax bracket) gets tax relief of 75% instead of the original 59%.
After taking into account the improved results due to the SALT deduction limitation, the arithmetic for the high-income earner becomes interesting - the tax benefits become even higher.
Nerd Note: Even though the loss of the SALT deduction results from the Tax Cuts and Jobs Act of 2017, the same phenomenon happened to many taxpayers who were subject to the alternative minimum tax (AMT) where SALT deductions are eliminated.
In the chart below, you can see how the cumulative tax benefit of a NAP donation increases as your income rises.
Nerd Note: The chart above does not include the phase-out of itemized deductions as income rises (known at the Pease Limitation) which would have a dampening effect of the federal tax deduction for charitable contribution. However, the Pease Limitation was repealed as part of the Tax Cuts and Jobs Act of 2017 and so does not affect the results. The analysis above also does not consider taxpayers potentially being subject to the alternative minimum tax.
Adding Benefits of Gifting Marketable Securities
Individuals can donate not only cash, but also marketable securities such as stocks and mutual funds to eligible charities under the NAP program. Since the charities themselves liquidate the marketable securities and do not pay income taxes, any capital gains that would have been owed by the donor if they sold it themselves are avoided.
In 2018, long-term capital gains are taxed at the federal level at 0% for taxable income below $77,200, 15% for taxable income between $77,200 and $479,000, and 20% for taxable income above $479,000. For those taxpayers with modified adjusted gross income above $200,000 ($250,000 if married filing jointly) there is also a 3.8% net investment income tax on unearned income above these thresholds.
Therefore, there are essentially four federal tax brackets: 0%, 15%, 18.8%, and 23.8% - plus the 5.75% marginal Virginia state tax rate.
Let’s illustrate capital gain tax savings by example. Let’s say you are married filing jointly and your taxable income is $350,000. You bought a stock 10 years ago for $50,000 and now it has doubled to $100,000. Your capital gain is $50,000. Your capital gain tax rate is 24.55% and so your capital gain tax would be $19,830.
Nerd Note: 22.55% if calculated as 15% capital gains rate plus 3.8% net investment income tax on unearned income plus 5.75% state tax rate and assumes you already have $10,000 of SALT deductions and therefore do not “lose” SALT deductions.
If you gift this $100,000 of stock, you avoid $12,275 in capital gain taxes that you would have paid at some point if you ever sold the stock. In fact, after gifting the stock, you could turn around and buy $100,000 of the same stock. When you ultimately sold it in the future, you would have avoided $12,275 in capital gain taxes because your cost basis is $100,000 now instead of $50,000.
Nerd Note: To be more precise, you are saving $12,275 in nominal terms, not today dollars. To calculate the precise amount of savings you would need to know how far in to the future you plan to sell the security and discount back the benefit based on time value of money.
Nerd Note: Advanced-age donors should be aware that appreciated securities you own would receive a step up in cost basis at death and so if you plan to die with the investment, there is not truly a tax benefit (to the heirs in this case).
Here is a summary table of the potential capital gain savings from gifting appreciated securities. The rows indicate how much capital gain there is relative to the cost basis of the security (50% represents a doubling, 75% represents a quadrupling, etc.) and the columns represent the tax rates.
Nerd Note: This table assumes you already have $10,000 of SALT deductions and therefore do not “lose” SALT deductions
Summarizing the Tax Benefits of a NAP Gift
The total tax benefits of a NAP gift really depend on your tax situation. To illustrate the range of opportunity, here are a few scenarios:
Obviously, this list of possible scenarios is not comprehensive, but it is provided to show you the range of potential opportunity here (from a tax perspective). At worst, you get a 65% state tax deduction (if your gift was in cash and you do not itemize deductions). Therefore, you cannot claim any other tax benefits from charitable gifts other than the 65% tax credit.
You will also notice that in any scenario in which you do not lose state tax deductions, you get at least 75% of tax benefits.
How to Take Advantage of the NAP Program
Qualified NAP organizations are listed on the Virginia Government websites. There are two lists since the program allocation is split between the Virginia Department of Social Services (VDSS) to administer for General Human Services organizations and the Department of Education (DOE) to administer for Education organizations.
- Approved organizations for 2017-2018 Neighborhood Assistance Programs through VDSS
- Approved organizations for 2017-2018 Neighborhood Assistance Programs through DOE
You can search these lists for charities locally and you may already support these organizations.
Once you have selected a candidate charity, consult with the organization’s development office to determine the availability of NAP tax credits. Each charity gets allocated a certain amount of credits based on its application and while the NAP program is not widely known, many savvy taxpayers and their advisors are aware of the program and jump on the opportunity. Therefore, credits generally get used up fast.
Since these tax credits are in high demand, you should consider developing a relationship with the candidate charity in advance of a future NAP program cycle (which starts July 1 of every year). Plan on making arrangements to make your donation at the beginning of the cycle before they are used up.
Be advised that that your donation must also meet the minimum tax credit donation amounts ($500 for individuals, 616 for businesses) and each organization may have its own criteria for eligibility of NAP tax credits (for example, having a higher minimum accepted donation to account for the processing time required by the charity and high demand for these credits).
The donation must be made directly to the NAP organization with no strings attached and without any conditions or expectations of monetary or other benefits. Discounted property, partial donations or bargain sales are not allowable for NAP donations.
To process the actual NAP donation application, you fill out the appropriate Contribution Notification Form (CNF) (see here for forms for the VDSS program and see here for forms for the DOE program) and return it back to the approved organization. The NAP organization will then forward the contribution notification form to VDSS or DOE to have your tax certificate issued. Processing time for tax certificates is generally 4-6 weeks and you attach this proof of NAP donation to your Virginia tax return.
For more information, reference the Neighborhood Assistance Program on the Virginia Department of Social Services website or the Virginia Department of Education website or reach out to me with questions.
Questions or comments? Email me at email@example.com , call the office at 703-821-2000 ext. 215 , or get me on my cell phone at 703-501-3495 .
The information is the personal views of Josh Stillman and is not necessarily indicative of those of Capitol Financial Consultants, Inc. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. Any opinions expressed here are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected.