SALT Cap Litigation and What It Means for Pennsylvania’s EITC Donors

The federal $10,000 cap on the state and local tax (SALT) deduction, enacted as part of the 2017 Tax Cuts and Jobs Act, continues to shape tax policy debates across the country. States that rely heavily on income taxes, including New York, New Jersey, and Connecticut, attempted to design charitable contribution mechanisms as a workaround to the cap. These programs sought to transform nondeductible SALT payments into deductible charitable contributions.

This strategy faced a decisive setback by the U.S. Court of Appeals for the Second Circuit. In New York v. Yellen, 88 F.4th 89 (2d Cir. 2025), the U.S. Court of Appeals for the Second Circuit upheld Treasury Department regulations limiting federal charitable deductions when a taxpayer receives a state tax credit in return for their contribution (see Tax Notes coverage at here). The decision confirms that the Internal Revenue Service (IRS) has broad authority to treat such arrangements as quid pro quo transactions, rather than true charitable gifts.

The Second Circuit’s Reasoning

At issue were state-created funds designed to preserve the federal deductibility of SALT payments. Taxpayers could “donate” to state charitable vehicles, receive a near-dollar-for-dollar state tax credit, and then attempt to deduct the full amount federally as a charitable contribution under I.R.C. § 170.

In response, the IRS issued Treas. Reg. § 170A-1(h)(3) (T.D. 9864, 84 Fed. Reg. 27513 (June 13, 2019)),  (see federal registry here)which reduces the amount treated as a charitable contribution by the value of any state or local tax credit received. For example, if a taxpayer contributed $10,000 and received a 90% state tax credit ($9,000), only $1,000 would qualify as a federal charitable deduction.

The Second Circuit upheld this regulatory approach, reasoning that:

• Quid pro quo doctrine applies. A charitable gift must be made without an expectation of receiving substantial benefits in return. A state tax credit is precisely such a benefit.
• IRS regulations were reasonable. Here, the court applied what’s known as the Chevron doctrine: if a statute is unclear, agencies like the IRS are allowed to fill in the details. Courts will uphold that interpretation as long as it’s sensible.
• Federal law prevails. States cannot redesign tax payments to sidestep federal limitations.

In sum, the court found that the IRS properly treated state tax credits as benefits received in exchange for contributions, not as true charitable gifts.

Key Distinction: Pennsylvania’s EITC and OSTC

Pennsylvania’s Educational Improvement Tax Credit (EITC) and Opportunity Scholarship Tax Credit (OSTC) programs share superficial similarities with the programs at issue in New York v. Yellen: both provide state tax credits for contributions to designated funds. But there are crucial distinctions that preserve the integrity and continued viability of Pennsylvania’s system:

1. Purpose. The EITC and OSTC were enacted in 2001, long before the 2017 SALT cap. Their intent is educational support, not federal tax avoidance.
2. Federal treatment. Donors in Pennsylvania are not permitted to claim both a state tax credit and a federal charitable deduction. This “double dip” is precisely what the IRS and courts rejected.
3. Alternative deduction path. For businesses and pass-throughs, contributions may qualify as ordinary and necessary business expenses under Treas. Reg. § 1.162-15(a)(1), so long as they are made with a legitimate business purpose (such as public relations, goodwill, or community investment). That regulation makes clear that “[p]ayments to organizations described in section 170 which bear a direct relationship to the taxpayer’s trade or business and are made with a reasonable expectation of financial return commensurate with the amount of the payment may constitute allowable deductions as trade or business expenses rather than as charitable contributions.”

In other words, Pennsylvania’s EITC is not a SALT cap workaround, it is a longstanding, education-focused program that fits within accepted federal tax rules when structured properly.

What This Means for Pennsylvania Educational Improvement Tax Credit Donors

For Pennsylvania taxpayers, individuals, partnerships, and S corporations, the implications are straightforward:

• You continue to receive the Pennsylvania state tax credit for your EITC/OSTC contribution: 75% if you commit for a single year, or 90% if you commit for two consecutive years.
• You cannot claim a charitable deduction for the same dollars the IRS has closed that door nationwide.
• You may qualify for a federal business deduction if contributions are structured through a business entity or special purpose entity with a business rationale.

Friends of Education: A Trusted Partner

In this evolving legal environment, Friends of Education plays a vital role for donors:

• Friends of Education collaborates with businesses, families, and advisors to navigate the complexities of contribution structuring, documentation, and tax reporting of the Scholarship and Educational Improvement Tax Credit Program.

By working with Friends of Education, donors can be confident that their contributions are both tax-compliant and transformative for Pennsylvania students.

Friends of Education is also preparing to qualify as a federal Scholarship Granting Organization (SGO) under newly enacted federal legislation, ensuring continued alignment with IRS standards.

If you have any questions pertaining to the Pennsylvania EITC tax credit program, then check out our FAQs here.  For more information, contact us.