The Tip Credit: Key Rules, Limitations and What Businesses Need to Know

Welcome to Traction with the Tiger. I am your host and tax tiger, Chris Wittich. I focus on moving myself, my clients, my firm, and the profession forward. Today we are talking about a unique tax credit. It is for scholarship granting organizations. It’s also abbreviated SGOs. If you look in like the actual tax code, you will find it.

The SGO tax credit

Under section 25 F. so some people might refer to it that way, but I would sort of just call it the SGO tax credit. So this is a new tax credit. It starts in 2027. So nobody has claimed it on their 25 returns. Nobody is going to claim it on their 26 returns. So why are we talking about something so far in advance?

because it’s very unique and very unusual and powerful. So at the sort of the base level, you can get individuals can get a seventeen hundred dollar tax credit if they contribute seventeen hundred dollars of cash to an SGO. So we’re saying

If they give 1700 of cash, they essentially get seventeen hundred of cash back from the IRS. You get a 100% tax credit for giving money to a qualifying organization, these SGOs. And so that’s that’s why it’s unusual and it’s powerful and the rules are, I’ll say, interesting and and a little hard to follow.

in my opinion, but when we’re giving money to regular charitable contributions, regular charitable organizations, you know, the maximum benefit you’re getting, the in top individual rate is 37%. So maybe you’re getting 37 cents of benefit. And, you know, maybe you’re getting some state benefit for that as well. Call it, you know, a maximum of.

maybe 40 or 45 cents on the dollar of benefit. But with this SGO, you’re getting a 100% credit. You are getting a full dollar back for every dollar that you donate. So it’s the only thing I’m really aware of where I spend a dollar and I get a dollar back. so that makes it very unusual. So what are these SGOs? They are scholarship granting

Organizations. And so they are they are giving scholarships to K-12 students. if you think about it, they are one of the requirements is that they spend at least 90% of their funds on scholarships for kids. So, you know, practically speaking, this is all they do, and they spend all of their money doing it.

And they need to have sort of a low administrative cost to get it done. So who are they sort of giving these scholarships to? Well, you know, public schools are free to attend. they are not giving these scholarships to kids going to public school. They’re giving these scholarships to kids going to private schools or charter schools.

And that’s the part that makes it a little bit unique. And and what we’ll get into is that some states are going to allow this and some states are not. And that’s the reason why some states are not going to, because it’s really putting money into sort of private education for K-12 students who need the money and you know can benefit from it. But it is not putting money into.

Sort of the public school realm. And so you you can see some states are maybe not as enthused about that as others. And so in order to sort of qualify for the credit, the SGO itself has to qualify. And so they need to meet their requirements, like they need to spend 90% of their funds on.

Scholarships. They can’t be spending it on marketing. They can’t be spending it on salaries, administrative stuff. They have to spend it on scholarships. Okay. But then from there, the state itself needs to opt in to the program. And then the state needs to certify all of these SGOs. So it is a federal tax credit, which is kind of being administered.

The state opt-in process

And opted into by the states. So that’s a little bit odd. you know, our itemized deductions are not determined by whether or not you live in Minnesota or Wisconsin. Like the rules are the same, but the rules are going to be different depending on what state you live in. So the state itself has to opt into the program, and then the state certifies that these SGOs are sort of meeting the requirements, and the state is going to list.

Publicly every SGO that qualifies in their state. So then the taxpayers, they’re not guessing. They know exactly like either they’re on the list and they qualify, or they’re not on the list and they don’t qualify. so that’s different, but the states have got to do that so that people can get this credit on their federal return. So it’s sort of a weird thing where the states are interacting with this federal tax credit.

Then the individuals they make contributions to these SGOs. It needs to be, you know, a cash contribution, and you can’t double dip. So you can’t use it for the credit, but then also claim it as a charitable contribution on Schedule A. You can’t claim it as a federal credit and then also claim it as a state credit because there are some states that have similar programs. So you can see how it gets a little messy, but

You know, it can be worth it. Certainly a $1,700 credit for giving $1,700 to a charity that you want to support, like that is very compelling. that’s far more compelling than any other tax deduction I can I can tell you about.

IRS guidance and timing

So the IRS has indicated that some guidance is coming. they gave sort of a rough, I’ll say, outline of what that guidance might look like and some of the things it will address.

it sounds like in or by September there should be some real regulations. So we’re talking about September of 2026. So that’ll be helpful so that in time for the end of the year, so the January first, twenty twenty seven, this tax credit becomes a real thing and you can make these contributions starting in twenty twenty seven. But then the states need to opt in.

And the states need to certify that these SGO entities are qualifying. And the states need to publish the list of all these SGOs that qualify. So I think that timing sounds pretty good, where we’ll get some regulations in September of twenty six. People have a little bit of time to digest it, work through it at the state level, also sort of understand how it’s gonna work on the federal, because there are definitely some open items, some open questions.

States that have opted in

So along that that same line, you know, one of the key things we’ve been talking about is that the states themselves need to opt in to the program. And some states have done that already. Some states have not yet. And some states, you know, have said they’re not going to. Right? And so the the IRS actually has a list.

Published, if you go to their website, you will see the list of states that have opted in. I can’t tell you the exact deadline for them to opt in. I I assume it’s like January 1st, 2027. So they still have time. If your state is not on the list today, they might be by January. This does not indicate that they won’t be on the list. It just means they’re not now.

And so on July 6th, actually July 7th, the IRS published their list of states that have opted in. I counted like 29 states that have opted into this program. And I will read you the list of states so you know if your state is on the list or not. But as you’re listening to the states,

I think what you will find is that there’s a lot of red states on this list. And there’s not very many blue states on this list. That doesn’t mean the blue states won’t come around and and opt into it, but I think you’re seeing this difference because of sort of where the money is going and the private schools versus the public schools. You can see there’s some, you know.

religious private schools in the red states that they’re more excited to support than the blue states. I’ll say like here in Minnesota. I haven’t heard our governor talk about it a ton, but you can sort of see our governor in Minnesota, he used to be a public school teacher. So it seems obvious, I think, that the public school like unions might be lobbying him

Against opting into this program. and you can see how that would influence him. perhaps there’s certainly groups that are trying to lobby him so that he opts in to the program. And I don’t know if he’s going to, but you can kind of see where his motivation might lie. And and I don’t know where it’ll end, but let me just run through these quick, and you’ll see it’s it’s mostly the red states that have opted in, opted in early.

I’ll say that doesn’t mean more states won’t come around. That doesn’t mean there won’t be, you know, twenty-one more states that opt into this, but Alabama, Alaska, Arkansas, Colorado, Florida, Georgia, Idaho, Indiana, Iowa, Kansas, Louisiana, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Dakota, North Carolina.

Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, and Wyoming. So you notice that Minnesota is not on that list. Wisconsin is not on that list. but like our neighbors in the Dakotas and Iowa, they are on the list. So I would check back.

A unique planning opportunity

But this is definitely a unique planning opportunity for individuals who are terribly inclined in the first place, like a hundred percent tax credit. And this is seventeen hundred dollars per person. So a joint couple, we’re talking about thirty four hundred dollars. You can give to sort of an SGO of your choosing, and then the IRS will reimburse you for it. So that’s a tremendous opportunity. It’s a

It’s a little bit odd how it’s administered by the states, but then the federal government is the one giving the credit. But keep an eye on the regulations that should be coming. Keep an eye on the list of states that opt in or opt out. And then the other thing I will I will mention about this is that some states, I think there’s about twenty states or so, they have a similar state run program.

Where if you give money to some type of similar SGO, you can get a tax credit on your state return. And often those credits, they they might be like 50% or 75%. So they’re not as generous as the 100% on the federal, but that’s you can see like if a state has a a program like this, that state is gonna opt in.

To the federal program because it’s essentially the same concept, it’s the same idea, very similar requirements. So you can see this is already a thing in in about 20 states across the country. And now at the federal level, it’s going to be a thing in at least 29 states, could be more.

Double-dipping and tracking contributions

And another, another you know, sort of thing to keep in mind is that you can’t double dip in between those, right? If you give

$1,000 and it’s qualifying for a state credit, you can’t then use the same $1,000 and use it as a 100% federal credit. So the tracing of funds and the tracking of funds will be important, especially if you have a state level program, so that you’re not double dipping with the state program or you’re not double dipping with your sort of itemized deductions. So keep that in mind.

Keep an eye out

But

Keep an eye out. I think it’ll be a key planning opportunity for you to be aware of. And and really by January of 2027, we should have this sorted out because we’ll have regulations, we’ll have the list of states that have opted in. And then each of those states will have published a list of the qualifying SGOs. And so at that point, you could take that list. You know, if I’m in Minnesota and Minnesota does opt in.

I will know there are exactly, you know, 17 or 72 different SGOs in the state that qualify. I’ll have that list. I could provide it to my clients. I could explain to my clients, hey, this opportunity exists. We’re here in Minnesota. This is the list. You gotta stick to the list in order to get the federal tax credit. So I think that’s kind of the planning opportunity for people, for practitioners.

And for, you know, just taxpayers to understand. So keep an eye on it. I think more to come, but that’s a that’s a pretty good overview as we have it, at least right now, but but more information from the IRS and from the states to come. I hope you found this interesting and useful. If you did, please share with a friend and subscribe for more Traction with the Tiger content.