For many years, state and local income and property taxes (SALT) have been deductible by taxpayers who itemize. However, the SALT deduction limit was set at $10,000 by the 2017 Tax Cuts and Jobs Act (TCJA). This limit was a concern for members of Congress from states with substantial income taxes. Taxpayers in those states who face high state or local income taxes and significant taxes on their homes were not able to deduct the full amount of those tax payments.

After a stirring debate in Congress, a compromise was reached, and the SALT limit increased to $40,000 in 2025 and $40,400 in 2026. It will be scaled up by an additional 1% each year until 2029. This higher limit will permit most taxpayers who itemize to deduct their full state and local income tax and the property tax on their home.

The new $40,000 SALT limit applies for 2025 through 2029. However, high income taxpayers will have a reduced deduction. If your 2025 income is over $500,000, your deduction is reduced by 30% of the excess amount. A couple with joint income of $550,000 would have a reduction of 30% of the $50,000 excess. Their SALT limit would be reduced by $15,000 and they could deduct $25,000.

The increased SALT deduction may benefit taxpayers in all 50 states, but the largest benefit will be states with higher taxes. Some top states are New York, California, Connecticut, New Jersey, Illinois and Minnesota.

Editor’s Note: The increased SALT deduction will cause more taxpayers to itemize. Some friends of nonprofits may discover that the SALT increase and charitable “bunching” could be helpful. The charitable “bunching” strategy is to give double the amounts to charity in one year and itemize deductions. The next year, the donor uses the standard deduction. This will be especially popular for those who benefit from the new $6,000 Senior Deduction (added to the standard deduction).

Mayo Clinic Qualifies as Educational Organization

In Mayo Clinic et al. v. United States; No. 23-2246 (8^th Cir. 2025), the Eighth Circuit determined that Mayo Clinic was a qualified Section 170(b)(1)(A)(ii) educational organization and exempt from unrelated business income tax (UBIT). Mayo Clinic qualified for a refund of approximately $11.5 million in UBIT related to property acquisitions from 2003 to 2012.

A Section 501(c)(3) organization must be "organized and operated exclusively for religious, charitable, scientific…or educational purposes." An educational institution with a regular faculty and curriculum and a body of students in a fixed place is qualified under Section 170(b)(1)(A)(ii).

When Congress created the acquisition indebtedness rules in the Tax Reform Act of 1969, they exempted educational organizations. However, in 2009 the Internal Revenue Service (IRS) determined that Mayo Clinic owed $11,501,621 in acquisition indebtedness UBIT. The IRS claimed that the UBIT was applicable because the "primary function" of Mayo Clinic was not formal instruction.

The District Court ruled that Reg. 1.170A-9(c)(1) was not valid and thus Mayo Clinic was a qualified educational organization. Mayo Clinic v. United States, 412 F. Supp. 3d 1038, 1042, 1057 (D. Minn. 2019). The Eighth Circuit reversed the invalidation of Reg. 1.170A-9(c)(1) and remanded the case to the District Court. Mayo Clinic v. United States, 997 F.3d 789, 802 (8th Cir. 2021) (Mayo I). In Mayo I, the District Court determined that patient care was inextricably linked to the educational purpose of Mayo Clinic. Therefore, Mayo Clinic did qualify for the exemption because it had "no substantial noneducational purpose."

Mayo Clinic operates five separate educational programs that are related to the medical or health sciences field. The original 1919 Deed of Gift stated it existed for "the promotion of medical, surgical, and scientific learning, skill, education, and investigation." All five schools directly relate to the Mayo Clinic health science purpose. The educational and research activities operate at a significant loss and the patient care and endowment funds are required to continue in operation.

The IRS claimed that an educational organization must have not just a "primary purpose" but also that education must be the "principal or most important purpose." However, the applicable regulation includes "museums, zoos, planetariums, symphony orchestras, and other similar organizations" in the examples of educational organizations. Therefore, while patient care is a substantial purpose, it is "not noneducational at Mayo.”

While there are various cases that attempts to define "primary purpose," the District Court determined that patient care was part of an integrated organization. Therefore, it held that the patient care was not noneducational and the exemption did apply.

The IRS noted this interpretation may enable a large number of institutions to qualify as an "educational organization" and could create serious problems in tax administration. The Eighth Circuit decided this was not a sufficient reason to change the decision. Mayo Clinic received a refund plus interest on the $11.5 million UBIT payment.

Captive Insurance Premiums Not Deductible

In Curtis K. Kadau et al. v. Commissioner; No. 286-21; T.C. Memo. 2025-81, the Tax Court determined that a micro-captive insurance company was not a qualified insurance arrangement because there was not the required assumption of risk. Therefore, the insurance premiums were not deductible. While the increased IRS deficiency of $131,308 was rejected by the Tax Court, there was a Sec. 6662(a) 20% accuracy-related penalty.

Surface Engineering & Alloy Co., Inc. (Surface) was an S corporation owned by Curtis K. Kadau. For several years, the corporation purchased commercial insurance for multiple purposes.

In 2012, Kadau met with the RMC Group and discussed the creation of a captive insurance company to be domiciled in Nevis. The RMC Group requested an analysis by actuary Marn Rivelle. Based on that analysis, the projected losses were approximately $1.1 million, and the recommended premium funding was $1.2 million. Risk & Asset was incorporated in Nevis on October 3, 2012. Mr. Kadau and William Jackson Arnold were the directors, officers and investment committee. Substantial premiums were paid to RMC Group. After deductions by RMC Group for their fees, the premiums were then returned to Risk & Asset. The IRS audited Surface, denied deductions for the premium payments and assessed penalties of 40% (or in the alternative 20%) for misstatement of deductions.

A micro-captive insurance company is permitted under an election in Section 831(b). The micro-captive insurance company is taxed on its investment income but is not subject to tax on premiums. Companies generally will deduct insurance premiums under Section 162(a) as ordinary and necessary expenses. These deductions may include payments to a micro-captive insurance program, so long as it qualifies as insurance.

The basic four factors in deciding whether an arrangement constitutes insurance are: (1) there must be an insurance risk, (2) there needs to be a risk of loss to the insurer, (3) the insurer must distribute risk among policyholders and (4) the agreement must be insurance in the common accepted sense.

The Tax Court determined that the taxpayers did not show that there was a distribution of risk of loss and the arrangement "is not insurance for federal income tax purposes."

Micro-captive promoters claim that by creating multiple policies, there is a sufficiently large pool of unrelated risks. However, there are multiple factors that determine whether or not there is actual insurance: (1) an insurance company is created for nontax reasons, (2) there must not be a circular flow of funds, (3) there must be an insurable risk, (4) an arm’s-length contract, (5) actuarially determined premiums, (6) costs similar to comparable coverage, (7) the insured and the micro-captive must be subject to regulatory control, (8) must be adequately capitalized and (9) maintain a separate account which is used to pay claims.

Because Kadau was the owner of Surface, and the funds were transferred from RMC Property back to the controlled entity Risk & Asset, there was a "near circular flow of funds." In addition, the IRS expert showed the premiums were between 2.5 and 3.5 times the cost of commercial coverage. Finally, there was only $50,000 of initial capitalization plus an additional premium of $300,000 paid to Risk & Asset. Therefore, it was significantly undercapitalized.

The taxpayer claimed that actuary Rivelle made appropriate estimates based on the potential risk. However, the premiums paid were substantially more than would have been appropriate in an arm’s-length transaction.

Other insurance business factors would be to determine whether it was adequately capitalized, the policies were valid and binding, the premiums were reasonable, and claims were appropriately paid. The relationship between Risk & Asset and RMC Group did not meet the standards of typical business practice. There were also defects in many of the policies that suggested there was not an actual attempt to provide insurance. Based upon these factors, the Tax Court determined that this was not insurance in the traditional sense.

The Tax Court did reject the IRS efforts to assess an additional penalty. It also determined that the 40% accuracy-related penalty was not applicable because the issue is going to be addressed in a later case.

The remaining 20% misstatement penalty under Section 6662 may be negated by a reasonable cause defense. The Tax Court noted a reasonable cause defense is available if there is advice "from a competent and independent advisor unburdened with a conflict of interest and not from promoters of the investment." Because RMC Group were the promoters, they did not qualify as independent advisors. Therefore, the 20% penalty for overstatement was applicable under Section 6662(a).

Editor's Note: The Tax Court is placing taxpayers on notice that micro-captives will be carefully examined for proper business practices. Professional advisors of business owners who are considering a micro-captive should review carefully the transaction to make certain that the promoters follow good business practices. There must be an adequately funded organization and reasonable premiums.

Applicable Federal Rate of 4.8% for August: Rev. Rul. 2025-14; 2025-32 IRB 1 (15 July 2025)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2025. The AFR under Sec. 7520 for the month of August is 4.8%. The rates for July of 5.0% or June of 5.0% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2025, pooled income funds in existence less than three tax years must use a 4.0% deemed rate of return. Charitable gift receipts should state, “No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property.”