Tax Cuts and Jobs Act: Issues Impacting Tax Exempt Organizations and Charitable Giving
On December 22, 2017 the Tax Cuts and Jobs Act was signed into law by the President. Most of the provisions are effective for tax years beginning after December 31, 2017. While many of the suggested provisions were omitted from the new law, there are still various provisions that will impact tax-exempt entities.
One provision that made it into law relates to the use of tax-exempt bonds. While qualified section 501(c)(3) bonds are still allowed to be used, the law includes the provision to treat interest paid to advance refund bonds as taxable.
Effects on Charitable Giving
There are many new provisions that will impact charitable giving of individuals.
The new law increases the percentage of an individual’s adjusted gross income (“AGI”) that may be deducted for cash contributions to public charities and other certain tax- exempt organizations. Donors can now deduct certain charitable contributions of up to 60% of the individual’s AGI per year, up from 50%. In order for the 60% threshold to apply, charitable contributions must be only cash payments to public charities. If other property is given, the threshold reverts to 50%. As in the past, to the extent that the deduction is limited in a year, any excess can be carried forward for five years, subject to the same annual percentage limitations. This should be beneficial to charities since the increased percentage may be an incentive for individuals to give more to such charities.
The new law eliminates the “Pease limitation” which essentially capped the amount of itemized deductions including charitable contributions for high-income earners. This change should also have a direct and positive effect on charitable giving by allowing donors greater flexibility in the use of itemized deductions in reducing their income tax liabilities.
The new law increases the standard deduction from $6,350 for single filers and $12,700 for married filing joint filers up to $12,000 for single filers and $24,000 for married filing joint filers. This provision may be a disincentive for certain individuals to itemize, and which may negatively impact charitable giving. Similarly, we may see an adverse effect on planned giving with the new law’s provision for the immediate doubling of the estate, gift and generation-skipping tax exclusions. The new law increases this exclusion from $5 million to $10 million, indexed for inflation, and is applicable for decedents dying or gifts made after December 31, 2017 and before January 1, 2026.
One other change that made it into law that may adversely affect charitable giving is the repeal of the charitable deduction for payment to higher education institutions in exchange for the right to purchase tickets to or seating at an athletic event. This is likely to have a negative impact on higher education institutions with athletic programs.
Unrelated Business Taxable Income (“UBTI”)
The new law attempts to more clearly define streams of unrelated business income (“UBI”) by requiring that every tax-exempt organization calculate UBTI by activity, and not allow the losses from one unrelated activity to offset the income of another unrelated activity. Further, a net operating loss (“NOL”) deduction is allowed only with respect to a trade or business from which the loss arose. The effective date of this provision is for taxable years beginning after December 31, 2017. Under a special transition rule, NOLs arising in taxable years before January 1, 2018 that were carried forward are not subject to the new rules. In essence, this provision would put tax-exempt organizations at a disadvantage relative to commercial entities that can use losses from one activity to offset income from other activities. A planning opportunity might be to establish for-profit subsidiaries in order to aggregate their unrelated business activities.
UBTI will be subject to the new corporate tax rate of 21%, down from the previous rate of 35%, if the entity is structured as a C corporation. If the entity is structured as a trust, the new trust income tax rates will apply. The top rate for trusts is at 37%. These new rates apply for tax years beginning after December 31, 2017.
The new law impacts the tax treatment of fringe benefits. UBTI of an organization is required to be increased by any amount paid or incurred and for which a deduction is not allowable for any qualified transportation fringe benefits, such as transit checks and any parking facility used in connection with qualified parking, as well as any on-premise athletic facilities. In each case, the expense should not be directly connected to an unrelated trade or business that is regularly carried on by the exempt organization. The impact of this new provision will effectively create UBTI even when the organization has no unrelated trade or business and is paying these specific fringe benefits to employees who are conducting the charitable activities of the organization. Employers may need to consider whether to treat the benefit as taxable compensation to the employee thus avoiding the imposition of the unrelated business tax; continue to pay the benefit to the employees and incur the tax; or discontinue payment of the benefit entirely.
Nonprofits Will Be Subject to a New Excise Tax on Certain Executive Compensation
A new provision of the law will have a significant impact on larger tax-exempt entities. A 21% excise tax will be imposed on compensation (including benefits) in excess of $1 million paid to certain “covered employees,” which is defined as the five highest paid employees or those covered employees of the organization (or any predecessor) for any preceding taxable year beginning after December 31, 2016. Compensation would be treated as paid when rights to remuneration are not subject to a substantial risk of forfeiture. The excise tax also applies to certain severance payments. Compensation paid to licensed medical professionals for providing medical or veterinary services is excluded from this excise tax.
The new law is intended to create parity in this area between for-profits and nonprofits. This new excise tax will be very costly for nonprofits. While they may reduce compensation of employees as a way to avoid the excise tax, they might not be able to attract the same level of talent that they had previously.
The effective date of this provision is for taxable years beginning after December 31, 2017.
Excise Tax on Investment Income of Private Colleges and Universities
Certain private colleges and universities will be subject to a new 1.4% excise tax on the net investment income, which is similar to the excise tax imposed on private foundations. Private colleges and universities do not include state or community colleges or universities.
Private colleges and universities are subject to this tax if the aggregate fair market value of their assets, other than assets that are used directly in carrying out the institution’s exempt purpose, exceed $500,000 per student. In addition, the entity must have 500 or more students, at least half of whom are located in the United States.
This is the first time an excise tax on net investment income has been imposed on a subset of public charities. This type of tax has been imposed on private foundations for years.
Provisions that did not make the cut!
Modifications to Intermediate Sanctions Excise tax on Excess Benefits Transactions—the proposal to eliminate the “rebuttable presumption” of reasonableness safe harbor was not addressed in the new law.
Private Foundation Excise Tax on Investment Income—private foundations are currently subject to a 2% excise tax on net investment income. The rate can be reduced to 1% if the foundation’s qualifying distributions form the tax year is higher than the five-year average of its prior distributions as compared to non-charitable assets, as adjusted. The provision to drop the 2% rate to 1.4% and eliminate the 1% option was not included in the final bill.
Private Foundation Excise Tax on Failure to Distribute Income (POF/Art Museums)—the provision that was considered related to private operating foundations (“POF”) that are art museums, whereby the POF classification was available only if the art museum was open to the public for a minimum of 1,000 hours. It did not make the cut!
Exception from Excess Business Holdings Tax for Independently-Operated Philanthropic Business Holdings—current law provides that a private foundation, together with any disqualified persons, may not own more than a 20% interest in a for-profit business. A private foundation that does have an excess business holding is subject to a 10% excise tax based on the value of that excess holding. The provision that was considered, but did not make it to law, would have exempted private foundations from the excise tax as long as the foundation held 100% of the interests in the business enterprise and all profits of the business were directed toward a charitable purpose.
501(c)(3) Organizations Permitted to Make Statements Relating to Political Campaign in Ordinary Course of Activities—under the Johnson Amendment, organizations classified as 501(c)(3) organizations are prohibited from participating or intervening in any political campaign of any candidate for public office. The provision that did not become law would have allowed certain political activities in the “ordinary course” of their activities as long as such actions resulted in no more than a de minimis increase in expenses.
Additional Reporting requirements for Donor Advised Fund (“DAF”) Sponsoring Organizations—the provision that provided organizations administering DAFs must disclose additional information on their annual form 990 was not included in the final bill.
UBIT Proposal on Licensing of the Name or Logo of a Tax-Exempt Organization—the provision treating this type of licensing income as UBIT did not become law.
Nonprofits will need to review the new law to identify the provisions that will impact them. Proper planning should be done to mitigate adverse situations and determine the best was to move the organization forward.