Tax Reform – The Impact of The Tax Cuts and Jobs Act on Tax Exempt Organizations and Charitable Giving
December 13, 2017
By Christopher Meringolo and Cindy Feder
We are on the brink of seeing the first major overhaul of the tax code since the Reagan administration’s Tax Reform Act of 1986. Tax reform has been at the forefront of the political stage since the Trump administration’s promise of a simplified tax code throughout the campaign trail leading up to the 2016 presidential election. With a little less than two weeks to go until both the House and Senate recess for the holidays, the sense of urgency around tax reform has increased, and both the House and Senate now have passed separate sweeping tax reform bills. Although the bills are similar, there remain differences which will be debated, with the hopes of achieving a revised bill that both sides can agree to pass. The new tax legislation, The Tax Cuts and Jobs Act, once ratified will go into effect for tax years beginning after December 31, 2017, and incorporates major changes to personal and corporate income taxes, estate taxes, and other changes to laws that will impact tax exempt organizations. Several key areas have been targeted in both bills including changes affecting tax exempt bond financing, charitable contributions, excise taxes, and unrelated business income taxes.
One provision that may impact exempt organizations relates to private activity bonds. The bill from the House contains a provision for the elimination of the federal tax exemption for interest earned on all private activity bonds or what is commonly known as tax exempt bond financing, while the Senate bill would only repeal the exclusion from income for interest on state and local bonds issued to “advance refund” another bond. Tax exempt bonds have long been used by state and local governments and tax exempt entities to secure financing for large capital projects. The allure of these bonds to investors, borrowers, and lenders alike is that the interest earned is exempt from federal, state, and local income taxes. With the elimination of the tax exemption on this financing vehicle, borrowing costs could increase for those who commonly use this type of financing including research institutions, charter schools, universities, hospitals, and other tax exempt health care and human services institutions. These added costs wouldn’t necessarily directly impact the cost of borrowing, but they would remove the incentive to invest in these bonds therefore indirectly making it more difficult for borrowers to secure this type of financing.
Another major area that could be affected by both bills is charitable giving by individuals to certain tax exempt organizations. While some of the new provisions of both bills would have a positive effect on charitable giving, others could potentially have a negative effect. Both the House and Senate bills contain a proposed revision to the income-based percentage limit. Specifically, both bills seek to increase the maximum amount of charitable contributions to public charities and other certain tax exempt organizations an individual can deduct on his/her tax return from 50% of the individual’s adjusted gross income to 60%. This may be beneficial to charities since the increased percentage may be an incentive for individuals to give more to such charities. In addition to this proposal, both the Senate and House bills attempt to do away with the “Pease limitation” which essentially caps 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 high income earners greater flexibility in the use of itemized deductions in reducing their tax liability. Other changes that may have a positive impact on charitable giving include provisions in the House bill for increasing the mileage deduction for inflation and the potential repeal of the written acknowledgement requirement on behalf of donors for amounts of $250 or more. The Senate bill does not contain such revisions. On the other hand, there are also provisions in both bills that would have a potential negative impact on charitable giving. For example, both bills propose an increase to 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. Many are looking at this provision as creating a disincentive to certain individuals to itemize, and consequently impacting tax planning strategies with respect to charitable donations. Similarly, with both bills currently calling for the immediate doubling of the estate tax exemption, and the House bill’s proposed provision to ultimately repeal the estate tax, planned giving may be adversely affected. One other change in the proposed legislation that could adversely affect charitable giving comes in the form of a 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. The current deduction is seen as an incentive to donors to higher education institutions potentially putting those institutions at a competitive advantage. In addition to changes that affect charitable giving, both the House and Senate bills attempt to modify unrelated business income tax (“UBIT”) provisions, with the Senate bill being much harsher on the nonprofit sector. The Senate bill proposes to tax royalty income derived from licensing the tax exempt organization’s name and logo. The Senate bill also requires every tax exempt organization to calculate its unrelated business taxable income (“UBTI”) by activity, and not allow the losses from one unrelated activity to offset the income of another unrelated activity. With the disallowance provision, the Senate bill looks to change the law that has been in place for 50 years by attempting to more clearly define streams of unrelated business income. 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. The House bill includes a provision to UBIT regulations that requires research organizations to share the results of their research with the general public or be subject to UBIT on the revenues derived from those aforementioned research publications. Other impacts to UBIT from both the House and Senate versions of the bill could come from provisions for taxable fringe benefits. This section of both bills proposes to disallow certain deductions for specific fringe benefits, including those related to providing employees with access to on-premise gyms or other athletic benefits as a part of employment with the organization.
Both the House and Senate bills attempt to have a significant impact on certain excise taxes paid by tax exempt entities by way of various changes to previous law. One such item that would have a significant impact on larger tax exempt entities is a provision for a 20% excise tax imposed on tax exempt organizations for compensation in excess of one million dollars paid to certain “covered employees,” defined as the five highest paid employees. Both bills also include provisions which will apply a 1.4% percent excise tax on the net investment income of certain private colleges and universities similar to the treatment of private foundations. The House bill goes a step further and eliminates the 1% option for private foundations and drops the 2% to 1.4% to make the application of this excise tax uniform. In addition, the House bill proposes to exempt certain private foundations from the current excise tax on excess business holdings as long as certain conditions are met.
There are some other items listed in the House bill that would specifically affect tax exempt organizations. Included is the repeal of the “Johnson Amendment,” which prohibits section 501(c)(3) organizations from engaging in political activities. Under the new House bill, religious organizations would be permitted to engage in political speech under certain circumstances. Another stand out from the House bill is in relation to private operating foundations (“POF”) that are art museums. The bill attempts to regulate these entities by limiting their ability to classify as a POF unless certain requirements are met. Specifically, the POF classification would only be available to an art museum if it is open to the public for a minimum of 1,000 hours during the year. The POF classification allows for a benefit of being exempt from complying with certain sections of the Code that impose a 30% excise tax on undistributed earnings. There remains a high level of uncertainty surrounding the final version of tax reform and its overall impact on the exempt sector. While consensus was reached on certain issues, the House and Senate remain far apart on other issues. Staying current on this historic legislation is essential and EisnerAmper LLP will continue to provide updates as changes come forth.