January 11, 2018
Tax reform is now reality. Last month, President Trump signed the largest tax reform legislation in more than 30 years. While many of the provisions that were initially proposed specific to exempt organizations did not make it into the final legislation, several key components remained in the final version and will have an impact on tax exempt organizations, either directly, or indirectly. It is now important for tax exempt organizations to understand how they will be affected moving forward and what actions should be taken to strategically plan for and adapt to the changes.
A number of changes that directly affect individuals may have an indirect impact on nonprofit organizations. Specifically, the bill nearly doubled the standard deduction, both for single taxpayers and married taxpayers filing jointly. This could potentially result in far fewer individuals choosing to itemize deductions and thus not being able to deduct charitable contributions. Whether the anticipated increased use of the new standard deduction will have a significant affect on charitable contributions depends largely on the prior charitable generosity of those now converting to use the standard deduction. However, for those that continue to itemize, the percentage limit for cash contributions to public charities increased to 60 percent of adjusted gross income. Whether these provisions will have an impact on the amount of charitable giving remains to be seen. Individuals who give gifts motivated by their belief in the work done by nonprofits likely will give regardless of the loss of tax deduction.
Unrelated Business Income
Exempt organizations that have unrelated business income could see numerous changes in the tax they will pay. First, those organizations that are taxed as corporations will see a change in tax as the corporate tax rate has been reduced to a flat 21 percent rate from the current graduated rates. Specific to exempt organizations, the calculation of unrelated business income has been changed to no longer allow for the aggregation of income and losses from multiple business activities. In the future, losses from one unrelated trade or business will only be available to offset income from that activity in the future. As such, it is likely many organizations will have more income subject to taxation. This change will be effective for tax years beginning after Dec. 31, 2017. Additionally, consistent with the treatment for other corporations, net operating losses will only be allowed to offset 80 percent of taxable income in the future.
In addition, exempt organizations that provide certain types of qualified fringe benefits, including transportation benefits, qualified parking facilities and use of employer provided athletic facilities will be subject to unrelated business income tax on the value of the benefits provided.
A new excise tax on executive compensation paid to top employees will also have an impact on many larger nonprofit organizations. The excise tax is levied at 21 percent on any remuneration in excess of $1 million per person paid to an organization’s top five compensated employees and former employees. Remuneration includes most forms of compensation paid by the organization. An exception to this rule does exist for compensation paid to qualified medical professionals attributable to medical services they provide to the organization.
Colleges and Universities
Colleges and universities will be especially impacted by a number of provisions in the new law. Private colleges and universities (not state institutions) will now be subject to a new excise tax of 1.4 percent on net investment income. This excise tax will apply to private educational institutions that have at least 500 students and have assets equivalent to at least $500,000 per full time student. Assets of related organizations could also be considered under this tax if that entity is controlled by the institution or it is a 509(a)(3) supporting organization to the institution. This tax is expected to have a large impact on many of the nation’s largest private educational institutions.
In addition, the bill eliminates a long standing charitable contribution benefit for individuals who make payments to educational institutions for the right to purchase tickets or seating at athletic events. The prior rules allowed a charitable contribution deduction for 80 percent of the amount paid for the right. This benefit has now been eliminated.
Private Activity Bonds
The bill also eliminated the exclusion from gross income of interest received on advanced refunding of private activity bonds. Private activity bonds provide a significant amount of capital financing for many nonprofit organizations. While the elimination of the advanced refunding bonds may have an impact on the overall capital financing market, it will be significantly less than the House proposal which would have completely ended the use of private activity bonds.
There are some items in prior versions of the bill that did not make it to the final version, including the reduction of the private foundation excise tax, repeal of the Johnson amendment (related to political activities), private operating foundation requirements, donor advised fund reporting requirements and non-deductibility of tax exempt bonds. These items are still important to note as their inclusion in previous versions indicates some level of interest in these provisions for future legislation activity. In addition, there are other provisions applicable to corporations and trusts that could also impact exempt organizations with certain activities.
Congress will no doubt need to propose modifications through technical corrections in order to ensure the law works as intended. In addition, Treasury will need to issue Regulations and guidance on the actual implementation. Contact your Eide Bailly professional or our Tax Exempt Team for more details on these upcoming changes and to learn how to best prepare your organization.