The Tax Cut and Jobs Act (the Act) makes numerous direct changes to tax-exempt organization taxation, as well as major changes to individual and corporate taxation that will indirectly affect tax-exempt organizations. Most of the provisions of the Act are effective for tax years beginning after Dec. 31, 2017.
There are several changes within the Act that may affect the amount of charitable contributions available to the charitable sector in the foreseeable future. With the nearly doubling of the standard deduction, the number of households that are expected to itemize will decrease from approximately 30 percent to 5 percent, estimated to be a loss of $26 billion in contributions per year. With this removal of the primary tax incentive to donate, there is expected to be a decrease in charitable giving as individuals are not receiving the deduction on their tax returns. The decrease of this impact may be offset by the increase in the charitable deduction limit for cash contributions from 50 percent of adjusted gross income to 60 percent. The Act also disallows the donor to deduct payments made to a college or university in exchange for the right to purchase tickets at college athletic events.
Further, the threshold for taxable estates and gifts increased from $5M to $11.2M and eventually disappears Dec. 31, 2025. The increase in the threshold lessens the incentive to donate portions of the estate to charity, as more property can be transferred to the beneficiaries tax free.
Unrelated business income modifications
Perhaps the Act’s provisions that have the most impact across the exempt organization sector are the two for unrelated business income tax. For tax years beginning after Dec. 31, 2017, (except when there is a net operating loss (NOL) carryover from a tax year beginning before Jan. 1, 2018), tax-exempt organizations may not use losses from one unrelated trade or business to offset income from another unrelated trade or business. Gains and losses from each unrelated business activity will now have to be calculated separately. The Act currently does not define what is considered to be a separate activity, therefore distinguishing various activities may be difficult. Items to consider in evaluating the impact on the tax-exempt organization absent further guidance from the IRS. Organizations will need to use professional judgment in isolating the current unrelated activities, audit the unrelated activities to determine if all expenses and allocations are reasonably assigned to each activity (overhead allocations need to be activity specific), track for any NOLs created before Jan. 1, 2018, and track segregated NOL schedules for each activity.
Also, effective for amounts paid or incurred after Dec. 31, 2017, the Act requires tax-exempt organizations to report the costs of certain fringe benefits as unrelated business income (UBI) where provided by the organization to their employees and not included in the employees’ taxable income. The fringe benefits subject to this provision include qualified transportation (commuter highway vehicle, transit passes), parking reimbursements and on-site gyms. Assuming the employer intends to continue providing these benefits there are two strategies for tax-exempt organizations as it relates to fringe benefits:
- Continue to pay the fringe benefit and report the UBI on the Form 990-T, or
- Make the benefit taxable to the employee by including it in wages on the Form W-2.
Other UBI impacts include the new lower 21 percent corporate tax rate that will be applied to all UBI net income. The Act also limits the NOL deduction to 80 percent of taxable income (determined by excluding the NOL deduction itself) and the Act also disallows any NOL carryback, but allows for indefinite carried forward.
The IRS recently announced its intention to provide guidance on the UBIT provisions presumably in the weeks prior to May 15 extension filings.
Excise tax on employee compensation
The provision to render taxable compensation in excess of $1,000,000 for top executives of tax-exempt organizations seems designed to put tax-exempt organizations on par with taxable entities. The top five highest compensated employees of exempt organizations will now be subject to a 21 percent excise tax rate on taxable wages in excess of $1,000,000. Taxable wages do not include qualified plan benefits such as Section 125 benefits or amounts set aside for Roth contributions. Taxable wages will include non-qualified plan deferrals when vested, whether or not payments have been made.
This provision requires an understanding of a number of terms including “covered employees” which can include both current and former highly compensated employees as well as compensation paid by a tax- exempt organization and its related organizations.
Payments upon separation of service, defined as "excess parachute payments" of covered employees will also bear an excise tax, based on a calculation that is three times the employees' most recent five year average compensation. Any amount of the present value of the payment stream that is over the calculated amount will also be subject to the 21 percent excise tax.
Excise tax on endowments
Another provision was the introduction of a 1.4 percent excise tax on net investment income for private colleges and universities. Educational institutions with at least 500 students must pay the excise tax if the organization's "nonrelated" assets (those not directly used in carrying out the organization's education purposes) are valued at the close of the preceding tax year as being at least $500,000 per full-time student. The number of students is based on the daily average of full-time students. Part-time students are counted on a full-time equivalent basis. Net investment income is determined under rules set out in Section 4940(c), which was originally designed solely for private foundations. This provision is expected to apply to as few as 30 colleges across the country. Since many commentators expected this provision to have application to a broader number of colleges, stay tuned for future legislation to expand the application of this tax.
Advance refunding bonds
The final version of the Act preserves qualified section 501(c)(3) bonds, which was a significant win for the charitable sector; however, the Act included a provision that disallows use of advance refunding bonds. Interest paid to advance refunding bond investors is also now taxable.
The Act expands the use of 529 plans to include deductions for certain elementary and secondary public, private or religious school expenses for tuition up to $10,000 per year to be “qualified higher education expenses” for section 529 plans.
Employee achievement awards
The Act excludes the following from the definition of “tangible personal property” for purposes of qualifying as non-taxable employee achievement awards: cash or cash equivalents, gift cards, coupons, certificates, vacations, meals or lodging and certain other nontangible property.
The new tax law significantly changes the taxation landscape for tax-exempt organizations. Tax-exempt organizations should evaluate how the changes could affect their business operations and develop a proactive plan to address the impacts.
For more information on this topic, or to learn how Baker Tilly not-for-profit specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.