The news is full of information about tax reform and the impact on corporate tax rates, lost deductions and lower rates, and fewer brackets for individual taxpayers. However, little is being said about the provisions within the House bill that could impact not-for-profits if the bill ultimately becomes law. On November 16, 2017, the House passed its version of the Tax Cuts and Jobs Act. On November 17, The Senate Finance Committee approved its own version of the tax reform bill. The full Senate plans to review the bill after the Thanksgiving holiday. Once the Senate passes their version of the bill, there will be a reconciliation which may take several weeks. The following items that could impact your organization are included in the House version of the tax reform bill:
- Fringe benefits where no deduction is allowed will be considered unrelated business income and taxed to the organization.
- A 20% excise tax will be assessed on compensation in excess of $1 million for the five highest paid employees of the organization. Additionally, there will be 20% excise tax on any parachute payments in excess of a base amount, which is defined as the average annual compensation of the employees in the five previous years.
- The tax charged to private foundations for their investment earnings will be 1.4%. Currently private foundations pay a 2% tax unless they meet a test where their distributions exceed an average of the previous five years, and then the rate is 1%.
- An excise tax of 1.4% will be charged on the investment earnings of private colleges and universities that have greater than 500 students and greater than $100,000 per student in their endowments.
- Certain private foundations would be exempt from the excess business holdings tax. This rule has limited applicability and involves holding an interest of greater than 20% in a business enterprise. In order to avoid the requirement to divest the greater than 20% interest, the private foundation must own 100% of the business enterprise; it must receive 100% of the operating profits annually; the private foundation must have obtained the interest in a manner other than a purchase; and the directors of the business entity must not be substantial contributors or board members to the private foundation.
- The bill would allow 501(c)(3) organizations to make political statements in the ordinary course of their exempt activities. This is basically a reversal of the Johnson Amendment of 1954. Political expenditures would not be allowed unless considered to be de minimis.
- Organizations holding donor advised funds would have additional reporting requirements which would include annual disclosure of the average amount of grants from the funds, and the organization’s policies regarding inactive donor funds and the frequency and minimum levels of distributions from those funds.
The Senate version of the bill, which has not yet passed, is silent on most of the House measures listed above. The Senate bill is identical to the House bill regarding the tax on compensation over $1 million and on the 1.4% excise tax on private college’s excess endowments. However, there are a few items of note for not-for-profits within the Senate bill:
- Exemptions for professional sports leagues would be excluded from the definition within Section 501(c)(6).
- Fees received for the use of an organization’s name or logo would be taxable as unrelated business income.
- Different activities that are considered unrelated would be listed separately on the 990T, and losses from one activity would not be allowed against income from another activity.
- An excise tax of 10% would be imposed on an exempt organization involved in an excess benefit transaction unless the organization establishes that minimum due diligence standards have been met. The rules regarding excess benefit transactions would be applied to 501(c)(5) and 501(c)(6) organizations. Additionally, athletic coaches and investment advisors would be considered disqualified persons for purposes of the excess benefit definition.
Other than the items above that directly impact not-for-profits, the deduction for charitable contributions remains intact under both bills. Lastly, the AGI limit will go from 50% to 60% and the five year carryforward will remain. Donors will no longer be able to deduct a portion of the amount they contribute to colleges and universities in exchange for the ability to purchase tickets to sporting events. Additionally, both the House and Senate versions of the bill include a reduction in the corporate tax rate from a current maximum rate of 34% to a flat rate of 20%. The Senate version has a later effective date for the new rate, 2019 rather than 2018. For some exempts paying tax on unrelated business income, the lower rate may improve overall cash flow from these activities. For those currently paying tax in the 15% bracket, there might be a decline in cash flow as more federal income tax is paid under the new flat tax.
The current versions of tax reform are complex and contain many new provisions that will impact almost any type of business entity and individual. The reconciliation process will likely result in a final law that differs greatly from the House and Senate versions. We will continue to watch this legislation and provide updates.