Passage of the new federal income tax law in late December 2017 has brought into reality a variety of concerns not-for-profits raised as the bill worked its way through the U.S. House of Representatives and Senate. In addition to the increased standard deduction that’s expected to depress charitable giving, the final Tax Cuts and Jobs Act (TCJA) includes several other provisions that had prompted objections from charities.
The TCJA significantly reduces the corporate tax rate — to 21%. This change will benefit not-for-profits paying unrelated business income tax, because the tax is imposed at the corporate rate. However, the income subject to the tax could go up for some not-for-profits.
Under the TCJA, not-for-profits must calculate their unrelated business taxable income (UBTI) separately for each unrelated business. As a result, they can’t use a loss from one unrelated business to offset income from another unrelated business for the same tax year. But they can use one year’s losses on an unrelated business to reduce their taxes for that business in a different year (subject to certain restrictions).
In addition, the law includes certain fringe benefits in UBTI. Not-for-profits now must include in UBTI any expenses incurred to provide employees with qualified transportation fringe benefits (for example, transit passes), a parking facility used in connection with qualified parking fringe benefits and any on-site athletic facility.
And under the TCJA, reimbursements to employees for moving expenses or any activity considered to be entertainment can’t be excluded from that employee’s taxable compensation.
Excise tax on excess compensation
The TCJA creates a 21% excise tax on not-for-profit executives’ compensation (including most benefits and any payments from related organizations) in excess of $1 million considered paid to a covered employee plus certain large payments made to that employee when he or she leaves the organization (known as “excess parachute payments”). “Covered employees” refers to current or former employees who are among the five highest paid employees for the taxable year or who were covered employees in 2017 or later. Once considered a covered employee, an individual will always be a covered employee.
A payment generally is considered an excess parachute payment if:
- It’s contingent on the employee’s departure, and
- The total present value of all such payments to the employee equals or exceeds three times his or her average annual compensation for the preceding five years.
The excise tax applies to the amount of the parachute payment, less the average annual compensation.
Reduced charitable giving impact
The near doubling of the standard deduction is expected to reduce the number of taxpayers who itemize their deductions and, therefore, the number who can deduct their charitable contributions.
The TCJA includes further impacts to giving. The law could affect major contributions because it increases the estate tax exemption to $10 million, annually indexed for inflation, through 2025. Some wealthy individuals make major gifts to reduce their taxable estates, and the larger exemption means they won’t need to shrink their estates as much to avoid the tax. Additionally, the TCJA also repeals the deduction for donations made in exchange for the right to buy tickets to college athletic events. This could reduce the incentive for some people to donate to universities in the upcoming years.
While the TCJA raises the limit on cash donation deductions from 50% of adjusted gross income (AGI) to 60%, that change isn’t predicted to have much of an impact. Cash donations of even 50% of AGI are already uncommon.
Certain tax-exempt bond interest repealed
Tax-exempt bonds usually pay lower interest rates than other bonds. The tax-exempt nature of the interest makes such bonds attractive to investors despite the lower rates.
A bond that is issued to pay principal, interest or the redemption price on an earlier bond issue is called an “advance repayment bond.” The TCJA repeals the tax-exempt treatment for interest paid on advance repayment bonds that are issued to repay bonds with more than 90 days remaining before the redemption date.
For example, if you issue tax-exempt bonds at 5% interest but subsequently learn you can refinance the bonds at 4% interest, the interest payments on the 4% advance repayment bonds won’t be tax-exempt for investors. You’ll probably need to pay more interest to cover the investors’ increased tax liability.
Although the final guidance and procedures have yet to be issued by the IRS, the TCJA may have some direct impacts for your organization going forward. Consult with your CPA now to determine the best steps to minimize any potential damage to your bottom line — and your ability to accomplish your organization's mission.
Sidebar: What didn’t make it into the Act?
Due to concern about other changes mentioned with the bills, the provisions listed below were not included in the final tax act:
Johnson Amendment repeal. The House of Representatives’ version of the TCJA would have repealed a prohibition against not-for-profits engaging in political campaign activity. Many not-for-profit leaders had mobilized in opposition to this repeal.
Private activity bond tax-exempt treatment termination. The House bill would have eliminated the tax-exempt treatment of interest on the private activity bonds some organizations use to finance capital projects.
Expanded donor-advised fund reporting. Under the House bill, sponsors of donor-advised funds (DAFs) would have been required to report additional information on their Forms 990, including the average amount of grants made from DAFs during the taxable year.
Excise tax rate on private foundation net investment income. The TCJA left out a House provision establishing a streamlined rate of 1.4%, sticking instead with the two current rates of 1% and 2%.