January 5, 2018 by Pamela A. Mann, Ahsaki E. Benion, Jeremy S. Steckel and Justin L. Peters
On December 22, 2017, the President signed into law the Tax Cuts and Jobs Act (the “Act”), effective January 1, 2018. The Act reconciles tax reform bills passed by both the U.S. House of Representatives and U.S. Senate, and makes sweeping changes to the nation’s tax system and the Internal Revenue Code. Every segment of the economy is impacted by the Act, including the nonprofit sector. Nonprofits must now work quickly to understand how the Act impacts them and prepare accordingly.
Individual Taxes and Charitable Giving
One of the most notable individual tax changes in the Act – the increase in the standard deduction that individuals may take when filing their tax returns – is expected to have a major impact on nonprofits. Under the Act, the standard deduction increases from $6,300 to $12,000 for singles, from $12,600 to $24,000 for married couples, and from $9,300 to $18,000 for heads of household. These changes will significantly reduce the number of individual taxpayers who have a financial incentive to itemize deductions, including gifts to charity. A reduction in filers who itemize is expected to result in a decrease in individual charitable giving, to the detriment of the nonprofits that rely on such funding. Indeed, the Council on Foundations estimates that giving to nonprofits could decrease by between $16 and $24 billion (4-6% of total charitable giving in 2017) per year due to this and other provisions of the Act. While the increased standard deduction may dampen charitable giving, taxpayers who continue to itemize their deductions could benefit from a separate provision in the Act that increases the percentage of an individual’s adjusted gross income (AGI) that may be deducted for cash contributions to nonprofits. Under the Act, donors can now deduct a maximum of 60% of their AGI, up from 50% previously.
New Taxes on the Tax Exempt – Executive Compensation and College/University Endowments
Nonprofits are now required to pay a 21% excise tax on the amount of compensation (including benefits) paid to any of their top five highest-paid employees that exceeds $1 million. The excise tax also applies to certain severance payments. This new tax is a slight increase from the 20% excise tax proposed in both the original House and Senate tax bills. According to analysts, this new excise tax is intended to create parity between tax policy governing executive compensation at nonprofits and for-profit companies. Colleges and universities may also be subject to a new excise tax on their net investment income. Under the Act, private colleges and universities with at least 500 students, at least 50% of whom are located in the United States, must pay a 1.4% excise tax on their net investment income if they have endowment assets of at least $500,000 per student. The threshold value for endowment assets needed to trigger this excise tax on investment income increased steadily from earlier versions of the bill, beginning with $100,000, increasing to $250,000, and settling at $500,000. After the addition of numerous provisions limiting the scope of this excise tax, only approximately 30 colleges and universities have endowments large enough to subject them to the tax.
More Taxable Unrelated Business Income
The Act also affects any nonprofit receiving taxable income from the operation of more than one business unrelated to its exempt purpose(s). Under the previous law, a nonprofit’s income from unrelated businesses was calculated in the aggregate, enabling nonprofits to offset gains from one unrelated business with losses from another. The Act eliminates this means for reducing the net taxable income from such unrelated business ventures. Income from each unrelated business must now be computed and taxed separately. The costs of certain benefits provided by a nonprofit to its employees are also newly taxable under the Act. Under the previous law, the costs of transportation fringe benefits (e.g., transit passes and employee parking) and on-premises athletic facilities provided by a nonprofit to its employees were not taxable. Now, under the Act, such costs must be included as unrelated business income and are therefore taxable. Eliminating the tax exemption for these costs mirrors a separate provision of the Act that eliminates the tax deductibility of such costs for for-profit entities. It is important to note that under the Act, all unrelated business income will be subject to the new corporate income tax rate of 21%, down from the previous rate of 35%.
What Did Not Make the “Cut”
Several noteworthy and controversial proposals in the House and Senate bills were not included in the Act, perhaps most notably the repeal of the “Johnson Amendment.” A repeal would have allowed nonprofits, religious organizations, and private foundations to support or oppose political candidates through actions “in the ordinary course” of their activities as long as such actions resulted in no more than a de minimis increase in expenses. This proposal did not survive Conference Committee negotiations, in part because of the high price tag associated with it – many donors who currently make taxable donations to political organizations would likely have made tax-deductible donations to nonprofits instead. However, we would not be surprised to see continued efforts to repeal the Johnson Amendment, which has been a priority for some Republicans and spiritual leaders who support them. The House bill also proposed a flat 1.4% excise tax on the net investment income of private foundations. This flat tax would have been a significant change from the current two-tiered tax structure in which a private foundation can reduce its investment income excise tax from 2% to 1% by making the required amount of qualified distributions in a given year.
Nonprofits should work closely with their legal and accounting advisors to identify the provisions of the Act that affect them, and to navigate the path forward in this new tax environment.For more information concerning the matters discussed in this publication, please contact a member of the Tax-Exempt Organizations Group below or your regular Carter Ledyard attorney. Pamela A. Mann (212.238.8758; email@example.com), Ahsaki E. Benion (212.238.8890; firstname.lastname@example.org), Jeremy S. Steckel (212.238.8786; email@example.com) and Justin L. Peters (212.238.8661; firstname.lastname@example.org)
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