How New Tax Law Affects Tax-Exempt Organizations
Although not considered to be taxpayers in the normal sense of the word, tax-exempt organizations (“NFPs”) are significantly impacted by the Tax Cuts and Jobs Act (“Act”) on multiple fronts. Several provisions in the Act reduce incentives for charitable giving and impose new taxes on NFPs. Nevertheless, a few areas offer opportunities for certain organizations.
Doubling the standard deduction, limiting the state and local tax deduction (including property taxes), and eliminating a number of miscellaneous itemized deductions means that fewer Americans will be itemizing their deductions. NFPs are concerned that contribution revenue will decrease because many donors will no longer receive a tax benefit for their donation. Additionally, the doubling of the estate tax exemption is expected to reduce the need to create charitable vehicles, such as private foundations and charitable remainder trusts, that serve as funders to NFPs.
Colleges and universities specifically will feel an impact, since the allowance of a charitable deduction for 80 percent of payments made for athletic event seating rights was eliminated.
Calculation of Unrelated Business Taxable Income
NFPs trying to make up for lost contribution revenue by engaging in creative new fundraising activities need to assess whether they may generate unrelated business taxable income (“UBTI”), especially in light of the new changes brought about by the Act affecting the taxation of such income.
For NFPs formed as corporations and that generate UBTI, some of the changes affecting for-profit corporations may be of benefit. Beginning January 1, 2018, the federal corporate tax rate moves from being a progressive rate to a flat 21 percent rate. For those NFPs previously paying tax on their UBTI at 34 percent, the lower rate will result in tax savings. For NFPs that have smaller amounts of UBTI that were taxed at 15 percent, the change will have the opposite result. Enhancements to bonus depreciation and section 179 expensing may also result in reduced tax liability for NFPs claiming such deductions in connection with their Form 990-T. (See the “Enhancements and Limits to Business Deductions” section from our earlier tax alert for a longer discussion about bonus depreciation and section 179 expensing.)
The Act increases the complexity of calculating UBTI by requiring that it be computed separately for each unrelated trade or business. Additionally, net losses from one business activity will not be allowed to offset income from another business activity. Net operating losses (“NOLs”) will no longer be allowed to be carried back two years and then forward for twenty years. Instead, they will be carried forward in perpetuity and be tracked by specific business activity. The deduction for NOLs generated in tax years beginning after December 31, 2017, will be limited to 80 percent of taxable income. The result will be that many NFPs may find themselves with a tax liability in the future, despite having NOLs.
New Taxes Relating to Employees
In an attempt to create parity between NFP and for-profit employers, several items of compensation are now either treated as UBTI or are subject to an excise tax equal to the new corporate tax rate of 21 percent.
For example, the Act causes amounts paid by NFPs for qualified transportation fringe benefits to be treated as UBTI. This change applies to amounts spent by employers on van-pooling arrangements, transit pass programs, qualified parking programs and bicycle commuting programs. However, many employers operate these programs as employee pre-tax contribution programs, which results in these benefits not being deemed to be paid by the employer. It isn’t clear whether this type of arrangement is excluded from this new provision or not.
Amounts paid by NFPs for a parking facility used in connection with qualified parking or any on-premises athletic facility are treated as UBTI. (It’s worth noting that the facility must be substantially used by the employees and their family members)
Lastly, NFPs providing significant annual compensation (defined as $1 million or more) to specified employees or a certain type of compensation known as an “excess parachute payment” will now be subject to an excise tax equal to 21 percent of such payments.
Negatives and One Positive for Educational Institutions
The new 1.4 percent excise tax on the net investment income of certain educational institutions has been a hot news item. The tax is only applicable to private institutions with at least 500 students, more than 50 percent of which are located in the United States, and that have non-exempt use assets (including assets held by related organizations) of $500,000+ per student. Even though fewer than 40 institutions are estimated to be subject to this provision, the Joint Committee on Taxation has said it expects to raise a hefty $1.8 billion over the next decade from this new tax.
Many colleges and universities (in addition to other types of NFPs) rely on tax-exempt financing for construction of their facilities. While tax-exempt financing in general was not eliminated by the Act, the tax-exempt status of bonds issued to advance refund previously issued bonds was repealed. Now NFPs will no longer be able to essentially refinance their bonds to take advantage of lower interest rates.
The one bright spot for K-12 schools is that now up to $10,000 per year per student of section 529 Plan funds may be used for elementary or secondary school tuition.
Should you have questions about the new tax law, reach out to the Nonprofit Tax Services team at Cherry Bekaert and start the conversation. Feel free to bring us your questions – we will be happy to talk with you. This will be a year-long journey, as we all work through this major transition in tax law together.