By Laura Kalick
On Dec. 2, the Senate passed its version of proposed tax reform legislation, the “Tax Cuts and Jobs Act,” on a vote of 51-49. The House had previously passed its own tax bill on Nov. 16, 2017. With Saturday’s Senate action, the House is now in the process of sending both bills to a conference committee for reconciliation. This sets the stage for a possible enactment of a final bill before the New Year.
With each bill proposing slightly different provisions, it’s important that nonprofits familiarize themselves with the proposals to understand how they may be impacted in the future. Should legislation pass, most provisions of both bills will be effective starting in 2018.
What’s at Stake for Nonprofit Organizations?
Navigating the proceedings on Capitol Hill isn’t easy, as new changes are introduced by the day.
The key highlights of the House and Senate tax bills affecting nonprofits are summarized below.
Increase the Standard Deduction (House & Senate): Both the House and Senate tax reform bills propose to nearly double the standard deduction for individuals and married couples filing jointly. The increase would be from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples, adjusted for inflation.
- While an increase in the standard deduction benefits taxpayers, many nonprofits fear that it may lead to a reduction in overall giving, as tax filers have less incentive to itemize their deductions—and consequently, less incentive to donate. In fact, the current proposals could lead to a decrease of between $4.9 and $13.1 billion in charitable giving, according to a study by the Indiana University Lilly Family School of Philanthropy.One nonprofit wish list item that did not make it to either bill is the idea of a “universal” charitable deduction, which would be available to all taxpayers, whether they itemize or not. This provision, many organizations argue, would not only increase the motivation for people to give, but would send Americans an important overall message on the importance and value of giving.
Increase the Charitable Contribution Deduction Limit (House & Senate): Both bills propose to increase the charitable contribution deduction limit for an individual to 60 percent of his or her adjusted gross income (AGI), up from the current limit of 50 percent.
- At first glance, a 10 percent increase in deduction limits appears to be an incentive for high-income donors to give more to charity, as they can claim more of their donations as a charitable deduction.However, this is unlikely in reality—especially when considering that the population of tax payers who actually do give up to 50 percent of their AGI currently is quite small. There may not be many more individuals who would give up to 60 percent of their AGI.
Repeal the “Pease” Limitation (House & Senate): Both bills propose to repeal the “Pease” limitation (named after former Senator Donald Pease), whose original intent was to raise tax revenue by increasing the taxable income for high-income earners. It does this by reducing the value/benefits of several itemized deductions (including charitable contributions) once a taxpayer’s AGI reaches a certain amount ($261,500 for single filers and $318,800 for married couples filing jointly).
- Since the “Pease” limitation reduced the benefits of itemized deductions (including charitable contributions), repealing it allows high earning taxpayers to go back to enjoying the full benefits of these deductions. It is anticipated that this measure could help prompt high earners to donate more to charity.
Impose an Excise Tax on Executive Compensation (House & Senate): Both bills propose to impose a 20 percent excise tax on the compensation of any covered employee in excess of $1 million. The term ‘covered employee’ means any employee (including any former employee) of an applicable tax-exempt organization if the employee a) is one of the five highest compensated employees of the organization for the taxable year, or b) was a covered employee of the organization (or any predecessor) for any preceding taxable year beginning after Dec. 31, 2016.
- If this should pass, tax-exempt organizations will need to factor this new excise tax into their overall tax planning and be aware that this extra payment may require budget cuts elsewhere.Many questions regarding this provision, however, still need to be addressed. For example, the compensation taken into account includes compensation from related organizations. Would the excise tax be paid by the exempt organization or the related organization? There are many details that still need to be worked out.
Increase the Estate Tax Exemption (House & Senate) and Repeal the Estate Tax (House): The House bill proposes to double the gift, estate, and generation-skipping transfer (GST) tax exemptions from $5 to $10 million (adjusted for inflation) per individual beginning in 2017. It would then repeal the estate and GST taxes and reduce the gift tax rate to 35 percent in 2023.
Like the House bill, the Senate bill would also double the tax exemptions. However, it does not propose to repeal the estate or GST taxes.
- Many nonprofits fear that an increase in the estate tax exemptions—and/or the repeal of the estate tax—could significantly reduce the incentive for people (especially wealthy individuals) to make charitable contributions.Under the current law, property in an estate is subject to a tax before it passes from a decedent to his or her beneficiaries. The first $5 million worth of transferred property is exempt from estate, gift, and GST taxes; however, any amount over the initial $5 million is subject to taxes. As wealth accumulates in a family, this $5 million limit plays a significant role when individuals are considering whether to donate. Many people would rather give their money to charity than see it go to taxes.
However, an increase in tax exemptions from $5 to $10 million could greatly decrease an individual’s incentive to donate, as more property can now be transferred to his or her beneficiaries tax-free. An eventual repeal of the estate tax entirely could further significantly stamp out this desire to give.
Create a Special Exception under the “Johnson Amendment” (House): The House bill includes a provision that would enable nonprofits to express their favor for a certain political candidate, even under the Johnson Amendment, which is designed to protect 501(c)(3) organizations from the demands from political candidates and donors for political endorsements and campaign contributions. Under this special provision, nonprofits would not lose their nonprofit status “because of engagement in certain political speech, as long as the speech is in the ordinary course of the organization’s business,” and if their spending is “not more than de minimis incremental expenses.”
The Senate bill does not include this provision under the Johnson Amendment.
- Reactions to the House bill’s provision has sparked a flurry of mixed reactions from nonprofits. Tim Delaney, president of the National Council of Nonprofits, publicly denounced the change, which he says could make nonprofits vulnerable to political demands by donors.Other nonprofits, however, applaud the provision, stating that it will help them express their freedom of speech while still putting the limits needed to prevent them from becoming political organizations.
Impose an Excise Tax on Nonprofit Colleges & Universities (Senate & House): Both bills propose to impose a new excise tax of 1.4 percent on the net investment incomes of applicable educational institutions. The term ‘applicable educational institution’ refers to an educational institution which a) had at least 500 tuition-paying students during the preceding taxable year; b) was not described in the first sentence of section 511(a)(2)(B) (relating to state colleges and universities); and c) the aggregate fair market value of the assets of which at the end of the preceding taxable year (other than those assets which are used directly in carrying out the institution’s exempt purpose) is at least $500,000 per student of the institution. The House plan imposes the same 1.4 percent excise tax to private college endowments valued at $250,000 per full-time student.
- Under the current law, private foundations must pay an excise tax on their net investment income; public charities, including colleges and universities, however, are excluded. The bills’ proposal to also include the latter, however, has led many nonprofits to worry about whether this is setting up an unhealthy precedent for the future—one where politicians are increasingly telling the sector how they should spend their philanthropic assets.
Modifications to the Unrelated Business Income Tax (UBIT):
Senate: The Senate bill would disallow tax-exempt organizations to take the business losses from one economic activity and deduct them from the gains of another economic activity. A previous version of the Senate bill would subject all royalty income derived from licensing out a nonprofit’s name or logo (income that is currently exempt) to the UBIT.
House: The House bill clarifies that certain state and local entities, including public pension plans, that are exempt under Section 115(1) as government-sponsored entities are subject to the UBIT, as well as those under Section 501(a). In addition, it states that organizations can only claim research spending as an UBIT exception if the research is freely available to the public. It also subjects exempt organizations to UBIT on the amount of certain fringe benefits for which a deduction is disallowed.
- These proposed modifications to the UBIT will raise tax revenue to make up for tax cuts elsewhere; thus, nonprofits can, more likely than not, expect an increase in their tax bills as more of their activities are subject to the UBIT.Nevertheless, if the corporate income tax rate is lowered from 35 to 20 percent, as both bills propose, then nonprofits would pay a lower tax rate on the UBIT than they are currently.
Many changes are expected over the next several weeks. Based on the magnitude of the changes proposed thus far, if a final bill is signed before the end of the calendar year as targeted by President Trump, the changes will require significant reassessments of tax positions for financial reporting purposes to be reported in the quarter.
Thus, it’s important that nonprofits do their best to prepare during this period of uncertainty. Given the multiple proposed changes on the individual level—i.e. nearly doubling the standard deduction and eliminating the estate tax—organizations should strive to fundraise as much as possible now to offset any potential cutbacks in charitable giving in the future, should reform become a reality.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (December, 2017). Copyright© 2017 BDO USA, LLP. All rights reserved. www.bdo.com