How Does the Tax Cuts and Jobs Act Impact Tax Exempt Organizations?
February 5, 2018
The following SC&H Group “2018 Tax Roadmap” blog post focuses on key changes the Tax Cuts and Jobs Act made for tax exempt organizations.
The House and Senate bills had a number of provisions that would impact tax exempt organizations. A handful of these made it to the final Tax Cuts and Jobs Act (TCJA) that recently became law.
Unrelated Business Income on an Activity by Activity Basis
Unrelated business taxable income is the gross income derived by an exempt organization that is (1) unrelated to the exempt organization’s exempt purpose; (2) is regularly carried on and (3) is engaged by the exempt organization with the intent to make a profit; less allowable deductions related to the unrelated business activity.
Under pre-TCJA law, exempt organizations with several types of unrelated business income could net the unrelated business income from one activity against the unrelated business losses of another business activity. To the extent that the net unrelated business activities resulted in an overall net operating loss, that loss could be carried over and used to reduce unrelated business taxable income generated from all unrelated business activities in the subsequent 20 years.
Under TCJA, for tax years beginning after December 31, 2017, unrelated business taxable income will need to be calculated on an activity by activity basis. Losses from one unrelated business activity will not be allowed to offset income from another unrelated business income activity. Losses incurred in tax years beginning after December 31, 2017 will need to be tracked separately and will only be allowed to offset unrelated business income for that activity in a subsequent year.
This provision will require exempt organization to put additional emphasis on tracking and allocating expenses to each activity. TCJA does not define an unrelated business income activity. For exempt organizations holding partnership investments that pass through unrelated business taxable income, it is unclear whether each investment is an activity or whether the partnership investment group is one activity. We expect further guidance from the IRS.
Excise Tax on Excess Tax-Exempt Organization Compensation
For tax years beginning after December 31, 2017, the TCJA imposes a 21% excise tax on exempt organizations on remuneration in excess of $1 million paid to any covered employee and on any excess parachute payments paid to a covered employee. A covered employee is one of the five highest compensated employees of the exempt organization for the tax year or for any tax year beginning after December 31, 2016. Once an employee is considered a covered employee, they remain a covered employee for all years they receive compensation. Remuneration includes amounts treated as paid when there is no substantial risk of forfeiture such as vested compensation under 457(f) plans. Compensation paid to a licensed medical professional (doctors, nurses, and veterinarians) for the performance of medical or veterinary services is excluded from the definition of remuneration for purposes of the excise tax.
Excess parachute payments are payments that are contingent on the employee’s separation from service from the organization and the aggregate present value of the compensation is greater than three times the base amount. Parachute payments do not include payments from qualified plans.
Remuneration of a covered employee includes compensation paid by a related person or government entity. A person or entity is related if it controls or is controlled by the exempt organization, is controlled by a person or persons that control the organization, is a supporting organization of the exempt organization or is a supported organization of the exempt organization.
Exempt organizations should review their compensation arrangements. Attention should be placed on maximizing qualified plan benefits. Careful attention should be placed on provisions that provide large severance payments.
Unrelated Business Taxable Income Increased by the Amount of Certain Fringe Benefits Provided
Exempt organizations must treat the value of providing employees with qualified transportation fringe benefits, qualified parking fringe benefits and on-premises athletic facilities as unrelated business taxable income. These fringe benefits continue to remain non-taxable benefits to the employees under Internal Revenue Code Section 132(f). The IRS may provide guidance regarding the allocation of depreciation and other costs incurred for organizations that provide on-site parking and on-premises athletic facilities.
Excise Tax on Investment Income of Certain Private Colleges
An excise tax of 1.4% is imposed on the net investment income of applicable educational institutions who have at least 500 students, with more than 50% of the students located in the United States and applicable assets exceed $500,000 per full-time student on a full-time equivalency basis. An applicable educational institution is based on the Hope and Lifetime Learning credit definition but excludes state colleges and universities.
Net investment income includes interest, dividends, rents, royalties and capital gains net of expenses to produce the investment income. Assets and income of related entities are considered attributable to the educational institution. Related organizations are those that control or are controlled by the applicable educational institution, are controlled by one or more persons that control the applicable educational institution or is a supported or supporting organization of the applicable educational institution.
Tax Reform on Bonds
The House version of the bill included provisions to repeal the tax exemption for all private activity bonds. The final TCJA includes very limited repeal provisions. The TCJA repeals the exclusion from gross income for interest on qualified advanced refunding bonds issued after December 31, 2017. The authority to issue tax credit bonds and direct-pay bonds is repealed after December 31, 2017.
A number of broader provisions of the TCJA may impact non-profits.
- Change in the corporate tax rate – The corporate tax rate is reduced from 35% to 21%. For tax exempt organizations paying tax on unrelated business taxable income this provides an overall savings in taxes. The reduction in rate may also have unwanted implications to organizations with tax exempt bond financing. Many tax-exempt bonds purchased directly by banks and other financial institutions contain “interest rate tax step up” provisions. Under these provisions, interest rates increase as the maximum federal corporate rate is reduced to maintain a tax equivalent yield. Tax exempt organizations should reach out to their lenders regarding these provisions.
- Change in standard deduction and itemized deduction rules – The standard deduction for married taxpayers filing a joint return increases from $12,700 in 2017 to $24,000. A number of itemized deductions that are available in 2017 are reduced or eliminated in 2018. Consequently, many more individual taxpayers will not itemize in 2018. To the extent these individuals look for a tax deduction for their charitable contributions, the incentive to give may be less. For those individuals who itemize, the charitable contribution limit for cash contributions to public charities and certain private foundations has increased from 50% of a taxpayer’s contribution base (adjusted gross income) to 60% of the taxpayer’s contribution base.
- Estate and Gift Tax – The estate, gift and GST lifetime exemption has doubled under TCJA to $11.2 million in 2018 and is indexed to inflation. This increase in the exemption may have charitable estate planning implications as less people will have a taxable estate.
- Elimination of deduction for amounts paid for college athletic seating rights – Under pre-TCJA law, payers who received the right to purchase tickets or seats at an athletic event as part of the payment to a college or university could treat 80% of the payment as a charitable contribution provided certain conditions were met. This provision has been eliminated. No charitable deduction is allowed for any payments to a college or university when the payer receives the right to purchase tickets or seating at an athletic event.
- Section 529 Plans – For tax years beginning after 2017, individuals can use their 529 plans to pay up to $10,000 per year per student for private elementary and high school expenses. Under prior law, individuals could only use 529 plans to fund college expenses. The definition of higher education expenses has been modified to include additional items such as online educational materials.
Do you need assistance assessing the impact of the TCJA? Please contact us if you have any questions as you navigate 2018 tax planning.