Tax Reform: A New Reality for Exempt Organizations

February 2, 2018

With the 2017 charitable giving season behind us, many exempt organizations (“EO”s) are concerned that their funding may start to decrease this year and in the foreseeable future as a result of the new Tax Cuts and Jobs Act (hereafter, “the Act”) passed into law on December 22, 2017. How is this possible? Effective January 1, 2018, the standard deduction has increased to $12,000 for individuals and $24,000 for couples filing joint returns. It may be advantageous for taxpayers who previously itemized their charitable contributions on Form 1040, Schedule A, to now elect the standard deduction instead.

This may not necessarily deter donations from wealthy individuals, who would still choose to itemize, but it could have a direct impact on middle-class Americans. However, when we consider that private funding for the EO sector was at an all-time high in 2017 – possibly spurred by the upward swing of the stock market, this potential decrease in giving is based on an assumption that charitable giving is largely tax-motivated, rather than primarily philanthropic. This would imply that a donor, although having the best interests of the particular charity in their hearts and minds, may not increase their contributions – or even donate at all – solely because they do not have the means to make itemized deductions a better fiscal choice for them. The impact, if any, is likely to be felt more by smaller charities that depend on smaller donations from a larger donor base, as opposed to larger charities that often depend on a smaller donor base capable of making more significant contributions. In fact, with the charitable deduction cap increasing under the Act from 50% to 60% of adjusted gross income, larger charities may actually see an increase in contributions this year.

To prepare for the possibility that the increased standard deduction could affect charitable giving in 2018, EOs should reevaluate their giving mix and try to find ways to increase their funding from foundations, governmental agencies and program service revenues.

While funding is primary, it is important to note how the Act will affect your not-for-profit’s tax and financial reporting requirements. Initially, the proposed tax bill had many changes that would impact EOs, and many of those provisions did not make it into the final version.

Below are the highlights of the Act’s provisions that will impact the not-for-profit sector:

New excise tax on excess executive compensation. The Act adds Code Section 4960 that imposes a 21% excise tax on an applicable EO for compensation paid in excess of $1 million to certain highest compensated employees (referred to as “covered employees”). A covered employee is either the chief executive officer (CEO) of the corporation, or one of the corporation’s four highest paid officers (other than the CEO), whose compensation must be reported to the shareholders of the corporation.

New excise tax on the net investment income of private colleges and universities. New Code Section 4968 impose a 1.4 % excise tax on the net investment income of certain applicable educational institutions. The excise tax applies to private colleges and universities that had: (A) at least 500 students during the preceding taxable year, (B) more than 50 percent of which are located in the United States, (C) which is not described in the first sentence of Code Sec. 511(a)(2)(B), and (D) an aggregate fair market value of assets at the end of the preceding tax 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.

Unrelated business taxable income must be separately computed for each trade or business activity. An EO with more than one unrelated trade or business can no longer aggregate the income and deductions from all unrelated business activities in computing its unrelated business taxable income. The Act amends the unrelated business income provisions by adding a new paragraph in Code Section 512(a)(6) that requires EOs with one or more unrelated trades or businesses to compute unrelated business taxable income separately with respect to each unrelated trade or business, including for purposes of determining any net operating loss deduction. Bottom-line: the losses from one unrelated trade or business cannot be used to offset the income derived from another unrelated trade or business. Gains and losses must be calculated and applied separately.

Certain fringe benefits to employees will be treated as unrelated business income. The Act adds a new paragraph in Code Section 512(a)(7) that requires an EO to include as unrelated business taxable income any amounts paid or incurred by the organization for the following fringe benefits (provided that a deduction is not allowable under Code Section 274): any qualified transportation fringe, any parking facility used in connection with qualified parking, or any on-premises athletic facility. This new provision does not apply to amounts directly connected with an unrelated trade or business which is regularly carried on by the organization.

While the Act brings many planning opportunities and some procedural changes to the not-for-profit world, there doesn’t appear to be any significant reason to fear its impact on charitable giving. If we lived in a world of donors who are strictly tax-motivated, then it would be safe to assume that charitable giving would take a big hit. But that is a rather shallow position and does not give the public enough credit for doing “the right thing” in supporting good causes.

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