How the Nonprofit World Fared with the Tax Cuts and Jobs Act of 2017
Like every sector, nonprofits won some and lost some. The final legislation, as compared to earlier drafts, ultimately had a narrower, though significant, impact in certain key areas. Following is a brief summary of the provisions of the Tax Cuts and Jobs Act of 2017 affecting nonprofit entities.
Unrelated Business Taxable Income (UBTI)
- Organizations carrying on more than one unrelated business activity must now separately calculate unrelated business taxable income for each activity. As a result, losses from one trade or business may not be used to offset income derived from another trade or business. Under a transition provision, net operating losses arising in a taxable year before January 1, 2018, and carried forward to a future taxable year are not subject to this rule.
Under prior law, exempt organizations were able to offset unrelated business taxable losses against unrelated business taxable income so they were taxed on the aggregate net UBTI.
Although the potential amount of taxable income is increased under the Act, the rate of tax has decreased. UBTI is generally taxed at corporate income tax rates, which are reduced to 21% from the prior maximum rate of 35%.
- Organizations that provide certain types of qualified fringe benefits, including transportation benefits, qualified parking facilities, and use of employer-provided athletic facilities, will be subject to unrelated business income tax on the value of the benefits provided.
- The use of net operating loss carryover deductions from unrelated business activities is now limited to 80% of taxable income for tax years beginning after December 31, 2017. Compliance and implementation guidance from the Treasury is forthcoming.
New Excise Tax for Large University Endowments
- A 1.4% excise tax is imposed on the net investment income of some private college and university endowments, for schools with enrollment of more than 500 students and an asset threshold of at least $500,000 per full-time student. The new law also makes a slight modification to the definition of “applicable educational institution,” which now includes only institutions with more than 50% of tuition-paying students located in the United States.
New Excise Tax on High Salaries
- A 21% excise tax will be imposed on wages in excess of $1 million for any covered employee of a nonprofit entity, including federally and state-chartered credit unions. This tax, paid by the organization, is applicable to compensation in excess of $1 million for current or former employees of a tax exempt organization who are among the five highest-paid employees for the taxable year. A special exclusion applies to compensation paid to licensed medical professionals (including veterinarians).
- The excise tax applies to any “excess parachute payments,” which is compensation contingent upon termination of employment where the aggregate present value of the payments exceeds three times the employee’s average annual compensation.
This change is intended to bring nonprofit salary taxation in line with tax policy regulating for-profit corporations.
A covered employee is an employee (i.e., principal executive officer, principal financial officer, and the next three most highly compensated officers [Section 162(m)], including former employees of an applicable tax exempt organization if the employee is one of the five highest compensated employees of the organization for the tax year or was a covered employee of the organization for any preceding tax year beginning after December 31, 2016. Once an employee is considered a covered employee, he or she will be a covered employee for all future years.
Repeal of Advance Refunding Bonds
- Interest on advance refunding bonds (i.e., refunding bonds issued more than 90 days before the redemption of the refunded bonds) will now be taxable. Interest on current refunding bonds continues to be tax-exempt. The provision is effective for advance refunding bonds issued after 2017.
Proposals that Did Not Pass
- Political Campaign Activity Repeal: Legislation would have allowed tax exempt organizations to engage in political and lobbying activities, including endorsing or opposing candidates. There is no change in current law on these issues.
- Private Foundation Excise Taxes: The current 1% or 2% structure for excise taxes on net investment income of private foundations would have changed to a tax rate of 1.4%. There is no change in current law.
- Donor-advised Fund Reporting: Proposals would have required donor-advised funds to disclose the average amount of grants made during the year and indicate whether the organization had a policy for minimum levels and frequency of distributions. This too, did not pass.
- Private Activity Bonds: Proposals to make interest on private activity bonds taxable did not pass.
- The key provisions are effective for taxable years beginning after December 31, 2017.
- With many variables still unknown on how multiple lines of unrelated business activities will be treated, consideration might be made to house profitable and unprofitable activities in a single taxable corporate subsidiary. This will enable expenses and income to once again offset and benefit from the lower 21% corporate income tax rate.
- The adjusted gross income limitation increased to 60% (from 50%) for cash contributions made to public charities by individuals. Tax exempt organizations should promote this benefit with donors to increase funding. The provision does retain the 5-year carryover rule to the extent the contribution amount exceeds 60% of the donor’s adjusted gross income.
- Boards and committees of tax-exempt organizations need to evaluate conditions for both current and deferred compensation that might result in exceeding the new compensation threshold for the 21 % excise tax. Essentially, the Act has manipulated tax exempt organizations into competing with the for-profit world by now having to pay market rates for recruiting and retaining talented professionals, as a result of the new 21% excise tax on executive compensation.
- New rules apply to 529 savings accounts whereby distributions can now fund public, private, and religious education below college level. Therefore, schools can emphasize these funding options to increase and strengthen enrollment.
Tax exempt organizations must carefully evaluate and strategically implement the best options to prevent any threat to their tax exempt status or cause unintended penalty consequences. To learn more about upcoming changes and for advice on the impact of the Tax Cuts and Jobs Act of 2017, contact your not-for-profit specialist at Marcum LLP.