Original proposals for the 2017 Tax Act (known unofficially as the "Tax Cuts and Jobs Act") had threatened to repeal or significantly restrict the Johnson Amendment (prohibiting/limiting charities from engaging in partisan activities), eliminate private activity bonds, further restrict donor advised funds, increase the excise tax on all private foundations, and convert some art museums to private foundation status. These amendments were not enacted, however other changes will impact tax-exempt organizations in several ways. The following is an overview of these changes, including the potential effect on charitable donations, taxes imposed on the investment income of large private colleges and universities, modifications made to unrelated business taxable income (UBTI), and new excise taxes on certain compensation and employee fringe benefit programs.
Charitable Contributions May Decline
There is speculation that some changes will decrease or eliminate the federal income tax benefit of making a charitable contribution and that this, in turn, will cause a drop in contributions. Alternatively, there is speculation that tax savings will increase net income available for charitable contributions and that this, in turn, will cause an increase in contributions.
- Individual Standard Deduction Doubled/Itemized Deductions Limited or Repealed. The combined effect of these changes will be that fewer individuals will be able to take advantage of the charitable income deduction because they will no longer itemize their deductions.
- Income Tax Rates Reduced. The reduction of the top corporate and most individual income tax rates will decrease the tax savings realized by those who make charitable contributions.
- Individual Limitation Increased. The 50% adjusted gross income limitation for cash contributions made by individuals to public charities and certain private foundations is increased to 60%. But again, fewer individuals will be likely to itemize.
- Estate Tax Exemption Doubled. This will eliminate the usefulness of the charitable estate tax deduction for many estates.
Excise Tax Based on Investment Income of Private Colleges and Universities
An excise tax of 1.4% is imposed on the net investment income of larger private colleges and universities. The tax applies to each private college and university with assets (other than those used directly in carrying out the institution’s exempt purpose) of at least $500,000 per student and with at least 500 students, more than 50% of whom are located in the United States.
Unrelated Business Taxable Income (UBTI) Changes
- UBTI Separately Computed for Each Trade or Business Activity. Losses from one unrelated trade or business may no longer be used to offset income derived from another unrelated trade or business. Gains and losses must be calculated and applied separately.
- Tax Rate Changes May Increase or Decrease UBTI Tax Imposed. Current corporate income tax rates range from 15% to 35%. These change to a fixed rate of 21% in all cases.
- The Net Operating Loss Carryback Is Modified. Most net operating losses will not be eligible to be carried back (only forward), and the deduction (going forward) is limited to 80% of taxable income.
Compensation Changes Mirror For-Profit Deduction Disallowances
- Excise Tax on Excess Tax-Exempt Organization Executive Compensation. Tax-exempt organizations (under IRC Section 501(a), 521(b)(1), 115, or 527(e)(1)) will be subject to a tax at the corporate income tax rate (21%) on the sum of: (a) the remuneration (other than an excess parachute payment) in excess of $1 million paid to a “covered employee” in any tax year; and (b) any excess parachute payment (as newly defined) paid by the applicable tax-exempt organization to a “covered employee.”
“Remuneration” paid to a licensed medical professional (which includes veterinarians) for medical or veterinary services performed by that professional is excluded. But, remuneration paid to such a medical professional in any other capacity (other than for the performance of medical or veterinary services) is taken into account.
Additional rules require consideration of remuneration paid for employment to a “covered employee” by certain related persons or government entities.
- UBTI Increased by Disallowed Fringe-Benefit Expenses. Tax-exempt organizations will include, as UBTI (taxed at 21%), any amount (a) for which a deduction is not allowed under Section 274, or (b) that the organizations pay for any “qualified transportation fringe” (as defined in Section 132(f)). Thus, exempt organizations will pay a tax for disallowed meal and entertainment expenses, as well as the cost of any parking facilities or on-premises athletic facilities, provided to employees.