Provisions of Tax Cuts and Jobs Act Affecting Tax-Exempt Organizations
The Act provides some welcome certainty for many tax-exempt organizations relative to tax-exempt bond financing. The proposed elimination of “private activity bonds” did not make it into the final bill. The Act does, however, adversely affect many tax-exempt organizations by eliminating their ability to undertake “advance refunding” transactions, where new tax-exempt bonds are issued to refinance existing tax-exempt bonds more than 90 days in advance of the redemption date or maturity date of such existing tax-exempt bonds. Under current law, tax-exempt Section 501(c)(3) organizations could undertake one “advance refunding” transaction, but the Act eliminates all “advance refunding” after December 31, 2017.
Increase in Standard Deductions and Estate Tax Exclusions
The increase in the standard deduction amount for individual filers and the increase in the estate tax exclusion likely will cause a significant decrease in overall charitable giving. A higher standard deduction means fewer taxpayers will itemize deductions, reducing their incentive to make charitable donations. Only taxpayers who itemize their deductions may deduct charitable contributions. Similarly, the doubling of the estate tax exclusion will reduce the incentive to make testamentary gifts to charities.
New Excise Tax on Executive Compensation Paid by Certain Tax-Exempt Organization (Medical Services Excluded)
The Act imposes a 21 percent excise tax on most tax-exempt organizations (defined as “applicable tax-exempt organizations”) on the sum of compensation paid to certain employees in excess of $1 million plus any excess parachute payments paid to that employee (defined as a “covered employee”).
- Applicable Tax-Exempt Organizations. An applicable tax-exempt organization is any organization that:
- is exempt from tax under Section 501(a) (such as Section 501(c)(3) charitable organizations);
- is a Section 521(b)(1) farmers’ cooperative organization;
- has income excluded from tax under Section 115(1) (this includes certain governmental entities); or
- is a political organization according to Section 527(e)(1) for the taxable year.
- Covered Employee. A “covered employee” is any current or former employee who:
- is one of the exempt organization’s five highest employee compensation for the current taxable year; or
- was a covered employee of the organization (or any predecessor) for any preceding tax year beginning after December 31, 2016.
- Compensation is referred to as “remuneration” under the new provision. It is defined as “wages” for federal income tax withholding purposes. It also includes remuneration pay by related organizations of the applicable tax-exempt organization. There are certain exceptions to the inclusion of remuneration under the definition including compensation attributable to medical services of certain qualified medical professionals.
Separate Computation of UBI for Each Trade or Business Activity
Certain tax-exempt organizations are subject to income tax on their unrelated business taxable income (“UBIT”). Under the current unrelated business income (“UBI”) rules, an organization that operates multiple UBI activities computes taxable income on an aggregate basis. As a result, the organization may use losses from one UBI activity to offset income from another, thus reducing total UBI. The Act requires tax-exempt organizations with two or more UBI activities to compute UBI separately for each activity. Accordingly, the losses generated by UBI activities computed on a separate basis may not be used to offset the income of other UBI activities. Under the new provision, a net operating loss deduction will be effectively allowed only with respect to the activity from which the loss arose. The inability to offset losses from one UBI activity income from another may increase an organization’s overall UBI tax burden.
Other Tax-Exempt Organization Provisions
- Excise Tax on Investment Income. The Act imposes a new 1.4 percent excise tax on the investment income of private colleges and universities and their related organizations with at least 500 students and the fair market value of investment assets, and those of related entities, of at least $500,000 per student.
- Electing Small Business Trusts. Under the Act, the charitable contribution deduction of an electing small business trust will be determined by the rules applicable to individuals, rather than those applicable to trusts.
- Partnership Allocations of Contributions. The Act modifies the partnership rules to clarify that a partner’s distributive share of loss takes into account the partner’s distributive share of charitable contributions for purposes of the basis limitation on partner losses.
- UBI Tax Rate. Like the C Corporation rate, the top tax rate for UBI is 21 percent.
- Increase in AGI Limitation. The 50 percent Adjusted Gross Income (“AGI”) limit for contributions to certain charities is increased to 60 percent.