The Tax Cuts and Job Act was passed in December 2017, but the total impact to nonprofits will not really be known until we get through 2018. The reason, not only are there direct impact items in the Act, but there are also indirect impact items. It is very likely that the indirect impact items will have a greater effect on nonprofits.
For direct impact there are six primary items affecting nonprofits, and it is quite possible that none of these items will affect your organization.
- The calculation for unrelated business income (UBI). Not all nonprofits have UBI, and there has been no change in the definition of UBI. So, if you have not previously filed a Form 990T, Exempt Organization Business Income Tax Return, you are most likely not affected. For those that do report UBI, the income should now be calculated separately for each unrelated trade or business activity – therefore UBI from one activity can no longer be used to offset the income of another unrelated activity. Also, net operatinglosses can no longer be carried back. Carryforwards will not expire, but are limited to 90 percent of taxable income. And finally, the UBI tax rate will now be a flat 21 percent.
- Excise tax on executive compensation. Executive compensation in excess of $1 million will now be subject to 21 percent excise tax. In addition, there will be an excise tax on excessive parachute compensation paid to any covered employee making over $120,000. Some quick definitions: Covered employees are any current or former employees that are reported as one of the five highest compensated employees on the Form 990, Return of Organization Exempt Form Income Tax. Parachute payments are generally any payments that exceed three times an employee’s base compensation. This excise tax assessment considers eligible executives as anyone who has ever been reported as a covered employee on a Form 990 for tax years beginning in 2017 and thereafter. Also, expect some additional scrutiny of employees being classified as contractors or employees compensated through pass-through entities, the IRS may be looking for individuals paid as contractors as a means to avoid the excise tax.
- Excise tax on certain private colleges and universities endowments. For institutions that have at least 500 tuition paying students for which more than 50 percent of these students are located in US, that are not defined as a state college or university and have an aggregate fair market value of assets of at least $500k per student at the end of the preceding tax year, the investment income will now be subject to a 1.4 percent excise tax.
- Funds used to pay for employee transportation fringe benefits and on-premises athletic facilities will now be treated as unrelated business income.
- Interest income received by investors on advance refunding bonds will no longer receive a tax break. Quick definition: Advance refunding bonds are used to refinance debt at lower rates and to pay principal, interest, or the redemption price on a prior bond issue. These bonds would be issued more than 90 days before the redemption of the prior issue.
- Charitable deductions for athletic seating rights will no longer be allowed.
The indirect impact of the tax reform act seems to be generating more concern. Will donors continue to donate at the same level if they are not receiving a tax deduction? There is no way to gauge this. While many donors give to support the public good, there are those for which a reduction in taxable income is an incentive to donate. To better understand the indirect impact of the tax reform act, we have summarized some of the pertinent provisions related to charitable giving.
- The standard deduction has increased. For single tax payers it is now $12,000 as opposed to $6,350 and for married taxpayers $24,000 as opposed to $12,700. Also, individuals will only be able to deduct up to $10,000 of state and local taxes when itemizing. Bottom line, less people will be itemizing their deductions and therefore not using charitable giving as a vehicle for tax savings.
- For individuals that do itemize, they will now be able to donate up to 60 percent of their adjusted gross income (AGI) to charity as opposed to the previous 50 percent. The five year carryover for donations in excess of the limit has not changed.
- Estate and gift tax unified credit exclusion has increased to $11.2 million (adjusted for inflation), from $5.6 million. Bequests to charitable organizations are allowed to reduce the amount of an individual’s estate that is subject to tax.
So while there is a chance that there may be a reduction in giving for those no longer itemizing, there is also opportunity for increased giving from high net worth donors. In addition, there are still some charitable giving tools that continue to receive beneficial treatment.
- Donating appreciated stock avoids capital gains taxes. The donor records a tax deduction for the fair market value when donating qualified appreciated stock; the nonprofit organization recognizes revenue for the fair market value of the stock at the date of transfer.
- Donors aged 70 ½ or older can still donate their required minimum distribution from their IRA for beneficial tax treatment. The donation alleviates reporting the distribution as taxable income.
- Planned giving. Naming a nonprofit the beneficiary of retirement plan assets can avoid tax burdens on the donor’s heirs.
Overall, the industry feels that donors will continue to support causes and organizations that they care about, so good stewardship continues to play a prominent role in charitable giving. Consider reaching out to your donors to acknowledge the change in tax incentives and to keep them up to speed on those giving methods that still receive favorable tax treatment.
As always, UHY, LLP is here to help. We invest significant time in understanding tax reform and other developments in the nonprofit sector in order to ensure the success of our clients. Please do not hesitate to contact your UHY LLP team member if you are in need of assistance.