Sikich Series on Tax Reform – Tax Cuts and Jobs Act Includes Significant Changes for Tax-Exempt Organizations

The passing of the tax reform bill means a new tax landscape for numerous businesses, individuals, and not-for-profit organizations. Congressional leaders and the administration announced their plans when they introduced a “tax framework” for reform in September (please click here for our article related to tax-exempt organizations when the tax framework was revealed). Numerous provisions included in the earlier House and Senate versions were not included in the final legislation.

Here are the key highlights in the tax bill affecting tax-exempt organizations that were the focus of much of the debate in Congress.

Highlights for Charitable Giving

All effective beginning in 2018:

• • Increase in Standard Deductions. The tax bill increases the standard deduction for all filing statuses:
    • MFJ: $24,000
    • HOH: $18,000
    • All other filers: $12,000

     

  • Increases % limits on Charitable Contributions. The tax bill increases the 50% AGI limitation for charitable contributions to 60%.

• • Denial of deduction for college athletic seating rights. The tax bill amends Section 170(l) to provide no charitable contributions shall be allowed for any payment to an institution of higher education in exchange for which the payor receives the right to purchase tickets or seating at an athletic event. Under prior law 80% of such payments were classified as a charitable contribution.

• Repealing the Pease limitation on itemized deductions. Under prior law, the total amount of most itemized deductions (other than the deductions for medical expenses, investment interest and casualty/theft losses) is limited for certain upper-income taxpayers. The 3% adjustment applied for AGI over a certain threshold amount (often referred to as the “Pease limitation”) has been repealed under the new tax bill.

Highlights for Unrelated Business Income

• • Unrelated business taxable income computed separately for each trade or business. The new tax bill will require UBTI first be computed separately with respect to each trade or business. An organization’s UBTI is the sum of the amounts (not less than zero) computed for each separate UBI activity. The result is that a deduction/loss from one unrelated trade or business may not be used to offset the income from a different unrelated trade or business. Net losses from one resulting activity may be used to offset income from the same unrelated trade or business in another taxable year.Under a special transition rule, net operating losses arising in a taxable year before January 1, 2018 that are being carried forward are not subject to this new provision.

    Effective for tax years beginning after December 31, 2017.

• Unrelated business taxable income is increased by amount of certain fringe benefit expenses for which a deduction is disallowed. The new tax bill includes any expenses paid or incurred by a tax-exempt organization for qualified transportation fringe benefits, a parking facility or any on-premises athletic facility. This provision generally treats amounts paid for such benefits as UBTI provided the amounts are not deductible under Section 274.Effective for amounts paid or incurred after December 31, 2017.

Not Included In the New Tax Law

• • Name and logo royalties treated as unrelated business income. The prior Senate version amended Section 513 to provide that any sale or licensing of any name or logo is treated as an unrelated business that is regularly carried on.

    This provision did NOT become law.

• Clarification of unrelated business income tax treatment of entities treated as exempt under Section 501(a) (“Dual status entities”). The House bill included a provision that certain organizations whose income is also exempt under another provision of the Code, such a Section 115 for state and local government entities (public pension plan) are subject to UBIT on its unrelated business income.

  This provision did NOT become law.

Highlights for Colleges and Universities

• Excise tax based on investment income of private colleges and universities. The new tax bill imposes a 1.4% excise tax on the net investment income of certain educational institutions. Net investment income is determined using similar rules relating to the investment income of private foundations under Section 4940.

This provision only applies to private colleges and universities that:

1. Have at least 500 students, AND
2. Have cash, investments, and other assets (other than those used directly in carrying out the institution’s exempt purpose) with an aggregate FMV of at least $500,000 per student at the end of preceding tax year.

For purposes of determining whether an institution meets the asset-per-student test and determining the net investment income, assets and net investment income would include the amounts from related organizations. For purposes of this test, a related organization would be included:

1. If the organization controls or is controlled by the institution.
2. If the organization is controlled by one or more persons that control the institution, or
3. the organization is a supported organization or a supporting organization.

Effective for tax years beginning after December 31, 2017.

Not Included In the New Tax Law

• • Limitation on exclusion for employer-provided housing. The House bill included a provision that the value of employer-provided housing as a condition of employment is limited to $50,000 and is phased out for highly compensated employees. The exclusion was phased out by $1 of every $2 above the indexed compensation threshold, which was $120,000 for 2017.This provision did NOT become law.

• Repeal of exclusion for qualified tuition deductions – Section 117(d). The House bill included a provision repealing Section 117(d) in which qualified tuition reductions for certain employees (and their dependents) of certain educational organizations are excluded from gross income.This provision did NOT become law.

Highlights for Private Foundations

• There are no new provisions in the Tax Cuts and Jobs Act that directly affects the code sections for private foundations.

Not Included In the New Tax Law

These provisions did NOT become laws:

• • Simplification of the excise tax on private foundation net investment income. The House bill repealed the contingent 1% or 2% excise tax on a private foundation net investment income and replaced it with a flat 1.4% tax rate.

• • Private operating foundation requirements relating to operating an art museum. The House bill included a provision requiring an organization that operates a museum as a substantial activity does not qualify as a private operating foundation unless the museum is open to the general public for at least 1,000 hours during the year.

• Provide an exception to the private foundation excess business holdings for philanthropic business holdings. The House bill included a provision that the excise tax on excess business holdings did not apply to any private foundation holding if all the following requirements are satisfied:
  1. The ownership requirement;
  2. The “all the profits to charity” distribution requirement; AND
  3. The independent operation requirements.

Highlights for Other Important Provisions Affecting Tax-Exempt Organizations

Effective for all tax years beginning after December 31, 2017:

• Excise tax on excess tax-exempt organization executive compensation. The new tax bills provides for a 21% excise tax for an applicable tax-exempt employer on the sum of:
  1. Any remuneration (not including excess parachute payment) over $1,000,000 paid to a covered employee; AND
  2. Any “excess parachute payment” paid by an applicable tax-exempt organization to a covered employee.Applicable tax-exempt organization” means any organization exempt under Section 501(a); an exempt farmer’s cooperative; a federal, state or local governmental entity with income excluded under Section 115; or a Section 527 organization.“Covered employee” is an employee (including former employees) of an applicable tax-exempt organization if the employee were one of the 5 highest paid employees for the tax year or was a covered employee for any preceding tax year beginning after December 31, 2016.“Remuneration” would be treated as paid when there is no substantial risk of forfeiture as defined under Section 457(f)(3)(B).This provision exempts compensation paid to employees who are not highly compensated employees from the definition of parachute payment and also exempts compensation for medical services of certain qualified medical professional from the definition of remuneration and parachute payment.

Effective to all advance refunding bonds issued after December 31, 2017:

• Repeal of advance refunding tax-exempt bonds. The new tax law repeals the exclusion from gross income for interest on a bond issued to advance-refund another bond.

Not Included In the New Tax Law

• • Termination of Private Activity Bonds. The House bill included a provision that repealed the exception form the exclusion from gross income for interest paid on qualified private activity bonds issued after December 31, 2017.This provision did NOT become law.

• • Political statements by Section 501(c)(3) organization. The House bill included a provision that allowed Section 501(c)(3) to make statements relating political campaigns if the statements were made in the ordinary course of activities and resulted in de minis incremental expenses.This provision did NOT become law.

• Additional reporting requirements related to donor advised funds (DAF). The House bill included a provision requiring additional reporting requirements.This provision did NOT become law.

Future Considerations

The President signed the tax bill into law on December 22, 2017. With a short time period before 2018, this leaves little time to engage in some 2017 year-end tax planning. Here are a few initial observations:

• • Unrelated business taxable income computed separately for each trade or business. UBI planning – Under the new law tax-exempt organizations will not be able offset losses from one unrelated trade or business activity against income/gains from another activity. This will more than likely increase an organization’s overall UBIT burden. After very careful considerations, an organization may engage in restructuring its unrelated activities including moving the unrelated activities to a taxable subsidiary.  CAUTION – Careful analysis of all possible implications should be performed prior to establishing a taxable subsidiary.

• • 4 % Excise tax based on investment income of private colleges and universities. Under the new law, certain college and universities are effectively subject to the Section 4940 net investment excise tax similar to private foundations. The same type of planning that private foundations perform to reduce their net investment excise tax will also apply to certain colleges and universities in 2018.

• 21% Excise tax on excess tax-exempt organization executive compensation. This provision could have a significant impact on tax-exempt organizations that employ highly compensated employees. Organizations subject to this provision should review their employee’s total compensation arrangements to determine timing and the resulting amount of their exposure to the new tax. Organizations will need to monitor the amount and timing of their compensation payments in the future.

If you are interested in any assistance with planning or analysis of the new tax law and its impact on your organization for 2017/2018, please consult your local Sikich tax advisor.