Since President Donald Trump signed the Tax Cuts and Job Act (TCJA) on December 22, 2017, not-for-profit and tax-exempt organizations have been analyzing the impact to their entities. While the law has wide-ranging implications, numerous provisions will specifically affect tax-exempt organizations, including public charities, social welfare organizations, colleges and universities, healthcare organizations, associations, and private foundations. For information related to ongoing changes in the new tax laws, please visit http://www.claconnect.com/topics/tax-reform#Resources.

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Charitable Giving

The TCJA creates uncertainty for charitable organizations by increasing the standard deduction, changing several itemized deductions, increasing the deductibility of cash contributions to charities, and lowering tax rates. The Urban-Brookings Tax Policy Center estimates that, while only 26% of taxpayers itemized their deductions in 2017, those taxpayers were responsible for 82% of charitable giving (http://tpc.io/2FALXPh). To the extent that taxpayers have a tax motive for making donations to charity, the impact on charitable giving may be significant.

Many taxpayers will benefit from the change in individual tax rates and the significant increase in the standard deduction. In 2018, the standard deduction increases to $24,000 for a married couple filing a joint return, $18,000 for head of household filers, and $12,000 for individual filers. With this change and various changes to itemized deductions, it is anticipated that more individuals will claim the standard deduction instead of itemizing. The Tax Policy Center estimates that the number of taxpayers who file itemized deductions could drop by almost 40 million by 2019 (http://tpc.io/2FBdzUh).

For taxable years beginning after December 31, 2017, the limitation for cash contributions to public charities and private operating foundations has increased from 50% to 60% of the donor’s adjusted gross income. Taxpayers who do not itemize will not benefit from this increase. A provision for an “above the line” deduction for charitable contributions that would benefit all taxpayers was not adopted in the final bill. It is important to note that the 20%, 30%, and 50% limitations applicable to other donations are unaffected by the new law.

The TCJA doubles the estate tax exclusion from $5.6 million to $11.18 million, adjusted for inflation, for taxable years beginning after December 31, 2017. Combined with the reductions in individual tax rates, charitable giving may be of decreased importance for estate planning purposes.

Unrelated Business Income

For tax years beginning after December 31, 2017, nonprofit organizations that report income from more than one unrelated trade or business must compute the net taxable income from each activity separately. Losses from one activity may no longer be used to reduce taxable income from another activity. Activities with net income will owe tax. Activities generating losses may carry those losses forward indefinitely, but may only utilize the loss against the same type of activity. Such losses may only be applied against 80% of that activity’s net income in any given year. Net operating losses (NOL) generated in tax years beginning before January 1, 2018, may continue to be applied against any type of unrelated business income (UBI), subject to the 20-year carry-forward limitation, and are not limited to 80% of net income. Organizations should take steps now to track the revenue, expenses, and net operating loss carryforwards specific to each activity and maintain adequate documentation to support the methodology used.

Because each unrelated business income activity must be tracked and reported separately, one might assume that all rental real estate activities would constitute a single activity and all alternative investment activities would constitute another activity. However, there is uncertainty whether a nonprofit investor in a partnership with both ordinary business income and rental activities would treat the partnership as one activity or as separate activities based on each of the partnership’s underlying activities. Likewise, must advertising in each periodical be tracked as a separate activity, or may all periodical advertising be combined as a single activity, with losses from one publication offsetting income from another? Further guidance from the IRS is needed.

Previously, an organization generating a net loss of $10,000 on its advertising activities (Form 990-T Schedule J) and net income of $5,000 from rental income from debt-financed property (Form 990-T, Schedule E) would report an NOL of $5,000 that could be carried forward 20 years (or carried back 2 years) and applied against any type of UBI activity. Under the new law, the organization will report $5,000 of taxable income and a $10,000 NOL that can be carried forward indefinitely. That NOL can only be applied against 80% of the net income from periodical advertising in any given year.

Losses from one activity may no longer be used to reduce taxable income from another activity. Instead, unrelated business income activities will be tracked separately.

The TCJA also changed the corporate tax rate to a flat rate of 21%, eliminating the historical tiered structure. Previously, a nonprofit organized as a corporation would pay tax at the rate of 15% on the first $50,000 of taxable income with rates graduated up to 35%. Under the new law, corporate UBI is subject to a flat rate of 21%. Nonprofit organizations with net taxable income below approximately $91,000 will thus experience a tax increase rather than a decrease. The change in tax rates does not apply to tax-exempt organizations established as a trust.

Exempt organizations are now required to pay UBI tax on the amount of certain fringe benefits provided to employees. These benefits include employer-provided parking, parking passes, transit passes, bus or rail passes, van pools, and similar payments or reimbursements to cover an employee’s normal commuting expenses. To the extent that the amount is directly connected with a regularly carried-on unrelated trade or business activity, the benefits are not included in UBI, but the expense will not be deductible. Bicycle commuting benefits are still deductible by the employer, but they are now included in the employee’s taxable income; such an expenditure is therefore not reported as UBI.

The TCJA appeared to require employers operating onsite athletic facilities, such as a gym, golf course, pool, or tennis court, to also include these expenditures as UBI. However, it failed to amend Internal Revenue Code (IRC) section 274; as a result, tax-exempt organizations do not report these expenses as UBI.

The IRS recently updated Publication 15-B, Employer’s Tax Guide to Fringe Benefits, making it clear that a tax-exempt employer is required to report as UBI not only direct payments for parking and transportation, but also any amount that the employee contributes to a flexible spending account (FSA) for transportation costs on or after January 1, 2018, regardless of the employer’s tax year (http://bit.ly/2qc84kb).

With all of the above changes associated with UBI reporting, tax-exempt organizations may consider whether to put in place a “blocker corporation” to house UBI activities. Use of a blocker corporation would allow all UBI activities to be combined to arrive at net taxable income instead of tracking and reporting each line of business separately. Organizations must carefully monitor each unrelated business activity for the purposes of quarterly estimated tax and extension payments.

Executive Compensation

The TCJA imposes a 21% excise tax on compensation paid by a tax-exempt organization in excess of $1 million to any covered employee for tax years beginning after December 31, 2017. This tax applies to cash and noncash compensation, including benefits. For this purpose, compensation does not include Roth elective deferrals, but does include 457(f) deferred compensation, including any amounts vested (even if not yet received). The excise tax does not apply to compensation paid to licensed medical professionals (including veterinarians) in exchange for medical services performed. If an individual is compensated for both medical and other services, only the amount of medical services is excluded from the tax.

The TCJA imposes a new 1.4% excise tax on the net investment income of private colleges and universities.

For the purposes of this provision, a covered employee is defined as an employee, including a former employee, who is the CEO, the CFO, or one of the next three highest paid employees of the organization for the taxable year or was a covered employee for any preceding taxable year beginning after December 31, 2016. Even if the employee no longer meets the definition of a covered employee, the individual will forever retain the classification. If an individual receives compensation from more than one employer, then the excise tax on excessive compensation is calculated proportionately among them.

In addition, the TCJA imposes a 21% excise tax on excess parachute payments. An excess parachute payment is defined as a severance payment, including transfer of property, to any highly compensated employee that is greater than three times the individual’s average salary for the previous five years. Highly compensated employees of nonprofit organizations include those who receive compensation exceeding $120,000 in 2018 (adjusted for inflation). Parachute payments do not include amounts paid to annuity contracts under 403(b) or 457(b), or amounts paid to licensed medical professionals (including veterinarians) in exchange for medical services performed.

The IRC treats this as an excise tax, not an income tax. At this time, it is unknown whether the taxable portion of the compensation will be reported on Form 990-T or Form 4720, Return of Certain Excise Taxes under Chapters 41 and 42 of the IRC. Since excise taxes are not subject to quarterly estimated payments, tax-exempt organizations should not need to include excess executive compensation in their computation of 2018 estimated taxes. The tax will be due by the initial due date of the return (e.g., May 15, 2019, for a calendar year organization).

Colleges and Universities

The TCJA imposes a new 1.4% excise tax on the net investment income of private colleges and universities. For the purposes of this provision, net investment income is computed similar to that of private foundations. A private foundation’s net investment income generally includes its interest, dividends, rents, royalties, and net capital gains, less expenses. The excise tax only applies to colleges and universities with at least 500 tuition-paying students, more than 50% of whom are located in the United States, and with noncharitable use assets equal to at least $500,000 per full-time equivalent student. The assets and income of related organizations available for the use or benefit of the educational institution, including supporting organizations described in IRC section 509(a)(3), are combined for purposes of this excise tax. This provision does not currently apply to state colleges and universities.

The TCJA eliminates the ability of donors to claim a charitable contribution deduction for amounts paid to educational institutions after December 31, 2017, if the amount includes the right to purchase tickets for seating at an athletic event. Prior to January 1, 2018, a donor who made a contribution that included the right to buy athletic tickets was entitled to a charitable contribution deduction equal to 80% of the payment. The disallowance is based on the right to purchase the tickets, regardless of whether the tickets would have been readily available anyway, or whether the individual actually purchased the tickets.

Elementary and Secondary Schools Now Eligible for 529 Plans

For many years, nondeductible cash contributions could be made to a qualified tuition program, known as a 529 plan, and accumulate tax-free earnings to be used for qualified higher education expenses. Beginning with 529 plan distributions made after December 31, 2017, eligible educational institutions now include elementary and secondary schools.

Tax-Exempt Bond Provisions

Tax-exempt bonds, including qualified 501(c)(3) bonds, are appealing to investors because the interest is excludible from taxable income. A refunding bond is issued to pay the principal or interest, or the redemption price, on a prior bond. A current refunding bond redeems the prior bond within 90 days, whereas an advance refunding bond is issued more than 90 days prior to the redemption of the prior bond. Advance refunding bonds effectively allowed two sets of federally subsidized debt in connection with a single activity. Under the new tax law, interest on current refunding bonds remains excludible from taxable income, but interest on advance refunding bonds issued after December 31, 2017, is not.

The holder of a tax credit bond receives federal tax credits instead of interest. Certain tax credit bonds are direct-pay bonds, which allow the issuer to receive a payment directly from the IRS instead of providing the bond holder with a tax credit. After December 31, 2017, the authority to issue tax-credit bonds and the provision for direct-pay bonds is repealed (e.g., forestry conservation, clean renewable energy, energy conservation, zone academy, school construction). Bonds issued prior to January 1, 2018, are still subject to the previous rules.

Miscellaneous Employer Provisions

Temporary family and medical leave.

The TCJA creates a paid family and medical leave credit for tax years beginning after December 31, 2017, and before January 1, 2020. In order to qualify for the credit, which ranges from 12.5% to 25% of wages, an employer must provide at least two weeks (but not more than 12 weeks) of paid leave providing at least 50% of normal wages. Any leave mandated or paid for by a state or local government does not count as wages for purposes of the credit. In addition, the employee must have been employed for at least one year, and the employee’s prior year compensation cannot exceed $72,000 (adjusted for inflation). Unlike other provisions that allowed tax-exempt employers to utilize the credit as an offset against payroll tax liabilities, this credit is a general business credit and not refundable. Organizations can claim it as an offset to unrelated business income tax reported on the Form 990-T.

Employee achievement awards.

The TCJA provides clarification on the tax treatment of employee achievement awards. Employee achievement awards for such things as length of service or safety records that are awarded as part of a meaningful presentation can be excluded from the employee’s taxable income, as long as they are not disguised compensation. The excludible amount is limited to $400 per person ($1,600 if there is a written plan that doesn’t discriminate in favor of highly compensated employees). For amounts paid after December 31, 2017, an excludible award cannot be made in cash, cash equivalents, gift cards, gift coupons, gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items preselected or preapproved by the employer), vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, or other securities. Achievement awards paid in the form of items noted above are includible in an employee’s compensation as taxable income and are subject to payroll tax.

Unreimbursed moving expenses are no longer deductible by the employee, and reimbursed moving expenses will now be taxable to the employee.

Moving expenses.

Unreimbursed moving expenses are no longer deductible by the employee, and reimbursed moving expenses will now be taxable to the employee. There is an exception for active-duty members of the Armed Forces who must move pursuant to military orders.

Employer entertainment deduction.

Many not-for-profit organizations utilize social clubs or other recreational facilities or events for the purpose of donor development. The TCJA provides that expenditures for entertainment, amusement, or recreation, including club dues paid on behalf of employees, are no longer deductible by the employer, even if the club is used for business purposes. Previously, an employer could deduct club dues as salary expense as long as the employee included the amount in taxable compensation. Because not-for-profit organizations do not generally receive a tax deduction for salary expense, employers would generally treat the mission-related portion of club dues as a working condition fringe benefit and exclude them from the employee’s compensation. With the elimination of the deduction for social club dues, not-for-profit organizations must include such benefits in the employee’s taxable compensation.

Tax Provisions Not Included in the Act

The final version of the TCJA did not contain a number of provisions that were under consideration. These provisions included the elimination of private activity bonds, simplification of the private foundation excise tax on net investment income, a special exception to the Johnson Amendment allowing 501(c)(3) organization to engage in political activities, the taxation of royalty income earned from the licensing of certain intangible property, and the elimination of certain employee tuition benefits. These provisions may surface again in future legislation.

Assess the Impact

Not-for-profit organizations will be significantly impacted by various aspects of the TCJA. However, the specific application of many provisions is unknown since organizations are awaiting guidance from the Treasury Department. Now is the time for CPAs to identify the provisions that will impact their clients or employer and analyze the potential effects. This may include revisiting and updating financial modeling and assumptions.

David Trimner, CPA, MST is a principal and national nonprofit tax leader at CliftonLarsonAllen LLP.
Karen A. Gries, CPA is a principal, tax services, at CliftonLarsonAllen LLP.