For better or worse, the Tax Cuts and Jobs Act (“Act”) is on its way to the White House and President Trump is expected to sign it. The bill will bring about sweeping changes to the US tax code for both businesses and individuals. However, it will also impact tax-exempt organizations and their donors.
Temporary Increase in Charitable Contribution Deduction Limitation
Pre-Act Law. The deduction for an individual’s charitable contribution was limited to 50%, 30%, or 20% of the donor’s adjusted gross income depending on the donee organization’s tax classification and whether the contribution consisted of capital gain property.
New Law. For contributions made after Dec. 31, 2017, but before Jan. 1, 2026, the Act increases the 50% limitation under Code Sec. 170(b) for cash contributions to public charities and certain private foundations to 60%. (Code Sec. 170(b)(1)(G) as added by Act Sec. 11023). Contributions exceeding the 60% limitation are allowed to be carried forward and deducted for up to five years. This change will provide an incentive for donors to plan to make significant gifts between 2018 and 2025.
New Excise Taxes for Highly Compensated Nonprofit Employees
Pre-Act Law. Tax-exempt entities’ executive compensation was required to be reasonable, and there were prohibitions against private inurement, but there was no excise tax tied to the amount of compensation paid.
New Law. Tax-exempt organizations are subject to a new 21% excise tax on the total of (1) the remuneration (other than an excess parachute payment) greater than $1 million paid to a covered employee; and (2) any excess parachute payment (as defined) paid to a covered employee. A covered employee is any applicable tax-exempt organization employee (or former employee) if the employee is one of the organization’s five highest compensated employees for the tax year or any preceding tax year after Dec. 31, 2016. Remuneration is treated as paid when it is no longer subject to a substantial risk of forfeiture. (Code Sec. 4960, as amended by Act Sec. 13602). This provision will primarily impact hospital, university, and large national nonprofit executives.
New Excise Taxes for Large University Endowments
Pre-Act Law. Private colleges and universities are treated as public charities rather than private foundations and are therefore not subject to excise tax on net investment income applicable to private foundations.
New Law. For tax years beginning after Dec. 31, 2017, the Act imposes an excise tax equal to 1.4% on net investment income of private colleges and universities with large endowments. Specifically, it impacts: (i) private colleges and universities with at least 500 students; (ii) more than 50% of the students of which are in the U.S.; (iii) with investment assets of at least $500,000 per student. (Code Sec. 4968, as amended by Act Sec. 13701).
Changes to the Calculation of UBTI
Pre-Act Law. Tax-exempt organizations determine their unrelated business taxable income (UBTI) by subtracting from their gross unrelated business income any deductions directly connected with the unrelated trade or business. In calculating UBTI, organizations with multiple separate unrelated trades or businesses are permitted to offset income from one unrelated trade or business with the deductions from another to reduce their total UBTI.
New Law. After Dec. 31, 2017, the Act disallows losses from one unrelated trade or business from offsetting income derived from a separate unrelated trade or business. Gains and losses must be separately calculated and applied which may increase taxable income for organizations with multiple lines of unrelated business. (Code Sec. 512(a), as amended by Act Sec. 13702). However, the Act’s reduction in the corporate tax rate from 35% to 21% will result in a decrease in unrelated business income rates paid by tax-exempt organizations.
Amounts Paid For College Athletic Seating Rights No Longer Deductible
Pre-Act Law. Special rules applied to payments to institutions of higher education when the payor received the right to purchase tickets or seating at an athletic event in exchange for the payment. The payor could treat 80% of a payment as a charitable contribution where: (1) the amount was paid to or for the benefit of an institution of higher education; and (2) the amount would be allowable as a charitable deduction if the taxpayer did not receive the right to purchase tickets for seating at an athletic event in an athletic stadium of such institution in exchange for the payment.
New Law. For contributions made after Dec. 31, 2017, a charitable deduction is disallowed for payments to institutions of higher education if the payor receives the right to purchase tickets or seating at an athletic event as a result of the payment. (Code Sec. 170(l), as amended by Act Sec. 13704).
Alternative Gift Substantiation Option Eliminated
Pre-Act Law. A donor who donated $250 or more to a charitable organization was required to obtain a contemporaneous written acknowledgment of the gift to substantiate the donation for tax purposes. Alternatively, the Internal Revenue Code permitted the charitable organization to file a document with the IRS detailing information about the donor and his or her gift.
New Law. For tax years beginning after Dec. 31, 2017, the alternative substantiation option will not be permitted. This change should have little impact because most charities prefer to send acknowledgment letters to donors thanking them for their contributions. (Former Code Sec. 170(f)(8)(D), as stricken by Act Sec. 13705).
“Pease” Limitation on Itemized Deductions Suspended
Pre-Act Law. Before the Act, higher-income taxpayers were subject to a limit on itemized deductions known as the “Pease limitation”. For taxpayers who exceed the Pease limitation threshold, the law reduced the otherwise allowable amount of itemized deductions by 3% of the taxpayers’ adjusted gross income that exceeded the threshold. The total reduction could not be greater than 80% of all itemized deductions, and certain itemized deductions were exempt from the Pease limitation.
New Law. The Pease limitation is suspended for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026. (Code Sec. 68(f), as amended by Act Sec. 11046).
Fortunately, the final Act omitted several provisions that would have had negative impacts on tax-exempt organizations. Such proposals included changes to the intermediate sanctions rules which would have made it harder to establish the rebuttable presumption of reasonableness, the elimination of private activity bonds, and the repeal of the Johnson Amendment which would have injected politics into the nonprofit sector.