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Tax Bill Causes Alarm for Some Charities and Tax-Exempt Organizations

The Tax Cuts and Jobs Act, which has been renamed the Amendment of 1986 Code, was signed into law by President Trump on December 22, 2017. Many are calling it the most sweeping overhaul to the United States tax system in decades. The Act positively impacts many sectors, including corporations with the significant reduction in corporate rates. In the case of tax-exempt organizations, however, the Act may have a significant negative impact.

Impact on Charitable Giving

An increase in the standard deduction amount for individual filers and the increase in the estate tax exclusion are predicted to cause a meaningful 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 receive a tax benefit from charitable contributions. The Tax Policy Center has estimated that before the Act, more than 46 million tax filers would itemize their 2018 returns, but with the passage of the Act, this number could drop to less than 20 million. In the short-term, donors are advised to consider making additional charitable contributions in 2017 since it is uncertain whether their charitable gifts will create a tax benefit in future years. 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”).

An applicable tax-exempt organization means 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 described in Section 527(e)(1) for the taxable year. 

A “covered employee,” is any current or former employee who:

  • is one of the tax-exempt organization’s five highest compensated employees for the current taxable 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 and is defined as “wages” for federal income tax withholding purposes. It also includes remuneration paid by related organizations of the applicable tax-exempt organization. 

There are certain exceptions to the inclusion in remuneration under the definition including compensation attributable to medical services of certain qualified medical professionals and any designated Roth contribution.

The new Section 4960 is effective for taxable years beginning after Dec. 31, 2017. Year-end compensation planning, such as accelerating incentive compensation, should be considered to help avoid or reduce the 2018 excise tax. Calendar year taxpayers have only a few days to engage in this planning while fiscal year-end taxpayers may have a few more months to plan.

Separate Computation of UBTI for Each Trade or Business Activity

Certain tax-exempt organizations are subject to income tax on their unrelated business taxable income (“UBTI”). 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 against income from another may increase an organization’s overall UBI, but the lower corporate tax rate may otherwise reduce the amount of tax paid.

Provisions Affecting Tax-Exempt Bonds

The Act provides some welcome certainty for many tax-exempt organizations relative to tax-exempt bond financing. The House version of the Act had proposed an elimination of the ability of entities to issue “private activity bonds” Section 501(c)(3) bonds that are issued for the benefit of many tax-exempt Section 501(c)(3) organizations. This proposed elimination 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 refundings” after Dec. 31, 2017.

Other Noteworthy Provisions

  • 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 which have investment assets, including those of related entities, of at least $500,000 per student. 
  • The existing income tax deduction for donations made in exchange for college athletic event seating rights will be repealed. 
  • 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.
  • 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.
  • The top corporate tax rate for UBI is reduced to 21 percent.
  • The Act increases the annual limit on cash contributions to most public charities from 50 percent to 60 percent. 
  • UBI will be increased by the amount of certain qualified transportation fringe benefit expenses for which a deduction is disallowed.
  • The Act repeals the deduction for local lobbying expenses which could impact Section 501(c)(6) rules.
  • The contribution limitation as to ABLE accounts is increased under certain circumstances.
  • The Act now allows for rollovers between qualified tuition programs and qualified ABLE programs.

The Act could have a significant impact on your tax-exempt organization. 

© Polsinelli PC, Polsinelli LLP in California


About this Author

Douglas K. Anning, Polsinelli PC, Corporate Mergers Lawyer, Acquisitions matters Attorney

Douglas Anning brings a unique blend of corporate mergers and acquisitions, corporate governance, healthcare and tax experience to serve health care and nonprofit clients. He is vice chair of the firm's Nonprofit Organizations practice group and a member of the firm’s Health Care practice group, with a primary focus on nonprofit hospital mergers and acquisitions, nonprofit tax law, and nonprofit corporate governance.

Douglas represents nonprofit and government hospitals, health systems, universities, academic medical centers, senior living,...

Alicia Beck, Kansas City, Tax Attorney, Polsinelli PC

Alicia M. Beck is an associate with Polsinelli PC concentrating her practice on providing counsel to nonprofit and tax-exempt organizations. Alicia uses her tax law background and experience to assist clients with planning and structuring issues, and operational matters including:

  • Forming nonprofit organizations and qualifying them for tax-exempt status 
  • Providing advice and counsel on corporate governance practices and policies
  • Developing financial assistance policies, emergency medical care policies, and billing and collection policies to comply with Section 501(r) of the Internal Revenue Code
  • Structuring relationships to ensure compliance with the intermediate sanctions rules and the private benefit and private inurement doctrines 
  • Analyzing and engaging in unrelated business income planning 
  • Providing advice and counsel on issues relating to fundraising and charitable giving
  • Ensuring compliance with the law related to political and lobbying activities
Jonathan Blum, tax Attorney, non-profit, charities, Dallas, Polsinelli Law FIrm

Jonathan Blum understands the nonprofit sector from a unique vantage point. He gained a wealth of experience while serving as in-house general counsel for a major international charity and a private foundation. Through this in-depth knowledge, Jonathan assisted nonprofit leaders to manage their legal matters and build capacity for the future. He recognizes the importance of concentrating on the key issues affecting clients and moving quickly to identify practical legal options in order for clients to stay mission-focused and make informed decisions.

Virginia C. Gross, Polsinelli PC, Tax Counseling Matters Lawyer, Corporate Governance Attorney

Virginia Gross has dedicated her career to counseling tax-exempt organizations. She advises clients on legal compliance issues and planning opportunities to more effectively advance their missions. She counsels organizations on qualification for tax-exempt status, permissible activities, joint venturing, governance and best practices, unrelated business activities, formation of affiliated and related entities, and political and lobbying matters. The clients she serves include public charities, private foundations, educational organizations, universities, hospitals and...

Thomas J. Schenkelberg, Polsinelli PC, Certified Public Accountant, Lawyer, Non-Profit Organizations Attorney

Business planning, whether nonprofit or for-profit, is a numbers game, full of complex jargon and legalese. Drawing on his experience as a certified public accountant, Thomas Schenkelberg walks his clients through this maze – helping them emerge on the other side with a sophisticated tax and business plan that creates a solid foundation.

Thomas is chair of the Polsinelli Nonprofit Organizations practice. His practice emphasizes tax, nonprofit, and health care law. His clients include national hospital systems, research organizations, private...