Not-For-Profits: What You Need to Know Related to the Tax Cuts and Jobs Act
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act – the most sweeping update to the IRS code in almost 30 years. The Act is intended to simplify the taxpaying process for many Americans, while lowering rates for individuals and businesses and enabling U.S. corporations to become more globally competitive. While the new tax reform law significantly alters the tax code for individuals and for-profit businesses, it also has several significant consequences for most not-for-profits.
To help you navigate through the Act and identify how best to maximize potential benefits – or minimize potential costs – arising from the new legislation, here we identify some key areas that have changed and several important considerations that should be made as you look at the impact the Act could have on your not-for-profit organization.
If an organization generated unrelated business income, it could aggregate all the UBI from various sources and net the income against any direct and/or indirect expenses relating to the unrelated business activities to determine the net taxable income. This net taxable income would then be taxed at the current corporate tax rates, varying from 15% to 35%, depending on the amount of income.
The organization will now need to calculate its net unrelated business income separately with respect to each trade or business. Each line of business needs to stand alone and can no longer be netted against another. In other words, losses from one trade or business cannot be used to offset income from a different trade or business. Additionally, a net operating loss (NOL) is only allowed to be utilized with respect to a trade or business from which it arose. The taxable income is taxed at a flat 21%, instead of the aforementioned tax rates of 15% to 35%. Be on the lookout for special transition rules for NOLs carried into years beginning after January 1, 2018.
In addition, organizations classified as corporations are no longer required to calculate tax under the previous alternative minimum tax (AMT) rules for their UBI.
Record-keeping for not-for-profits will be more burdensome because of the need to segregate activity for trade and businesses when calculating UBI reported on the 990-T. Organizations must create proper workpapers to capture different types of UBI and for the newly segregated NOLs to be carried forward. It is important to review this when evaluating potential investment opportunities. In addition, more important than ever is the need to conduct proper and reasonable allocations of indirect expenses to help mitigate potential tax exposure.
Not-for-profit organizations are not held to the same requirements of IRC 280G, the “golden parachute payment” rules. These rules are in place to disallow a tax deduction for certain compensation payments made to disqualified persons (such as officers, shareholders, and highly compensated individuals), but are only applicable pursuant to a change of control.
For years beginning after December 31, 2017, tax exempt organizations will now be required to pay a 21% excise tax for any compensation that it paid to its “covered employees” that exceeds $1 million. This excise tax only applies to: a) current compensation, b) vested deferred compensation, and c) “excess parachute payments” with respect only to the employee’s separation from service. It is important to note that payments attributable to medical services of certain qualified medical professions (including doctors, nurses, and veterinarians) are exempt from this calculation.
Organizations must carefully review employment contracts to see if recognition of deferred compensation and/or severance arrangements could trigger an excise tax.
It is difficult to predict with any degree of certainty what impact the Tax Cuts and Job Act will have on charitable giving; however, most prognosticators are predicting a downward trend. A recent CBS News Money Watch article noted that Patrick Rooney, a professor of economics and philanthropic studies at the Lilly Family School of Philanthropy at Indiana University, and his colleagues foresee a resulting drop in charitable donations of around $14 billion next year, or five percent of the $282 billion that U.S. charities pulled in last year.1
We believe changes in the standard deduction will likely have a profound effect on the deductibility of donations. However, we believe there is merit to published claims that wealthier donors, who tend to give to arts, cultural institutions, research facilities, and universities, are less likely to significantly change their giving habits.2 We also believe middle class donors, as a whole, may be less likely to donate as generously as they did in the past.
Coupled with changes in the gift tax exemption and the AMT ceiling, we are certain the changes contained in the Act will create, at a minimum, uncertainty for many not-for-profit organizations, and in all likelihood, dramatic changes in their fundraising campaigns. We encourage not-for-profit leaders to consider the possible consequences to their organization’s revenue and evaluate the effectiveness and efficiency of their fundraising operations. Organizations that can appeal to the hearts of donors with differing motivations will fare well during the uncertain and possibly trying times ahead.
Tax Reform: The Tax Cuts and Jobs Act –
What you need to know, now