Not-for-Profit: Tax Reform for Exempt Organizations - Is a Wave of Change Forthcoming?
The following was distributed as part of CohnReznick's The Not-for-Profit Advisor - Spring 2014 issue.
On February 26, 2014, House Ways and Means Committee Chairman Dave Camp (R-MI) released a discussion draft of legislation for comprehensive tax reform. The draft includes many provisions that, if enacted, could have a major effect on tax-exempt organizations and charitable giving.
Several of the proposed provisions are described below. Unless otherwise noted, the provisions would be effective for tax years beginning after December 31, 2014.
Unrelated Business Income (UBI)
- UBI treatment of tax-exempt government entities - The UBI tax would apply to so-called “dual status” entities that are tax exempt under section 501(a) and also exempt or exclude amounts from gross income under any other provision of the Internal Revenue Code. For example, governmental plan pension trusts that are exempt under section 501(a) and also exclude income under section 115 would be subject to UBI tax.
- Name and logo royalties - Any sale or licensing by an exempt organization of its name or logo (including any related trademark or copyright) would be treated as an unrelated trade or business regularly carried on by the organization. The exclusions from UBI for certain types of passive income (including royalties) would not apply.
- UBI separately computed for each trade or business - Where an exempt organization conducts two or more unrelated trades or business, the net unrelated taxable income of each unrelated trade or business would be separately calculated. Losses generated by one UBI activity could not be used to offset income from another UBI activity. Any unused losses would be subject to the general rules for net operating losses (NOLs). An NOL deduction would be allowed only with respect to the UBI activity from which the loss arose. Transition rules would be provided.
- Qualified sponsorship payments - The exclusion from UBI of qualified sponsorship payments would not apply if, in return for the sponsorship payment, the exempt organization uses or acknowledges any of the sponsor’s product lines. Also, if an exempt organization receives more than $25,000 of qualified sponsorship payments for any one event, a payment would not be treated as a qualified sponsorship payment unless the use or acknowledgement of the sponsor’s name or logo appears with, and in substantially the same manner as, the names of a significant portion of other donors to the event (determined based on the total number of donors and the total contributed with respect to the event, but in no event fewer than two other donors).
- Specific deduction - The specific deduction allowed in calculating unrelated business taxable income (UBTI) would be increased from $1,000 to $10,000.
- Parity of charitable contribution limitation between trusts and corporations - The charitable contribution deduction for trusts would be lowered from 50% to 10% of the trust’s UBTI, which is the same limit that applies to corporations.
- Fundamental research - The exclusion from UBI for income from fundamental research would apply only if the results of the research are freely available to the public.
- Sale of distressed property - The exclusion from UBI of gains or losses from the sale, exchange, or other disposition of certain distressed property would be repealed (effective for property acquired after December 31, 2014).
- Mandatory electronic filing - All tax-exempt organizations that file Form 990 series returns would be required to file electronically, effective for tax years beginning after the date of enactment. The IRS could delay the effective date for small organizations and for the e-filing of Form 990-T for up to two taxable years.
- Increase in information return penalties - The daily penalties on exempt organizations and managers for failure to file various returns, disclosures, or public documents would be doubled, effective for information returns required to be filed on or after January 1, 2015.
- Manager-level accuracy-related penalty on underpayment of UBI tax - A new 5% penalty (limited to $20,000) would be imposed on managers of a tax-exempt organization when an accuracy-related penalty is imposed on the organization for any substantial understatement of UBI tax. In addition, a new 10% penalty (limited to $40,000) would apply to managers of a tax-exempt organization for an understatement of UBI tax relating to a “reportable transaction” or “listed transaction.” (A reportable transaction is defined as one that the IRS determines must be disclosed because it has a potential for tax avoidance or evasion. A listed transaction is a reportable transaction that is specifically identified by the IRS as a tax avoidance transaction (or is substantially similar to such a transaction).)
Excise Taxes on Excess Benefit Transactions1
- Application to 501(c)(5) and 501(c)(6) organizations - The excess benefit excise tax rules would be extended to apply to organizations described in section 501(c)(5) or section 501(c)(6).
- Entity-level tax - A new 10% excise tax would be imposed on the exempt organization when the excess-benefit excise tax is imposed on a disqualified person. The entity-level tax would not be imposed if the organization follows minimum standards of due diligence.
- Elimination of rebuttable presumption and manager reliance on professional advice safe harbor -The presumption of reasonableness would be eliminated for purposes of the excise tax on disqualified persons and managers. Also, managers would no longer be able to rely on the professional advice safe harbor.
- Athletic coaches and investment advisors as disqualified persons - The definition of disqualified persons would be expanded to include athletic coaches and the organization’s investment advisors.
Excess Compensation and Parachute Payments
- Entity-level excise tax - A tax-exempt organization would be subject to a 25% excise tax on compensation in excess of $1 million paid to any of its highest five paid employees for the tax year (“covered employee”). Once an employee qualifies as a covered employee, the excise tax would apply to compensation in excess of $1 million paid to that person. The excise tax would also apply to excess parachute payments paid to covered employees. An excess parachute payment generally would be a payment contingent on the employee’s separation from employment with an aggregate present value of at least three times the employee’s base compensation.
Qualified 501(c)(3) Bonds
- Exemption repealed for newly-issued private activity bonds (PABs) - The exclusion from gross income for interest paid on PABs, including qualified 501(c)(3) bonds, would be repealed, effective for PABs issued after December 31, 2014.
- Repeal of Type II and Type III supporting organizations - Type II and Type III supporting organizations would be repealed, effective for entities organized after the date of enactment. For Type II and Type III organizations in existence on the date of enactment, the repeal would be effective for tax years beginning after December 31, 2015.
Donor Advised Funds
- Distribution requirement - Donor advised funds would be required to distribute contributions within five years of receipt to a public charity (other than a section 509(a)(3) supporting organization or another donor advised fund). Failure to make required distributions would result in a 20% excise tax. The provision would be effective for contributions made after 2014. For contributions made before, and remaining in the donor advised fund on, January 1, 2015, the five-year distribution period would begin on January 1, 2015.
- Self-dealing - A new entity-level excise tax of 2.5% (10% in cases involving payment of compensation) would be imposed on a private foundation where the self-dealing tax is imposed on a disqualified person. Also, foundation managers would no longer be able to rely on the professional advice safe harbor.
- Excise tax on net investment income - The tax would be reduced to 1%. The rules for a reduction in the excise tax rate from 2% to 1%, and the exception from the excise tax for exempt operating foundations, would be repealed.
- Private operating foundations - Private operating foundations would be subject to the minimum payout requirements applicable to private foundations generally.
Private Colleges and Universities
- Excise tax on net investment income - Private colleges and universities with assets (other than those used directly in carrying out the institution’s exempt purpose) valued at the close of the preceding tax year of at least $100,000 per full-time student would be subject to a 1% excise tax on net investment income.
Section 501(c)(4) Organizations
- Notification requirement - Any section 501(c)(4) organization that is organized after December 31, 2014 would be required, within 60 days of formation, to notify the IRS that it has commenced operations as a social welfare organization. Existing organizations that have not filed a Form 1024 exemption application or a Form 990 would be required to meet the new notification requirement within 180 days after the date of enactment.
- Declaratory judgments - Section 501(c)(4) organizations could seek judicial relief in the form of a declaratory judgment if the IRS challenges the organization’s initial or continuing qualification for tax exemption. This provision would be effective for pleadings filed after the date of enactment.
- Restriction on donation reporting - A section 501(c)(4) organization would be required to include on Schedule B (Form 990, 990-EZ, or 990-PF), Schedule of Contributors, only information concerning a donor who both (1) contributes at least $5,000 (in money or property) during the current tax year, and (2) is either an officer or director of the organization or one of the five highest compensated employees of the organization for the current or any preceding tax year. Schedule B would continue to be excluded from the public disclosure requirement for information returns filed by exempt organizations. This provision would be effective for returns for tax years beginning after December 31, 2013.
- Exemption standards - The IRS would be required to apply the standards and definitions in effect on January 1, 2010 to determine whether an organization is operated exclusively for the promotion of social welfare under section 501(c)(4). The IRS would also be prohibited from issuing, revising, or finalizing any regulation (including the proposed regulations issued on November 29, 2013), revenue ruling, or other guidance that is not limited to a particular taxpayer relating to standards or definitions used to determine whether an organization is operated exclusively for the promotion of social welfare under section 501(c)(4). This provision would be effective on the date of enactment and expire one year after such date.
Additional Tax-Exempt Organization Provisions
- Professional sports leagues - Professional sports leagues would not be eligible for tax-exempt status under section 501(c)(6).
- Repeal of tax exemption for certain insurance companies and co-op health insurance issuers - The exemption under section 501(c)(15) for certain property and casualty insurance companies, and the exemption under section 501(c)(29) for certain co-op health insurance issuers, would be repealed. Transition relief would be provided.
- In-state requirement for workmen’s compensation insurance organizations - A workmen’s compensation insurance organization would be exempt under section 501(c)(27) only if it provides no insurance coverage other than workmen’s compensation insurance required by state law (or insurance with respect to which state law provides significant disincentives if it is not purchased by an employer). This provision would apply to insurance policies issued, and renewals, after December 31, 2014.
Charitable Contribution Deduction
- Extension of time to file - Individuals could deduct charitable contributions made after the close of the tax year but before the due date of the return (generally April 15).
- Two percent floor - An individual’s charitable contributions could be deducted only to the extent they exceed 2% of the individual’s adjusted gross income (AGI).
- Contributions of appreciated property - The amount of the charitable contribution deduction would generally be equal to the adjusted basis of the property. The deduction would be based on the fair market value of the property (less any ordinary gain) for certain types of property, including publicly traded stock.
- College athletic event seating rights - The provision allowing a charitable deduction of 80 percent of the amount paid for the right to purchase tickets for athletic events would be repealed.
- Additional changes - Changes would be made to AGI limitations on individual charitable contribution deductions, qualified conservation contributions, and contributions of intellectual property.
What Does CohnReznick Think?
The discussion draft may provide a blueprint for future legislation, but it is unclear at this point whether or when any of the provisions in the draft will become law. Exempt organizations and charitable donors should consider how these proposals, if enacted, could affect their specific activities or charitable giving plans.
To learn more about CohnReznick’s Not-for-Profit and Education Industry Practice, please visit our webpage.
1An excise tax is imposed on any “disqualified person” who receives an excess benefit from a section 501(c)(3) public charity or an organization exempt under section 501(c)(4) or section 501(c)(29). An excess benefit occurs where the amount provided by the organization is greater than the value it receives in return. A disqualified person is generally any person in a position to exercise substantial influence over the organization. Managers of the organization may also be subject to an excise tax.
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