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The Tax Cuts and Jobs Act: Impact on Nonprofits
Feb 28, 2018
By Linda J. Kramer, CPA, MBA
Accounting & Auditing Director
Jayme F. Moore, CPA
Accounting & Auditing Director
The Tax Cuts and Jobs Act (TCJA) signed into law in December 2017 will impact nearly every individual taxpayer and business in America. Nonprofit organizations will feel the impact, as well, with some changes being immediately apparent and others likely taking years to emerge.
One thing is certain – many American taxpayers will find fewer tax incentives for charitable giving in the Internal Revenue Code than have existed for the past 30 years.
How this will change giving patterns among middle-income and wealthy individuals, as well as corporations and foundations, remains to be seen. Americans traditionally have been among the most charitable people in the world, supporting organizations that serve their communities, help people in need, and uplift the arts. But they have had a tax code that supported those charitable instincts. While the charitable giving deduction remains in the tax code, under the TCJA it will be irrelevant for millions of taxpayers who will find they are better off taking the standard deduction rather than itemizing.
Moreover, while several provisions of the TCJA do not directly relate to nonprofits, they may result in reduced charitable giving among the wealthy and corporations.
Many nonprofit professional managers and lay leaders are already examining their financial reports and historical donor sources to ascertain how they can communicate with their donors and guard against reductions in future contributions.
(Important note: Many of the provisions of the TCJA that impact individuals are made temporary by the law, generally sunsetting on December 31, 2025. What Congress may do between now and then to make any of these provisions permanent is unknown.)
Among the major provisions of the TCJA directly affecting nonprofit organizations that nonprofit leaders are looking at are:
Modification of Unrelated Business Income Tax (UBIT) rules
Under the new law, nonprofit organizations with income from activities not related to their core missions – such as selling advertising on their websites or operating a parking lot - must now account for each line of UBIT separately, meaning they no longer will be able to offset profits in one activity with losses in other activities. Any profit from a single line of UBIT, above certain thresholds, will result in a tax liability, regardless of the amount of losses in other lines.
The law also imposes a flat 21% tax on UBIT income above applicable thresholds. Although this provision is generally effective for taxable years beginning after December 31, 2017, the legislation provides a transition rule grandfathering pre-existing net operating losses and permitting them to offset future income from any of an organization’s unrelated businesses. Changes in the carry forward rules in the new tax law complicate the UBIT picture, and should be evaluated to determine the full impact of the TCJA on an organization.
How to plan for this change: Organizations with significant UBIT from several different activities should examine those activities that are consistently profitable, and evaluate whether the level of profitability will justify the likely tax liability going forward.
Excise tax of 1.4% on the net investment income of certain assets – potentially including endowments - of private higher educational institutions
This change in U.S. tax law represents a first, in that the government has never before taxed the investment earnings of universities, or endowments of any nonprofit organizations. While this new excise tax applies only to private institutions of higher education with more than 500 students, and will affect relatively few schools, leaders in the nonprofit community are eyeing it warily as the camel’s nose under the tent.
This excise tax will affect colleges and universities (not secondary schools) that have high endowments relative to their student enrollment. And since the endowments of an institution’s support organizations – such as alumni groups and “friends of” groups – may count toward the institution’s endowment total, some schools will be surprised to find they have a tax liability.
To determine tax liability, generally an institution must divide the amount of money in its endowment (and those of support organizations) by the number of full-time-equivalent students. If the result is more than $500,000, the institution has a tax liability.
How to plan for this change: Smaller colleges with sizeable endowments and active support organizations should perform preliminary calculations now, and if a tax liability looks likely, speak to their tax advisors about how to prepare.
Excise tax on excessive executive compensation
This provision of the TCJA imposes a 21% excise tax on the portion of executive compensation (applicable to employees covered by the law) that is over $1 million a year. Compensation includes salary/wages, separation pay including any “golden parachute” payments, and vested deferred compensation. The timing of the vesting can have a major impact on this new excise tax. What is important to note is that this excise tax is levied on the nonprofit organization, not the executive as an individual taxpayer. Also important to note is that the tax on regular salary includes any vested deferred compensation amounts, so if the salary is below $1 million, but is boosted over that level by vested deferred compensation, the tax liability applies.
How to plan for this change: Examine your organization’s compensation policies and salary levels for the five highest-paid employees (to whom this provision applies), and prepare in advance for any tax liability that will apply to your 2018 fiscal year.
Donor-advised fund disclosures
The new law requires enhanced disclosure related to nonrofits with donor-advised funds. Specifically, organizations must indicate the average amount of grants made from donor-advised funds, and they need to adopt policies on frequency and minimum levels of distributions from these funds.
How to prepare for this change: If your organization has donor-advised funds, you likely already report on the impact and importance of these funds in order to inform donors. Consult with nonprofit associations and your trusted advisors as to best practices in adopting the required new policies.
Contributions in exchange for the right to purchase athletic tickets
A fundraising tactic long employed to encourage college sports fans to support the institution beyond just buying game tickets will now come with a price under the TCJA. Donors who make a contribution to a university and, in exchange, receive the right to buy athletic tickets, will no longer be able to deduct 80% of the donation as a charitable contribution.
In addition to the provisions that directly affect the nonprofit community, numerous provisions of the TCJA could have indirect – but significant – impacts, as well. The three most significant are:
Doubling of the standard deduction for individual taxpayers to $24,000 for married couples ($12,000 for individuals)
This change will likely dramatically reduce the number of Americans who itemize their deductions on their tax returns, and hence, reduce the value of the charitable giving deduction. Will taxpayers reduce their giving if they no longer can deduct donations? Or will their impulse to support worthy causes win the day? Time will tell.
How to prepare for this change: Communicate, communicate, communicate. If your organization relies on smaller to medium-sized donations from a broad mix of middle-income to affluent individuals, put extra resources into your marketing and outreach efforts this year. Make sure your supporters understand how their donations impact your ability to carry out your organization’s mission.
Doubling of the estate tax exemption to approximately $22 million for married couples ($11 million for individuals)
This is where organizations that rely on large donations and planned giving may see an impact. Charitable giving through bequests amounted to approximately $30 billion in 2016. Numerous studies have reached different conclusions about the potential impact of repealing the estate tax or raising the exemption, and the Congressional Budget Office estimated that repeal would reduce charitable bequests by 16% to 28%. The estate tax was not repealed by the TCJA, but the effect of doubling the exemption may be significant.
How to prepare for this change: Organizations that rely on large donations and planned giving should reach out to their major donors now to discuss how important these individuals’ donations are, and to ascertain whether their level of giving is likely to be affected by the TCJA. The response may be good, or it may not, but it’s best to be armed with facts – rather than anxiety – when engaging in strategic planning for your organization.
Reduction of corporate tax rates
While the significant reduction of corporate tax rates to 21% from a high of 35% does not directly impact nonprofit organizations, in the long-term nonprofits could see a reduction in corporate charitable giving as companies shift their tax planning priorities and find that they do not need the number or size of deductions that they have had in the past.
How to prepare for this change: Again, as with individual major donors, nonprofit organizations that rely on corporate gifts and corporate foundations should have honest discussions with those donors about their future plans. In some cases, shifting corporate donations from outright gifts to sponsorships may help preserve those contributions.
Preservation of 501(c)(3) status
In light of the changes likely to occur because of the TCJA, nonprofit organizations should ensure that they have a crystal clear understanding of where they stand in terms of maintaining their 501(c)(3) status. Tax-exempt status depends on many different factors for different types of nonprofits, sometimes including the percentage of public support they receive and the percentage of overall income that is derived from investments.
How to prepare for this change: Analyze your organization’s historic sources of income, and familiarize yourself with the requirements of 501(c)(3) status for your type of organization. If your organization is on the margins with respect to its 501(c)(3) status, and the TCJA results in a significant change in support, or shift in revenue mix, your federal tax-exempt status may be threatened. It’s better to examine this issue now and engage in some strategic planning than be caught short when a notice from the IRS arrives in the mail.
Clearly, when it comes to the TCJA, there is a lot to think about for nonprofits as well as individuals and corporations. If you would like help figuring out what questions you should be asking, and what financial factors your organization should be evaluating with regard to the TCJA, please contact Linda J. Kramer, CPA, MBA, or Jayme F. Moore, CPA, at 617-696-8900.
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