The Internal Revenue Code recently received its most significant overhaul in decades by the Tax Cuts and Jobs Act of 2017 (2017 Tax Act). Below is a brief summary of the 2017 Tax Act’s impact on healthcare organizations. Additional guidance is expected to be forthcoming from the IRS on many of these topics.
Tax Rate and Choice of Entity. The corporate tax rate was reduced to 21% (25% for personal service corporations). The corporate alternative minimum tax was repealed, interest deductions are limited to 30% of adjusted taxable income, and net operating losses (NOL) are limited to 80% of taxable income, with no carry back, but unlimited carryforward. These changes apply to all activities taxed at corporate rates, including unrelated business activities. The Act added a 20% deduction against income received from certain pass-through entities (generally not applicable to professional services such as doctors). Individual tax rates (applicable to income from pass-through entities) were also reduced and now range from 10% to 37%.
Unrelated Business Income Tax (UBIT). There were several additional changes to the UBIT rules. Losses from one activity can no longer offset gains from another activity. However, NOL generated prior to 2018 can be carried forward (subject to the limitations above) against income from any activity. Further, payment by a tax-exempt organization of certain fringe benefits, including certain transportation, parking, and on premises athletic facilities, now results in unrelated business taxable income.
Excise Tax on Five Highest Paid Employees. One of the most important changes is the new 21% excise tax on the 5 highest paid employees of a tax-exempt organization (“Top 5”). The tax only applies to compensation in excess of $1 million. Once a person is a Top 5 employee in any year, the tax applies to them in all future years if their compensation exceeds $1 million. The Top 5 test is applied beginning in 2017. The tax does not apply for 2017, but a person may have become a Top 5 employee during 2017 subject to the tax in future years. An important exception provides that the tax does not apply to compensation paid to a licensed medical professional for services directly related to performance of medical services. Note, however, that the tax applies to administrative type services not directly related to the performance of medical services even if performed by a licensed medical professional. Accordingly, it is important to track the type of services performed.
Charitable Donations. Charitable giving was disincentivized for many individuals who no longer will itemize deductions and for estates which now receive double the exemption from estate tax. However, the limit on charitable deductions was raised to 60% of adjusted gross income. Also, written substantiation must now be given to all donors who contribute $250 or more regardless of whether the donation is reported to the IRS.
Other Items of Note. The Affordable Care Act’s individual mandate on health insurance is repealed beginning 2019, making it likely that fewer patients will have health insurance. Finally, tax-exempt bonds can no longer be advance refunded on a tax-exempt basis.