The Tax Cuts and Jobs Act, currently under consideration in the US House of Representatives and Senate, proposes fundamental changes to the US tax law affecting all sectors of the economy, including nonprofit organizations.
On Thursday night, the Senate Finance Committee released the “Chairman’s Mark of the Tax Cuts and Jobs Act” outlining the Senate’s proposed take on tax-reform legislation. The House Committee on Ways and Means completed its markup of H.R. 1, the “Tax Cuts and Jobs Act” (House bill) on Thursday night as well. The Senate Finance Committee is scheduled to markup the Chairman’s Mark on November 13, and the House of Representatives will vote on the House bill next week.
The Senate bill differs from the House bill in some key respects that impact nonprofits, including modifications to the unrelated business income tax (UBIT) in particular. The Senate bill would subject all royalty income derived from licensing a nonprofit’s name or logo to UBIT, and it would limit the application of UBIT net operating losses to a trade or business from which the loss arose. The Senate bill also revises the intermediate sanctions rules by eliminating the rebuttable presumption of reasonableness and applying the excess benefit transaction excise tax to Section 501(c)(5) and 501(c)(6) organizations. The House bill, through an amendment introduced Thursday night, now includes a provision allowing all Section 501(c)(3) organizations to engage in certain types of political activity, not just churches, for the period beginning January 1, 2019 through December 31, 2023 (a partial repeal of the “Johnson Amendment”).
Key highlights of the House and Senate bills are as follows.
Charitable Giving and Charitable Financing
- Both the House and Senate bills expand the standard deduction, increase the deductibility of cash contributions to charities, and tighten some of the rules on the charitable contribution deduction.
- The House and Senate bills almost double the standard deduction by increasing it to $24,400 for joint filers (and surviving spouses), $18,300 for head of household filers, and $12,200 for individual filers. Amounts would be adjusted for inflation based on chained consumer price index (C-CPI-U), a slightly different measure of inflation. The implication is that fewer individuals will itemize and take the charitable contribution deduction.
- The House and Senate bills generally retain the charitable contribution deduction for those (few) taxpayers able to claim itemized deductions, and increase the limitation for cash contributions to public charities (and certain private foundations) to 60% of the donor’s adjusted gross income (AGI).
- The House bill, but not the Senate bill, accounts for inflation in the calculation of the charitable mileage rate in connection with the amount deductible per mile driven in service to a charitable organization.
- The House bill, but not the Senate bill, repeals the IRS’s authority to prescribe a “form” for substantiating charitable contributions (which some taxpayers have attempted to exploit by amending an organization’s Form 990 to claim that a charitable contribution was substantiated in a prior year).
- Both the House and Senate bills repeal the “Pease” limitation, which sets an overall limit on itemized deductions including charitable contribution deductions.
- The House and Senate bills almost double the amount eligible for exclusion from estate, gift, and generation-skipping taxes to $10 million, indexed for inflation occurring after 2011. However, the House bill also repeals estate and generation-skipping taxes beginning after 2023. The Senate bill does not repeal these taxes.
- The House bill, but not the Senate bill, eliminates private activity bonds (PABs) by requiring taxpayers to include the interest on newly issued PABs in taxable income. Interest on the following PABs is currently excludible: exempt facility bonds, qualified mortgage bonds, qualified veterans’ mortgage bonds, qualified small issue bonds, qualified student loan bonds, qualified redevelopment bonds, and qualified Section 501(c)(3) bonds.
- The House bill and the Senate bill eliminate advance refunding bonds used to refinance previously issued bonds at a lower interest rate by requiring taxpayers to include the interest on advance refunding bonds in taxable income. Advance refunding bonds are used to pay principal, interest, or the redemption price on prior bonds issued more than 90 days before the redemption.
- The Senate bill, but not the House bill, revises the intermediate sanctions rules under Section 4958 currently applicable to Section 501(c)(3) and Section 501(c)(4) organizations in a number of ways.
- It expands application of the rules to Section 501(c)(5) and Section 501(c)(6) organizations, and it modifies the definition of a disqualified person to include investment advisors of all applicable organizations (and not just those of donor-advised funds (DAFs)) and athletic coaches at eligible educational institutions.
- It imposes a 10% excise tax on an exempt organization if an initial tax is imposed on a disqualified person for purposes of the intermediate sanctions rules. The tax would not apply if the organization establishes that it met minimum standards of due diligence (described below) or establishes to the satisfaction of the Secretary that it used other reasonable procedures to ensure no excess benefit.
- It eliminates the rebuttable presumption of reasonableness but uses the procedures for establishing the rebuttable presumption (i.e., advance approval by an authorized body, reliance upon comparability data, and adequate concurrent documentation) to establish minimum standards of due diligence.
- It eliminates the special rule providing that an organization manager’s participation in an excess benefit transaction is not “knowing” if the manager relied on professional advice, although it provides that such reliance is a relevant consideration. It also eliminates the rule providing that an organization manager does not act knowingly if he or she met the requirements of the rebuttable presumption of reasonableness.
- Both bills impose a 20% excise tax on an employer with respect to compensation in excess of $1 million paid by an applicable tax-exempt organization to a covered employee. The tax would apply to all remuneration in excess of $1 million, including cash and the cash value of all noncash items (including benefits), except for designated Roth contributions. The tax would also apply to excess parachute payments (under a new definition related solely to separation pay). A covered employee is defined as an employee (including a former employee) who is one of the five highest paid employees of the organization for the taxable year or who was a covered employee of the organization (or a predecessor) for any preceding taxable year beginning after December 31, 2016. An applicable tax-exempt organization includes organizations exempt from tax under Section 501(a). Special rules apply to compensation paid by related entities.
Private Foundations, Private Operating Foundations, and Donor-Advised Funds
- The House bill simplifies the excise tax on private foundation net investment income by replacing the current two-tiered tax with a single rate of 1.4%. Under current law, certain private foundations making significant qualifying distributions are eligible for a lower 1% tax. The Senate bill does not contain a similar provision.
- The House bill (but not the Senate bill) excepts independently operated philanthropic business holdings from the tax on excess business holdings applicable to private foundations. Private foundation holdings in for-profit businesses will not be subject to the tax if (1) the foundation owns all of the business’s voting stock; (2) the foundation acquired all of its interests in the business other than by purchasing it; (3) the business distributes all of its net operating income for any given tax year to the foundation within 120 days after the close of that tax year; (4)substantial contributors to the foundation (and their family members) are not the business’s directors, officers, trustees, managers, employees, or contractors (or individuals with similar responsibilities); (5) at least a majority of the foundation’s directors are not also directors or officers of the business or family members of substantial contributors; and (6)there is no loan outstanding from the business to a substantial contributor or a family member of a substantial contributor. The Senate bill does not contain a similar provision.
- The House bill (but not the Senate bill) imposes new requirements on art museums seeking to qualify as private operating foundations. The House bill now requires such art museums to be open to the public during normal business hours for at least 1,000 hours per year.
- The House bill (but not the Senate bill) imposes new reporting requirements on the sponsoring organizations of DAFs. The House bill requires such organizations to annually disclose their policies on inactive DAFs as well as the average amount of grants made from their DAFs.
Colleges and Universities
- The House bill and the Senate bill impose a new 1.4% excise tax on the net investment income of private colleges and universities. Net investment income is defined to correspond to the definition under the private foundation rules, which generally includes interest, dividends, rents, royalties (and income from similar sources), and capital gain net income, reduced by expenses incurred to earn this income. The tax only applies to colleges and universities that have at least 500 students and assets (other than those used directly in carrying out the institution’s educational purposes) valued at the close of the preceding tax year of at least $250,000 per full-time student. State colleges and universities are not subject to the provision. Private colleges and universities must include the net investment income and assets of related organizations—such as controlling and controlled organizations and supported and supporting organizations—in order to assess the applicability of the tax.
- The House bill and the Senate bill repeal the special rule enabling a donor to take a charitable deduction of 80% of the amount paid for the right to purchase tickets for athletic events.
- The House bill repeals above-the-line deductions for certain educational expenses, including interest payments on qualified education loans and qualified tuition and related expenses. The Senate bill does not repeal these deductions.
- The House bill also repeals the exclusions of certain educational expenses from taxable income. These include interest on US savings bonds used for qualified higher education expenses, qualified tuition reductions provided by educational institutions, and employer-provided educational assistance. The Senate bill does not repeal these exclusions.
Political Campaign Activity
- The House bill creates a special exception under the “Johnson Amendment” by permitting Section 501(c)(3) organizations to make political statements in the ordinary course of business. The Act modifies the existing political campaign prohibition on Section 501(c)(3) organizations by providing that such organizations will not fail to be treated as organized and operated exclusively for Section 501(c)(3) purposes or deemed to have participated in a political campaign solely because of the content of any statement which is made in the ordinary course of the organization’s activities and results in the organization incurring not more than de minimis incremental expenses.
UBIT and Other Issues
- The Senate bill requires that an exempt organization with more than one unrelated trade or business compute unrelated business taxable income separately with respect to each trade or business and without regard to the specific deduction allowed under Section 512(b)(12). The organization’s unrelated business taxable income for a taxable year is the sum of the amounts for each unrelated trade or business, less the specific deduction allowed under section 512(b)(12). A net operating loss deduction is allowed only with respect to a trade or business from which the loss arose. The House bill does not include a similar provision.
- The Senate bill modifies the UBIT treatment of the licensing of an exempt organization’s name or logo generally to subject royalty income derived from such a license to UBIT. Specifically, the proposal provides that any sale or licensing of any name or logo is treated as an unrelated trade or business that is regularly carried on by the organization. The House bill does not include a similar provision.
- The House bill clarifies that certain state and local entities (such as public pension plans) that are exempt under Section 115 as government-sponsored entities are subject to UBIT. The Senate bill does not include a similar provision.
- The House bill modifies the UBIT exception for fundamental research organizations to apply only to income arising from research, the results of which are freely available to the public. The Senate bill does not include a similar provision.
- The House bill subjects exempt organizations to UBIT on the amount of certain fringe benefits for which a deduction is disallowed. These include qualified transportation fringe benefits, any parking facility used in connection with qualified parking, and on-premises athletic facilities. The provision doesn’t apply to the extent that the amount is directly connected with a regularly carried-on unrelated trade or business. The Senate bill does not include a similar provision.