The memorandum summarizes the impact on tax-exempt organizations of the new tax reform legislation passed by Congress just prior to the end of 2017 (H.R. 1, called the “Tax Cuts and Jobs Act”).
Decrease in Charitable Giving?
Perhaps the biggest impact of the new tax law on section 501(c)(3) charities is likely to arise from the doubling of the standard deduction, which for a married couple filing jointly is raised to $24,000. The result of that increase is that many people will no longer find it advantageous to itemize their deductions because the new standard deduction will produce a larger tax benefit. As you may know, donations to charities – both under prior law and under the new law – can only be deducted by those who itemize their deductions on Schedule A of Form 2010. Consequently, it is anticipated that many people will no longer have any tax incentive to donate to charity, although they still may have a number of other incentives to do so. Exactly how much charitable donations will decrease remains to be seen, and estimates of the expected decrease by experts vary widely and are quite speculative at this point. Most likely, the impact will vary from one charity to another depending upon whether a particular charity’s typical donors are wealthier individuals who are still likely to itemize under the new tax law.
There is some good news for charities. Specifically, the percentage limit for cash donations by an individual taxpayer to public charities and certain other organizations increases from 50% to 60% of the donor’s adjusted gross income. Consequently, it is possible that wealthy people who itemize may in fact donate more to charity under the new law.
Membership Dues No Longer an Itemized Deduction
Trade and professional associations exempt under Section 501(c)(6), as well as charities with dues-paying members, may experience a slight impact from the new tax law in that any members who previously deducted their membership dues as a miscellaneous itemized deduction on Schedule A will no longer be able to do so under the new tax law. However, it is relatively rare that an individual joins a nonprofit membership organization solely because dues are deductible. Moreover, any business owner that typically files Schedule C will still be able to deduct business-related expenses, including membership dues paid through a corporate account, under the new law.
Qualified Transportation Fringe Benefit Changes.
Some nonprofit employers provide their employees with a transportation benefit and/or a qualified parking benefit that is tax-free to the employee under prior law up to $255 per month. Under the new law, while employees can still receive these benefits tax-free, any tax-exempt employer providing such transportation or parking benefits must pay unrelated business income tax on the value of such benefits. Consequently, tax-exempt employers will need to decide whether they can afford to both continue to pay for the benefit and also pay a new income tax to the federal government on the value of such benefits, or whether these benefit programs will need to be terminated.
Taxability of Moving Expense Reimbursements. Some nonprofit employers reimburse their executives for moving expenses incurred in joining the organization, and under prior law, those reimbursements were tax-free. But beginning on January 1, 2018 and continuing through at least the end of 2025, employees will incur income tax on the value of these moving expense reimbursements.
Executive Compensation and Severance Provisions
Two particularly onerous executive compensation rules are included in the new tax law. First, tax-exempt employers are now subject to a 21% penalty tax on compensation over $1M paid to covered employees (defined as any current or former employee who is one of the five highest paid employees of the employer for the current tax year, or who was in this category in any tax year after 2016). Compensation subject to the penalty tax does not include amounts paid to a licensed medical professional (e.g., physician, P.A, or nurse) for medical services, but does include other amounts paid to the medical professional for any other services. Compensation subject to the penalty tax also includes amounts that become vested under an IRC section 457(f) supplemental retirement plan.
Second, the new law imposes a 21% penalty tax on tax-exempt employers that provide excess severance benefits to certain employees and former employees. Specifically, if a tax-exempt organization pays severance to a covered employee and that severance equals or exceeds three times the executive’s average annual wages, then the tax-exempt organization (but not the executive) would be subject to a 21% tax on the excess of the value of the severance benefit over one times such average wage amount
Unrelated Business Income Tax Changes
Tax-exempt organizations have always been required to pay income tax on any income from a so-called “unrelated trade or business” (i.e., an activity that is unrelated to the tax-exempt entity’s nonprofit mission). Under prior law, losses from one unrelated business activity could be used to offset gains from another unrelated business activity. However, under the new law, unrelated business taxable income must be separately computed for each business activity. This change would only affect nonprofits with more than one unrelated business activity.
For those who use their automobiles in furtherance of charitable services, the deductible mileage rate remains at a modest 14 cents per mile and is not adjustable for inflation.
Finally, the new tax law repeals what had been a controversial provision in the tax code whereby the IRS would allow a charity to report charitable contributions to the IRS in lieu of sending a contemporaneous written acknowledgement to the donor. The result of this change is that all donors are now likely to demand a written receipt memorializing their donations so that they will have a valid record that can be used to deduct the donation.
For more information regarding how the new tax reform legislation will impact tax-exempt organizations, please contact Rob Portman at Rob.Portman@powerslaw.com or 202-872-6756 or Ben Tesdahl at Ben.Tesdahl@powerslaw.com or 202-872-6743.