December 18, 2017
Exempt Organization Tax Alert: Tax Cuts & Jobs Act
Late Friday afternoon the Congressional Conference Committee released what may be the final version of the Republican Tax Cuts and Jobs Act (“the Act”). While this legislation has not yet become law, it appears to be headed for approval in Congress this week. Further, as currently written, this legislation would be in effect for taxable years beginning after December 31, 2017. While this bill makes sweeping changes to the overall U.S. Tax Code, there are several important provisions directly affecting certain tax-exempt organizations worth highlighting:
Unrelated Business Taxable Income
Unrelated Business Taxable Income Separately Computed for Each Trade or Business Activity: Under current law, a tax-exempt organization aggregates all sources of unrelated business taxable income, subtracts ordinary and necessary business expenses connected with these activities, and calculates tax due on the net amount. Under the Act, tax-exempt organizations with more than one unrelated trade or business would be required to compute the profit or loss of each unrelated trade or business separately. Should any specific unrelated trade or business result in a net loss, that loss would not be available to offset the profitable status of any other unrelated trade or business.
Left unclear in the Act is what the Internal Revenue Service will consider to be a separate unrelated trade or business. For instance, if a tax-exempt organization receives rental income from several debt-financed properties, does this rental income constitute one trade or business or several activities divided by property? Similarly, would each publication of a tax-exempt organization constitute a separate trade or business or will “publishing” and the resulting advertising income be viewed as one activity? Will consolidated periodical rules continue to apply? In a similar vein, would a tax-exempt organization’s investment in several partnerships constitute one activity (i.e. “investing”) or several activities by partnership?
One favorable item in this potential tax methodology transition is the treatment of historical net operating losses. Under the Act, any net operating loss incurred before January 1, 2018 would be available to offset any source of unrelated business taxable income regardless of the activity that originally generated the loss.
Finally, it is worth noting that while the separate taxable income calculations may drastically change an organization’s taxable income status at the federal level, state level income taxation will continue to be calculated on a net basis as mandated by the income tax regulations of each state.
Unrelated Business Taxable Income Increased By Amount of Certain Fringe Benefit Expenses for Which Deduction is Disallowed: Under current law, a tax-exempt organization’s expenses incurred in carrying out it’s exempt function are not considered for income tax purposes. Under the Act, certain employee fringe benefit expenses including transportation benefits, parking benefits, and on-premises athletic facilities would be considered disallowed deductions and would increase a tax-exempt organization’s unrelated business taxable income. As a small concession, any fringe benefit expense attributable to an unrelated trade or business and disallowed as a deduction from that activity will not be included in this item.
Tax on Excess Tax-Exempt Organization Executive Compensation: Under current law, compensation paid to the employees of a tax-exempt organization is not subject to excess remuneration rules as would be a similar for-profit organization. Under the Act, should certain employees of a tax-exempt organization receive compensation greater than $1,000,000 during the tax year from any combination of a tax-exempt organization and/or its related organizations then the payee organizations would be subject to an excise tax on that employee’s compensation in proportion to their payments to the employee. This rule applies to the five highest compensated employees of the tax-exempt organization with compensation greater than $1,000,000 for the taxable year, as well as any employee of the tax-exempt organization with compensation greater than $1,000,000 who was formerly classified within the “five highest compensated employees” during any taxable year beginning after December 31, 2016.
Excise Tax Based on Investment Income of Private Colleges and Universities: Under current law the investment income is excluded from income taxes unless an exception applies. Under the Act, the investment income of certain colleges and universities could potentially be subject to an excise tax of 1.4% should the fair market value of the institutions’ invested assets exceed $500,000 per student.
Selected General Business Items Affecting Tax-Exempt Organizations
Corporate Tax Rate: Under current law, the maximum corporate income tax rate is 35% for taxable income over $10,000,000. Under the Act, the maximum corporate income tax rate is 21%, and this rate would also apply to incorporated tax-exempt organizations.
Net Operating Losses: Under current law, a net operating loss incurred in one year is allowed to offset the taxable income of the previous two years or, if no taxable income was generated in those years, the current loss is allowed to be carried forward for up to 20 years to offset future taxable income. If sufficient, these net operating losses are allowed to offset up to the full amount of taxable income in the carryback or carryforward years. Under the Act, a net operating loss may only offset up to 80% of taxable income and may only be carried forward, though the carryforward period is indefinite.
Charitable Contributions: The Act increases the individual taxpayer charitable contribution deduction from 50% to 60% of the taxpayer’s adjusted gross income. Additionally, the Act denies any charitable contribution when the donor receives the right to purchase tickets or seating at an athletic event in return for their contribution.
Local Lobbying Expenses: Under current law, local lobbying expenses (for instance, a local council) are eligible for deduction as ordinary and necessary business expenses and are therefore not included in a 501(c)(6) organization’s non-deductible dues calculation or proxy tax calculation. Under the Act, this exception is removed and local lobbying expenses would need to be considered along with all other lobbying expenses when calculating these items.
Professional Society Dues: Under current law professional society dues are generally considered to be ordinary and necessary expenses for taxable entities. Under the Act, the deduction for membership dues is disallowed for any club organized for business, pleasure, recreation or other social purposes. A strict reading of the Act would indicate that dues paid to a professional society would not be deductible. This change could have far reaching impacts to professional societies and trade associations from membership recruitment and retentions to the proxy tax on lobbying.
Selected Items in Previous Versions of the House and Senate Bills not Included in the Conference Committee Bill
Simplification of Excise Tax on Private Foundation Investment Income: The original House version of the Act replaced a current tiered excise tax on private foundation investment income with a single rate. The current Act does not contain this modification.
Section 501(c)(3) Organizations Permitted to Make Statements Relating to Political Campaign in Ordinary Course of Activities in Carrying Out Exempt Purpose: Under current law, Section 501(c)(3) organizations (religious, charitable, scientific, etc.) are expressly prohibited from participating in any political campaign. Previous House versions of the Act had relaxed this restriction insomuch as the political activity was in the ordinary course of the organization’s regular and customary activities in carrying out its exempt purpose, and did not incur more than de minimis additional expenses. The current Act does not allow for Section 501(c)(3) political intervention.
Additional Reporting Requirements for Donor Advised Funds: The original House version of the Act created additional Form 990 reporting requirements for sponsoring organizations maintaining donor advised funds. The current Act does not contain this additional reporting requirement.
Please note that the items discussed here are not exhaustive. Please contact us through our contact form with any questions.