Impact for Nonprofit Organizations
The United States Congress has passed legislation comprising the most significant overhaul of federal tax law in more than 30 years. The Tax Cuts and Jobs Act (“the Act”) was signed by President Trump on December 22, 2017, and is now law. The Act contains numerous provisions directly and indirectly impacting nonprofit organizations.
Following is a summary of the key provisions of the Act that will impact nonprofits. We also note that a number of the changes outlined below expire after December 31, 2025.
1. Changes to individual income tax rates
The current seven tax brackets (10%, 15%, 25%, 28%, 33%, 35%, and 39.6%) for individual taxpayers are modified. The new tax brackets are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. For married couples filing jointly, the 37% rate applies to taxable income in excess of $600,000. These new brackets are effective for taxable years beginning after December 31, 2017.
Additionally, the Act increases the exemption amounts for individuals from the alternative minimum tax. Under the Act, the exemption for married individuals filing jointly increases from $78,750 to $109,400 and the exemption for single individuals increases from $50,600 to $70,300. These increased exemptions begin to phase out when the alternative minimum taxable income exceeds $1,000,000 for married individuals filing jointly and $500,000 for single individuals. The increased exemptions are effective for taxable years beginning after December 31, 2017.
2. Replacement of corporate tax brackets with a flat 21% rate
Under the Act, the current four tax brackets applicable to corporate taxpayers, which range from 15% to 35%, are replaced with a flat tax rate of 21%. The new tax rate is effective for taxable years beginning after December 31, 2017.
The Act also repeals the alternative minimum tax for corporations. The repeal is effective for taxable years beginning after December 31, 2017.
Under the Act, the 21% flat rate is applicable to unrelated business taxable income of exempt organizations taxed as corporations, which could actually increase the taxes owed by exempt organizations with small amounts of unrelated business taxable income.
3. Increase in the standard deduction
Under the Act, the standard deduction (for those taxpayers who do not itemize their deductions) is approximately doubled from 2017 amounts to $12,000 for individual filers, $24,000 for married individuals filing joint returns and surviving spouses, and $18,000 for head-of-household filers (typically, single filers with at least one qualifying child or dependent). The amount of the standard deduction is indexed for inflation in future years.
The increase in the standard deduction is effective for taxable years beginning after December 31, 2017.
4. Repeal of the “Pease” limitation on itemized deductions
The Act eliminates the overall limitation on itemized deductions (sometimes referred to as the “Pease” limitation) which currently reduces itemized deductions in circumstances where a taxpayer has adjusted gross income (AGI) above certain thresholds. The repeal is effective for taxable years beginning after December 31, 2017.
5. Limitation of the itemized deduction for mortgage interest on acquisition indebtedness and elimination of the itemized deduction for mortgage interest on home equity indebtedness
Currently, individuals may take an itemized deduction for mortgage interest incurred on acquisition indebtedness (limited to indebtedness of up to $1,000,000) on the taxpayer’s principal residence and one other residence of the taxpayer. Additionally, taxpayers may take an itemized deduction for interest paid or accrued on qualifying home equity indebtedness (limited to indebtedness of up to $100,000) on the taxpayer’s principal residence and one other residence.
The Act limits the itemized deduction for mortgage interest to interest incurred on acquisition indebtedness of up to $750,000. This reduced limitation of the mortgage interest deduction applies to interest on debt incurred on or after December 15, 2017.
Additionally, the Act eliminates the itemized deduction for interest on home equity indebtedness. This provision is effective for taxable years beginning after December 31, 2017.
6. Temporary expansion of the medical expense itemized deduction
Currently, taxpayers may take an itemized deduction for out-of-pocket medical expenses of the taxpayer, a spouse, or a dependent, subject to a floor of 10% of the taxpayer’s adjusted gross income (AGI).
The Act temporarily reduces the medical expense deduction floor from 10% to 7.5% (effectively expanding the available deduction). The provision is effective for taxable years beginning after December 31, 2016, and ending before January 1, 2019.
7. Changes to itemized deductions for various state and local taxes
Currently, taxpayers may take an itemized deduction for either: (1) state and local income taxes, or (2) state and local sales taxes. Additionally, taxpayers may currently take an itemized deduction for real estate and personal property taxes. The Act replaces the current itemized deductions described in the preceding sentences with one itemized deduction of up to $10,000 ($5,000 in the case of married individuals filing a separate return) for the aggregate of: (1) state and local property taxes, and (2) state and local income taxes (or sales taxes in lieu of income taxes). This provision is effective for tax years beginning after December 31, 2017. The Act also clarifies that an individual may not claim an itemized deduction in 2017 on a pre-payment of income tax for a future taxable year in order to avoid the applicable dollar limitation for years beginning after 2017.
8. Elimination of the unreimbursed employee business expense miscellaneous itemized deduction
Currently, taxpayers who are employees may claim unreimbursed trade or business related expenses related to their employment as a miscellaneous itemized deduction, subject to a floor of 2% of the taxpayer’s adjusted gross income (AGI). The Act eliminates this deduction. This elimination is effective for tax years beginning after December 31, 2017. This deduction elimination increases the economic benefit of employer reimbursements to employees for eligible business expenses under an accountable plan.
9. Increased limitation for cash contributions to public charities and certain private foundations
Currently, donors may generally take an itemized deduction for charitable contributions of cash made to public charities, private operating foundations, and certain private non-operating foundations up to 50% of the donor’s adjusted gross income (AGI). The Act increases this limitation to 60% of the donor’s AGI. Other limitations continue to apply for gifts of certain noncash property and for contributions to most private non-operating foundations. This change is effective for tax years beginning after December 31, 2017. The Act continues to allow a 5-year carryover for contributions exceeding the 60% AGI limitation.
10. Elimination of the deduction for moving expenses and the qualified moving expense reimbursement exclusion
Currently, taxpayers may claim a deduction for certain moving expenses incurred in connection with starting a new job. Additionally, taxpayers may currently exclude from income employer-paid qualified moving expense reimbursements. The Act eliminates the moving expense deduction and the qualified moving expense employer reimbursement exclusion. An exception exists for moving expenses of members of the Armed Forces of the United States. These eliminations are effective for tax years beginning after December 31, 2017.
11. Modification of the net operating loss deduction rules
The Act eliminates the net operating loss (NOL) 2-year carryback period, with an exception for certain farming losses and certain insurance company losses, and also creates an indefinite NOL carryforward period. These provisions are effective for net operating losses arising in taxable years ending after December 31, 2017. The Act also limits the allowable NOL deduction to 80% of taxable income. This provision is effective for losses arising in taxable years beginning after December 31, 2017.
12. Increase in the estate tax exemption
Under current law, property of a decedent’s estate is generally subject to an estate tax, with an exemption of approximately $5 million. The Act increases the exemption to approximately $10 million, indexed for inflation occurring after December 31, 2011. The increased exemption is effective for estates of decedents dying and gifts made after December 31, 2017. This increased exemption eliminates the estate and gift tax incentive associated with bequests to nonprofit organizations for most taxpayers (other than those with high-value estates).
13. Elimination of the deduction for the cost of certain fringe benefits provided to employees, and elimination of the deduction for entertainment expenses
The Act eliminates deductions for entertainment, amusement or recreation activities, facilities (including on-premises gyms and other athletic facilities), or membership dues relating to such activities or other social purposes. The Act also eliminates the deduction for transportation fringe benefits (including parking) provided to employees. Under the Act, the deduction for meal expenses is generally limited to 50%. The provisions above are effective for amounts paid or incurred after December 31, 2017. Additionally, the deduction for employer-operated eating facilities and meals provided for the convenience of the employer is limited to 50% for amounts incurred and paid after December 31, 2017, and until December 31, 2025, and is eliminated entirely for amounts paid or incurred after December 31, 2025.
14. Imposition of an excise tax on certain executive compensation
Under the Act, a nonprofit organization is subject to a 21% excise tax on compensation in excess of $1 million (and on certain excess compensation payments contingent upon separation from employment) paid to any of its five highest paid employees during the year, including former employees. Compensation includes cash wages as well as the cash value of benefits (except for payments to certain retirement plans), and includes compensation from related organizations and government entities. Notably, the definition of wages used in the Act does not appear to include wages for services performed by a duly ordained, commissioned, or licensed minister of a church in the exercise of his/her ministry or by a member of a religious order in the exercise of duties required by such order. The Act also provides an exemption from the excise tax for compensation attributable to medical services provided by certain qualified medical professionals. This provision is effective for tax years beginning after December 31, 2017.
15. Imposition of an excise tax on the net investment income of certain private colleges and universities
The Act assesses a new excise tax of 1.4% on the net investment income of certain private colleges and universities with large endowments or investment portfolios. The Act also clarifies that, for purposes of computing the excise tax imposed under this provision, the assets and net investment income of organizations that are related to the private college or university are included. This provision is effective for tax years beginning after December 31, 2017.
16. Certain fringe benefits provided by nonprofit entities to their employees are treated as unrelated business taxable income
Under the Act, nonprofit entities are taxed on the cost of providing their employees with transportation fringe benefits, parking facilities used in connection with qualified parking, and on-premises gyms and other athletic facilities, by treating the expenses incurred by the nonprofit organization in connection with the provision of such benefits as unrelated business taxable income. This provision is effective for amounts paid or incurred after December 31, 2017.
17. Prohibition from offsetting unrelated business income with losses generated from separate unrelated business activities
Under current law, nonprofits that conduct more than one unrelated trade or business activity may offset income generated by one unrelated trade or business activity with losses generated by another unrelated trade or business activity. The Act requires nonprofits with more than one unrelated trade or business to calculate the unrelated business taxable income separately with respect to each trade or business, thereby prohibiting nonprofits from offsetting unrelated business income from one unrelated business activity with losses generated from a separate unrelated business activity. Under the Act, a net operating loss deduction is only allowed with respect to the trade or business from which the loss arose. This provision is effective for taxable years after December 31, 2017.
Under a special transition rule, net operating losses arising in a taxable year beginning before January 1, 2018, that are carried forward to a taxable year beginning on or after such date are not subject to this provision.
18. Elimination of the Affordable Care Act (ACA) individual shared responsibility payment
The Act reduces the ACA individual shared responsibility payment to zero. This provision is effective with respect to health coverage status for months beginning after December 31, 2018.
Certain provisions of the House and/or Senate Bills that would have affected nonprofits have not been included in the final legislation, such as:
· Repeal of the exclusion for qualified tuition reduction plans
· Limitation of the exclusion for housing provided for the convenience of the employer
· Modification of the Johnson Amendment allowing political statements to be made by §501(c)(3) organizations
· Adjustment to the charitable mileage rate
· Repeal of the exclusion for employer-provided educational assistance programs
· Elimination of the exclusion for employer-provided adoption assistance programs
· Elimination of the exclusion for employer-provided dependent care assistance programs
· Termination of the new markets tax credit
· Modification of private foundation excess business holding rules
· Additional reporting requirements for donor advised fund sponsoring organizations
· Simplification of the excise tax rate on private foundation investment income
· Elimination of private activity tax-exempt bond financing for §501(c)(3) projects
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