The Tax Cuts and Jobs Act became law on December 22, 2017, which made multiple new tax provisions effective as of January 1, 2018. Nonprofit organizations should use this time to revisit their budget and strategic plan, sharpen their fundraising efforts, and implement more sophisticated fundraising techniques. In addition to individual tax provisions that are of particular concern for charitable nonprofits, there are four new tax provisions that directly impact exempt organizations, including:
- Changes to unrelated business income (UBI) and net operating loss (NOL)
- Excise tax on excess executive compensation
- Taxability of employee benefits
- Excise tax on investment income to private colleges and universities
Unrelated Business Taxable Income and Net Operating Losses Must Be Calculated Separately for Each Business Activity
If an organization has multiple streams of UBI, the net profit from each separate unrelated business activity must now be isolated in order to calculate the tax liability for that specific activity. In essence, each unrelated business activity will be considered a silo on which tax is assessed. Therefore, the net loss from one activity may not offset the net profit from a different activity. This is a change from the previous case where an organization could add together the profits and losses from all unrelated business activities, and tax would be assessed on the overall net income of those activities.
NOLs also need to be tracked separately for each activity and may only be carried forward to offset the future taxable income from the activity which generated the NOL. In addition, there is no longer a two-year carryback allowed. However, there is an infinite carryforward.
Another big change for net operating losses is they can only be utilized up to 80 percent of taxable income. Previously, NOLs could offset the entire taxable income of an organization. This could potentially be a big change if you have, or expect to have, future taxable income and have an NOL that could be carried forward.
The recent tax reform also changed the corporate tax rate to a flat rate of 21 percent. This flat tax rate will be applied regardless of the amount of taxable income for each organization. Previously, a graduated tax rate was assessed depending on the amount of taxable income. There are also some changes to expensing and depreciation methods of certain property. Specifically, increased thresholds for accelerated depreciation, such as Section 179 and bonus depreciation. Additionally, the alternative minimum tax and the domestic production activities deduction were repealed.
Excise Tax on Highly Paid Executives
There is a new 21 percent excise tax required to be paid by the nonprofit organization on compensation that exceeds $1 million to a covered employee and on certain parachute payments. A covered employee is defined as one of the five highest compensated employees for the tax year or for any preceding tax year beginning after December 31, 2016. However, there is an exclusion available for certain medical professionals, such as doctors.
Taxability of Fringe Benefits for Employees
If an organization provides certain fringe benefits to its employees, the value of those benefits will now be considered unrelated business taxable income to the organization upon which the new corporate tax rate of 21 percent is applicable. Taxable fringe benefits include on-site health facilities and qualified transportation fringe benefits, such as parking, bicycle costs, and payment or reimbursements for commuting between an employee’s residence and the place of employment. In order to avoid UBIT on these fringe benefits, an organization could gross-up their employee wages to include the value of these benefits instead of directly providing the taxable fringe benefits.
There are also a couple significant changes to the exclusions previously available from employee gross income. The following exclusions from gross income are now disallowed:
- Employer-paid moving expenses.
- Employee achievement awards, including cash, gift cards and certificates, meals, lodging, tickets to events or similar items. These types of employee benefits must now be included in an employee’s gross income.
New Excise Tax on Investment Income of Private Colleges and Universities
A 1.4 percent excise tax is imposed on net investment income of certain private colleges and universities. This excise tax applies to private colleges and universities with at least 500 students of which more than 50 percent are located in the U.S. and who have assets of at least $500,000 per student.
Individual Tax Provisions of Particular Concern to Charitable Nonprofits
The significant increase in the standard deduction means fewer taxpayers will itemize deductions on their tax return. This is expected to have a significant impact on charitable giving. Analysts estimate the approximate one-third of taxpayers who currently itemize will reduce to less than 10 percent, leading to an expected reduction in giving estimated at six to nine percent per year. Nonprofit organizations should plan to acquire their revenues in different ways, such as bunched giving, which is a planning opportunity for donors to accumulate their donations over multiple years for a larger single donation instead of making consistent smaller annual gifts.
The estate tax exemption, which was almost doubled, reduces tax incentive for wealthy individuals who can now transfer more assets to their beneficiaries tax-free. This could result in a reduction in planned giving, also known as charitable bequests, that has traditionally assisted taxpayers with their estate planning strategies in order to minimize estate and gift tax.
The repeal of the healthcare mandate penalty could also impact organizations, as healthcare premium costs are expected to rise.
A positive change that creates an opportunity for charitable organizations is an increase in the charitable contribution deduction from 50 percent to 60 percent of adjusted gross income. Also, the limitation on itemized deductions was repealed. This means that individuals with high income who do itemize could now have more incentive to give higher amounts.
The theme is tax cuts and revenue cuts, which equal federal and state spending cuts. If states choose to conform to federal law, it could result in increased revenues from individual taxes, but reduced revenues from business taxes. If an organization receives a federal, state, or local grant, there may now be an impact on the way it receives revenue.
From a fundraising perspective, there may be fewer overall donors but increased donation amounts from wealthy donors. Organizations can combat some of the changes by coming up with more strategic fundraising plans and by engaging their donors. Board members can prepare for some of these changes by including relevant discussion topics for future board meetings, such as operational matters affected by the new tax reform, future policy risks and opportunities, and implementation of advocacy strategies with government, local media and potential funders.
Meet the Author
Elsa Romero, CPA
Aldrich CPAs + Advisors LLP
Elsa Romero brings nearly 25 years of experience providing strategic, holistic tax planning and compliance services. She is a trusted advisor for closely held businesses and high-net-worth family clients. Elsa has an extensive understanding of providing tax transaction and succession planning, trust and gift tax compliance, and tax planning services to many client industries, including... Read more Elsa Romero, CPA
- Tax planning
- Privately held companies
- Certified Public Accountant (CPA)