On Dec. 20, 2017, Congress enacted sweeping tax reform legislation commonly referred to as the Tax Cuts and Jobs Act (the “Act”) shifting the landscape for many charitable organizations and individuals who support them philanthropically. Following is a summary of the most important provisions impacting operating charities and their donors, and we also highlight a few proposed changes that ultimately were not included in the Act, but may foreshadow future legislation. Most of the key proposals impacting private foundations and donor-advised funds were excluded from the final version of the Act.
Although the final version of the Act omits a number of proposals that generated great concern within the nonprofit community, operating charities did not escape tax reform entirely. To the contrary, there are a number of provisions in the Act to which operating charities should pay particularly close attention.
Changes to Unrelated Business Income Tax Rules
The Act changes the method by which operating charities must calculate income from their unrelated trade or business activities. Rather than having the flexibility to aggregate all sources of unrelated business income, an operating charity must calculate the amount of unrelated business income it generates separately for each trade or line of business in which the operating charity is engaged. This new calculation eliminates operating charities’ ability to offset gains in one trade or line of business with losses in another, potentially increasing the total amount of unrelated business income on which operating charities are taxed. Because of the Act’s reduction in the corporate tax rate, however, operating charities will now pay tax on unrelated business income at a rate of 21 percent—a substantial decrease from the 35 percent rate previously imposed on net unrelated business income generated by operating charities.
New Excise Taxes for Highly Compensated Nonprofit Employees
The Act imposes a new 21 percent excise tax on compensation in excess of $1 million paid by tax-exempt organizations to their covered employees. An individual is a “covered employee” if he or she is one of the five most highly compensated employees of the tax-exempt organization for the tax year in question, or was one of the five most highly compensated employees during any preceding tax year, beginning with 2017. The excise tax must be paid by the tax-exempt organization, not by the covered employee. Note that this provision applies not only to operating charities but also private foundations and certain other organizations that are tax-exempt but not charitable.
New Excise Taxes for Large University Endowments
Private nonprofit colleges and universities that have at least 500 full-time or full-time equivalent (FTE) students and endowment assets exceeding $500,000 per student are now subject to a new 1.4 percent excise tax on the net investment income. For a university with 50,000 full-time or FTE students, the tax would be applied if the university’s endowment exceeds $25 billion.
Elimination of Alternative Gift Substantiation
The Act eliminates alternative gift substantiation for operating charities. Prior to the Act, a donor who made a donation of $250 or more to a charitable organization was required to obtain a contemporaneous written acknowledgement of the gift from the organization to substantiate the donation for tax purposes. As an alternative to this contemporaneous written acknowledgement, the Internal Revenue Code permitted the charitable organization to file a document with the IRS containing detailed information about the donor and his or her gift. This change should have limited practical effect as most operating charities send acknowledgement letters thanking all donors for their contributions.
The Act also contains a number of provisions likely to affect charitable giving by individuals. Certain provisions could positively influence giving, but others are likely to discourage giving by some donors. Some industry leaders predict charitable giving in the U.S. to decline by up to $20 billion annually.
Increased Standard Deduction
The Act nearly doubles the standard deduction for individual taxpayers. As a result, individuals are more likely to opt for the standard deduction than to itemize deductions. Relatedly, individuals are less likely to benefit from or be incentivized to give by the favorable tax treatment accorded to charitable contributions under current law.
Increased Estate Tax Threshold
The Act substantially increases the threshold to qualify for the estate tax to $11 million for individuals and $22 million for couples, such that fewer estates will be subject to taxation. One potential result of this change is a decline in the number of bequests to charitable organizations.
Increased AGI Limits for Cash Contributions
On the positive side for nonprofits, the Act increases the adjusted gross income limitation for individual donors’ cash contributions to operating charities from 50 percent to 60 percent. This means that an individual donor now may deduct cash contributions to operating charities and donor-advised funds up to an amount of 60 percent of the donor’s adjusted gross income. Although this increase in the adjusted gross income limitation would be likely, standing alone, to incentivize cash contributions to charitable organizations, when coupled with the Act’s increase to the standard deduction, the impact on individual charitable giving patterns is unclear. Adjusted gross income limitations on other types of charitable contributions, such as contributions of capital gain property, are not affected by the Act.
Repeal of “Pease Rule”
In addition, the “Pease rule” limiting all itemized deductions, including but not limited to charitable deductions, by certain high-income earners is repealed.
Proposals Omitted from the Final Act
The final Act omits a number of proposals with potentially broad negative implications for the nonprofit sector including changes to the intermediate sanctions rules (including more burdensome procedures to establish the rebuttable presumption of reasonableness), the elimination of private activity bonds, and perhaps most importantly the repeal of the Johnson Amendment.
Additional federal legislation impacting operating charities, private foundations, donor-advised funds and philanthropists is likely on the horizon. For updates check back and follow me on Twitter @Dianne_C_Bailey.
Many thanks to my Robinson Bradshaw colleagues Morgan Abbott, Charles Bowyer and Travis Hinman for their assistance preparing this update.