The new tax bill enacted in December (the “Tax Bill”) includes many changes affecting tax-exempt organizations, including changes to excise taxes imposed on private foundations and universities, the charitable donations deduction, tax-exempt bonds, and the treatment of unrelated business taxable income (“UBTI”). The changes are effective January 1, 2018. The following summarizes the key changes in the Tax Bill for tax-exempt organizations.
Excise Tax on Private University Endowments. Under prior law, the 1% to 2% excise tax on net investment income that applies to private foundations did not apply to private universities. The Tax Bill imposes a 1.4% excise tax on the net investment income of a private university that has (i) at least 500 students during the taxable year, and (ii) assets (other than those used for educational purposes) with an aggregate fair market value exceeding $500,000 per full-time student. State colleges and universities continue to be excluded from the excise tax.
Excise Tax on Compensation over $1 Million. Organizations exempt from tax under Section 501(c)(3) and Section 501(c)(4) of the Internal Revenue Code (the “Code”) are prohibited from paying compensation that exceeds the fair market value of relevant services, but under prior law there was no specific dollar cap on compensation. The Tax Bill imposes a 21% excise tax on compensation paid to an exempt organization’s five highest paid employees in excess of $1 million per year, including excess parachute payments. The compensation provisions in the Tax Bill apply to charitable and religious organizations as well as public utilities and municipalities.
Increase in Standard Deduction. Taxpayers generally can claim a deduction for charitable contributions made during the year as part of their itemized deductions, in place of the “standard deduction” available to all taxpayers. Accordingly, a taxpayer receives a tax benefit for the charitable contribution deduction only to the extent that the taxpayer’s itemized deductions exceed the standard deduction. The Tax Bill doubles the standard deduction to $12,000 and $24,000 for individuals and married couples, respectively, thereby significantly decreasing the number of taxpayers who can benefit from a charitable contribution deduction.
Increase in Percentage Limitation. The charitable contribution deduction is limited to a certain percentage of the taxpayer’s adjusted gross income (“AGI”), with that percentage varying from 20% to 50% depending on what type of asset is contributed and whether the donee is a public charity or a private foundation. The Tax Bill increases the AGI limitation for cash contributions to public charities and certain private foundations from 50% to 60%. Additionally, the Tax Bill repeals a current rule permitting a taxpayer to treat 80% of a payment to a university for university athletic seating rights as a charitable contribution.
Advance Refunding and Tax-Credit Bonds. Gross income generally does not include interest paid on state or local bonds. However, the Tax Bill repeals the interest exclusion for advance refunding bonds. Refunding bonds are used to pay principal, interest, or redemption price on a previously issued bond. The Tax Bill also repeals the authority to issue tax-credit and direct pay bonds. Section 54 of the Code previously allowed holders of tax-credit bonds a credit against their income taxes to replace a proscribed portion of their interest cost.
Separate Computations of Unrelated Business Income. Under the current Treasury Regulations, an organization calculates its UBTI by aggregating the income from all of its unrelated trade or businesses and subtracting its aggregate deductions. Thus, organizations could use deductions from one unrelated trade or business to offset the income of another in reducing total UBTI. The Tax Bill requires UBTI to be calculated separately with respect to each trade or business. This separate calculation prevents net operating losses attributable to one business from offsetting income of another unrelated trade or business.
UBTI Increased by Certain Fringe Benefits. Under the Tax Bill, funds used to pay for certain transportation fringe benefits and on-premises athletic facilities will no longer be deductible by taxable employers and, correspondingly, will be treated as unrelated business taxable income for tax-exempt employers. Specifically, UBTI will be increased by any expenses, for which a deduction is not allowable by reason of Section 274 of the Code, paid or incurred for qualified transportation benefits, parking facilities used in connection with qualified parking, and an on-premises athletic facility (except to the extent such expenses are directly connected to an unrelated business carried on by the organization, in which case they will still increase UBTI because they will be non-deductible expenses).
The Tax Bill is available here and the provisions affecting tax-exempt organizations have been previously summarized in a Client Alert available here. Please contact one of the above attorneys or the Thompson & Knight attorney with whom you regularly work if you would like to discuss the impact of the Tax Bill on you.