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The Tax Act: The Impact on Exempt Organizations

by Renee Ordeneaux, Kelly Gillette

After months of speculation and changes to various details, Congress passed the Tax Cuts and Jobs Act (TCJA), instituting new rates and significant modifications to deductions for corporations and individuals. While there had been discussion of numerous changes that would directly apply to exempt organizations, such as the potential repeal of the Johnson Amendment, only a few provisions directly impact nonprofits, and will generally apply to only a small number of exempt organizations. The most significant effects will likely be indirect, resulting from changes to the individual and corporate tax rules.

The Direct Impact 

Organizations conducting unrelated business activities: Organizations with multiple, taxable unrelated business activities will need to reconsider tax planning strategies for these activities, since the TCJA eliminates the ability to offset losses from one activity against income from other activities. For entities organized as corporations, the new flat corporate tax rate will need to be considered, as the prior tiered system no longer applies. 

Organizations with very highly compensated employees: Organizations paying more than $1 million in compensation to a covered employee will pay an excise tax of 21% of the amount of compensation above $1 million. In most cases, this won’t apply to local nonprofit organizations, but it will impact some colleges and universities, as well as hospitals, whose administrators are subject to this rule (healthcare providers are not covered).

Private colleges and universities with large endowments: Colleges and universities with endowments totaling more than $500,000 per student will face an excise tax of 1.4% on net investment income. Small colleges with a student body of less than 500 are exempt.

Private K-12 schools & 529 plans: 529 plan distributions used to pay qualifying education expenses are generally tax-free. The TCJA has expanded the definition of qualified education expenses to include not just postsecondary school expenses, but it now also includes primary and secondary school expenses, limited to $10,000 per year per student. This change is permanent. More than 30 states allow income tax deductions for 529 plan contributions. 

The Indirect Impact

The most significant impact to charities comes from the changes the TCJA makes to corporate and individual tax rules that could reduce the incentive for donors to give. The Tax Policy Center (TPC) estimates that charitable giving will decline by $12 billion to $20 billion annually (out of approximately $282 billion in individual annual contributions). However, the individual provisions in the TCJA are currently set to expire in 2025, so the not-too-distant future could bring about additional changes.

Increase in the standard deduction: The TCJA doubles the standard deduction, which will undoubtedly make tax filing for many families significantly easier. However, it also means that many more people will no longer need to track and deduct their charitable contributions. Taxpayers on the cusp might benefit from itemizing every other year and grouping deductions on a bi-annual basis. Nonprofit development departments can help donors by facilitating this type of giving.

Reduction in individual rates: For 2018, tax rates for individuals are reduced across the board, though the rate reductions are not as dramatic as the big corporate tax rate cut. For many donors, the reduced rates will not create a significant consideration in giving activity.

Charitable contributions: The income-based limitation for cash contributions to public charities is increasing from 50% to 60%. The provision retains the five-year carryover period to the extent that the contribution amount exceeds 60% of the donor’s AGI. For some donors this will provide additional opportunities for current giving.

Changes to the Alternative Minimum Tax (AMT) and reduction in state tax deductions: The limit on deducting state and property taxes to $10,000 combined has gathered a lot of press in states with higher state and local tax rates such as California. However, many Californians have had their itemized deductions effectively limited by AMT, which requires taxpayers to recalculate taxable income and add back the deductions for taxes, among other items. By increasing the amount of income exempt from AMT, fewer taxpayers will be subject to the add-back of state and local taxes or other “tax preference” items. Many higher-income Californians are likely to see a net decrease in their taxes, which will free up disposable income that could be used to increase donations.

Cut to the corporate tax rate: The top corporate rate is going from 35% to 21%, which significantly reduces the economic incentive for corporations to make charitable contributions. Fortunately for the nonprofit sector as a whole, corporate giving is a small component of overall philanthropic activity—it accounts for a little less than $19 billion or about 5% of overall giving. Organizations that depend heavily on corporate philanthropy—either through corporate gifts or event sponsorships—may need to revisit their strategies.

Increase in the estate tax exemption limit: The TCJA doubles the estate tax exemption, which means that many “smaller” estates will not be subject to an estate tax. This will reduce the incentive to make large gifts if the primary motivation for the philanthropy is tax reduction.

In addition to these provisions, there are many other items impacting deductibility of certain fringe benefits, some of which will cause nonprofit organizations to incur unrelated business income tax on expenditures. We will cover these in a separate article.

What Now?

The TCJA is the largest overhaul of the tax code in more than 30 years, and we’ve covered only the highlights of the direct and indirect impact the law has on exempt organizations. Please contact a local Armanino expert if you have questions about how the new rules may affect your organization.

January 03, 2018

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