No one likes to talk about corporate taxes, especially those in the nonprofit industry who feel as though taxes are primarily a concern for the for-profit world. However, the new tax law passed in December 2017, known as the Tax Cuts and Jobs Act (and also known as PL 115-97/HR 1), contains four provisions that directly impact nonprofits. These four provisions are:
- Executive Compensation,
- University Endowments,
- Unrelated Business Income Tax, and
- Fringe Benefits.
With the passage of the new tax law, there is now an excise tax on excess executive compensation. Essentially, Section 501(c) and 501(d) organizations will now have to pay an annual 21% excise tax on employee compensation in excess of $1M. This rate of 21% is the top corporate income tax rate under the new law, and it’s assumed that large trade associations, universities, and hospitals will be most affected by this provision given that they are most likely to pay such high salaries.
The way the law is structured, the current top five (5) highest paid employees, irrespective of position or title, whose compensation is in excess of $1M will be subject to this 21% excise tax. However, the taxes don’t stop there. As these five employees fall out of the top five in future years, they are still part of the group of employees that are subject to this excise tax provided they are making over $1M, along with any new employees that may have joined the top five. So, the group of employees subject to this tax isn’t limited to just five employees – it can grow as those in the top five change year-over-year. The good news is that licensed professionals providing medical services, including doctors and veterinarians, are excluded and should not be counted in this employee group.
When calculating employee compensation, this will be the total of current compensation, deferred compensation, and excess parachute payments (an excess parachute payment relates to the present value of the parachute payment that is equal to or exceeds three times the base salary amount). Also included in the compensation is remuneration for services as determined for income tax withholding purposes and amounts required to be included in gross income under IRC section 457(f) — but excluding designed Roth contributions.
This provision is also applicable to political organizations under 527(e)(1) and organizations whose income is excluded under IRC section 115(1), as well as related entities (such as parent organizations).
Under the new tax law, there is a 1.4% excise tax for endowment investment income. This applies only to colleges and universities with endowments of at least $500K per student, and it is limited to institutions with at least 500 students and where more than 50% of the college/university’s student body is located in the US. However, this provision does not apply to state colleges and universities.
Unrelated Business Income Tax (UBIT)
As was the case before the new tax law, all income generated from unrelated business activities will be subject to UBIT; however, now at a lower tax rate of 21%. But there is a catch! Starting January 1, 2018, all income generated from unrelated business activities have to be calculated separately and the new 21% tax rate will apply to the income on each of those individual activities. Therefore, you will be unable to net the activities and pay the 21% on the whole amount as was the case before the new tax law. Thus, if you have an operating loss on one unrelated business activity, that loss carries forward to the next year as opposed to being netted against the profit making activities for that year.
Perhaps an area that will affect many nonprofits, certain fringe benefits are now subject to the 21% UBIT rate. These fringe benefits include qualified transportation, parking, and on-premises athletic facilities. The cost of these benefits, if provided by the employer, should be calculated and a 21% UBIT paid on them by the employer.
There are other concerns with the new tax law and its impact on nonprofits. One such concern is that the increase in the standard deduction could cause less people to donate to nonprofits going forward since there would be no need or incentive for them to itemize their deductions. In addition, the limit on the amount that a contribution can be deducted has increased from 50% of an individual’s adjusted gross income (AGI) to 60%, charitable deductions for amounts paid for college athletic event seating rights has gone from 80% to 0%, and the indexed Estate Tax exemption has doubled from $5.5M to $11M.
Needless to say, there is a lot of uncertainty in the tax community about how the IRS will apply some of these rules as the new law was put together rather quickly, left a lot of room for interpretation, and was issued without going through the proper questioning period. Given that, it is always best to reach out to a tax accountant or your organization’s audit firm before making any assumptions.