Who was it that said there are downsides to everything, unintended consequences to everything? Well, true or not, there are certainly consequences to everything. And downsides to many.
The original intent of tax reform was to reduce taxes and enhance finances. But for many not-for-profit organizations, the consequences may be the opposite.
In fact, if the conclusions of a study conducted by George Washington University prove prescient, the Tax Cuts and Jobs Act may actually cost the not-for-profit sector some 220,000 jobs.
Unrelated Business Income Tax (UBIT)
An unrelated business is a trade or business that a not-for-profit organization regularly conducts and that does not further the organization’s charitable mission.
On the plus side for all but the smallest not-for-profits, under the Act the federal unrelated business taxable income (UBTI) tax rate beginning in 2018 has changed from a graduated rate to a flat 21 percent. Pre-Act the rates began at 15 percent for UBTI less than $50,000 and increased to a maximum of 35 percent.
However, your not-for-profit can no longer group its unrelated business activities — offsetting the profits of one business with the losses from another. Instead, each unrelated business income (UBI) activity must be reported separately, with all profitable businesses subject to tax.
As an additional consequence, if your not-for-profit has more than one unrelated business, you will need to determine how to allocate various expenses.
Net Operating Losses
Under the Act, net operating losses (NOLs) can only be used to offset up to 80 percent of taxable income. NOLs can’t be carried back, but can be carried forward with no expiration.
Transportation and Other Fringe Benefits
If you provide qualified fringe benefits for your employees — for example, parking, bus passes, paid carpooling, even an on-premises gym or athletic facility — the cost of providing those benefits is now included in your UBIT calculation.
As a result, those costs are subject to tax at the 21 percent UBIT rate and there are no offsetting expenses to the calculation.
Qualified bicycle commuting reimbursements are now taxable fringe benefits to your employees.
Changes to the federal tax rules for corporate and non-corporate donors under the Act have reduced the tax incentive for charitable contributions.
For C corporations, the major cut in the federal tax rate reduced the financial benefit of making charitable contributions. In other words, the corporation’s after-tax cost increased.
For individuals, the tax rates are also lower, increasing after-tax costs. Perhaps more important when it comes to charitable donations, the standard deduction increased — meaning fewer people will itemize and therefore fewer people will receive a tax benefit from donating.
Taken together, these changes have been projected to reduce charitable giving by as much as $20 billion per year, according to the nonpartisan Tax Policy Center. The Center also estimates that 21 million taxpayers will stop taking charitable deductions.
Under the Act, the federal estate tax exemption increased from $5.6 million to $11.18 million — double that for married couples.
It’s predicted that charitable bequests will decrease as a result. There’s no tax benefit for bequests from nontaxable estates, increasing the after-tax cost of the bequest. Independent Sector estimates the decrease in bequests from tax reform at roughly $7 billion.
Highly Compensated Employees
A not-for-profit that pays more than $1 million per year in compensation to any of its five highest compensated (i.e. covered) employees is subject to an excise tax of 21 percent on the excess compensation. Compensation includes amounts paid by the filing organization and all related organizations, as well as severance or parachute payments. There is, however, an exclusion for licensed professionals providing medical or veterinary services.
Over time, the tax may apply to the compensation of more than five employees. A top-five employee who drops into sixth place or lower, but still receives more than $1 million per year in compensation, continues to trigger the tax.
Tax on Endowment Income
Certain large private colleges and universities are subject to a tax on the income from their endowments. Subject institutions are those with:
500 or more tuition-paying students
endowments of at least $500,000 per student, and
more than 50 percent of their tuition-paying students located in the U.S.
The tax is equal to 1.4 percent on institution’s net investment income from endowments, as well as other assets not used for educational purposes.
Advance Refunding Bonds
Interest on advance refunding bonds issued after 2017 is no longer exempt from tax. Current refunding bonds remain tax exempt.
Wondering how else not-for-profits were affected by the TCJA?
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