Months after the Tax Cuts and Jobs Act (TCJA) was signed into law, nonprofits are still trying to assess its consequences. Some of the early proposals that raised alarms in the charitable sector — such as a repeal of the Johnson amendment — didn’t make it into the final version of the law. But there’s still plenty to mull over and plan for.
How deductions affect donations
The biggest news for nonprofits is that the TCJA nearly doubles the standard deduction to $12,000 for individuals and $24,000 for joint filers. Fewer Americans are expected to claim itemized deductions starting in 2018 because their standard deduction will exceed their itemized deductions. Therefore, fewer are expected to make charitable giving part of their tax planning strategy. Unfortunately, it’s impossible to predict to what extent this provision will affect donations. After all, people give to charity for many reasons besides the tax benefits.
One likely consequence, however, is that, while the higher standard deduction is in effect (2018–2025), some taxpayers who previously made annual gifts — often in December — will now itemize deductions only every other year and “bunch” their donations into those years. Nonprofits may need to adjust their expectations and budgeting processes accordingly.
The TCJA also doubles the estate tax exemption to $10 million (plus inflation adjustments) through 2025. With fewer wealthy individuals exposed to the tax, fewer may make the generous donations that can shrink their taxable estates. Plus, the law eliminates deductions for donations made in exchange for the right to buy season tickets to college athletic events.
The law does raise the limit on cash donation deductions from 50% of adjusted gross income to 60%. But cash donations at this level are uncommon, so the higher limit may not stimulate much additional giving.
How UBIT rules are changing
The TCJA has substantially lowered the maximum corporate tax rate to 21%. This is a benefit to any nonprofit that’s already paying unrelated business income tax (UBIT) for income that exceeds $50,000, because UBIT is paid at the applicable corporate rate, which previously ranged from 25% to 35% for income above this level. However, nonprofits with taxable net income under $50,000 will now pay the 21%, vs. the former 15%, rate.
The new law requires nonprofits to calculate unrelated business taxable income (UBTI) separately for each unrelated business activity and pay tax on any activity with net income. That means you can’t use a loss from one unrelated business to offset income from a different unrelated business for the same tax year.
Your nonprofit generally still can, however, use one year’s losses on an unrelated business to offset profits in a different year for that business, subject to certain restrictions. For example, if you incurred a loss in your bookstore business in 2018, you could use that loss to offset bookstore profits in 2019.
The TCJA also includes certain fringe benefits in UBTI. Beginning in 2018, your nonprofit must pay the 21% UBIT on any expenses you incur to provide qualified transportation (such as transit passes) or qualified parking fringe benefits and access to on-site athletic facilities.
Which compensation faces excise tax
Under the TCJA, a 21% excise tax will now be imposed on high executive compensation. The tax applies to the sum of any compensation (including most benefits) in excess of $1 million paid in the tax year to a covered employee — plus any “excess parachute payments.”
A “covered employee” means a current or former employee reported as one of your five highest paid employees for any taxable year beginning after 2016. Licensed medical professionals aren’t covered employees for this tax as long as compensation is for medical services.
A payment generally is considered an excess parachute payment if it’s contingent on the employee’s departure and the present value of the payment equals or exceeds three times the base amount, which is the employee’s average annual compensation for the preceding five years. The excess parachute payment subject to the excise tax is the amount of the parachute payment less the base amount.
Why financing may get more expensive
If your nonprofit issues tax-exempt bonds to finance construction and other capital activities, you know that they typically pay lower interest rates than other bonds. Investors are willing to accept the lower rates because they aren’t required to pay income taxes on the interest.
But the TCJA repeals the tax-exempt treatment for interest paid on an “advance refunding bond.” This is a refunding bond used to pay principal, interest or redemption price on another tax-exempt bond (the refunded bond) if the refunding bond is issued more than 90 days before redemption of the refunded bond.
Let’s say you issue tax-exempt bonds at 4% interest but later discover you can refinance the bonds at 3% interest. Under the TCJA, interest payments on the 3% advance refunding bonds won’t be tax-exempt for investors. That means you’ll need to pay more interest to attract investors.
Where to start
It’s not surprising that many nonprofits regard the TCJA as a blow to charitable organizations and the communities they serve. The Tax Policy Center estimates that rules related to deductions will reduce charitable giving by as much as $20 billion a year. But it’s important to remember that every nonprofit is different. By understanding how the law is likely to affect your unique organization, you can plan to minimize negative effects.
To learn more about how our firm can serve your nonprofit organization, please contact me at (302) 254-8240.