Tax Cuts and Jobs Act: Changes That Affect Tax-Exempt Organizations

UPDATE: The Taxpayer Certainty and Disaster Tax Relief Act of 2019 amended the Tax Cuts and Jobs Act by repealing the tax on certain employee fringe benefits (parking) for nonprofit employers.  An organization that paid the tax may be eligible for a refund. To claim a refund, the organization needs to file an amended 990-T, as further explained by the IRS here.  The Taxpayer Certainty and Disaster Tax Relief Act also established a flat 1.39% excise tax on private foundation net investment income, instead of the variable 1% or 2% tax.

The Tax Cuts and Jobs Act made sweeping changes to the Internal Revenue Code including some that apply to tax-exempt organizations.  Exempt organizations should become familiar with the new tax law and make plans to comply with it. 

One of the most significant changes is how unrelated business income tax is calculated.  If an organization has more than one unrelated business, income from each business must be calculated separately.  This means that deductions from one business can no longer be used to offset income from another business.  Another unusual provision requires any organization that provides certain disallowed fringe benefits to its employees to add the value of those fringe benefits to its total unrelated business income.  As a result of the Tax Cuts and Jobs Act, a new tax rate applies to unrelated business income.  The new rate is now a flat rate of 21%, instead of the graduated rates that applied under prior law.

The new tax law includes several provisions that apply exclusively or primarily to colleges and universities.  Any college or university that qualifies as an “applicable educational institution” will be required to pay a new excise tax of 1.4% on its net investment income.  This tax will apply to approximately 30 colleges and universities with large endowments relative to their student enrollments.

Another new excise tax of 21% applies to compensation in excess of $1 million paid to the organization’s five highest paid employees or any person who has been one of the five highest paid at any time following December 31, 2016.  Compensation for medical or veterinary services performed by the employee are excluded from the income subject to the new tax.  The tax is assessed on the organization, not the employee.  It is expected that this tax will be owed primarily for salaries of athletic coaches at major colleges and universities.

Changes made by the Tax Cuts and Jobs Act that apply to individuals could have an indirect effect on tax-exempt organizations.  The new law raised the deduction limit for cash contributions to public charities to 60% of a donor’s adjusted gross income from 50% under the prior law.  The carryover provisions were maintained and increased to 60%.  Under the prior law, individuals could deduct up to 80% of a donation made to a college or university for the privilege of purchasing tickets to athletic events.  The new law eliminates this deduction.  Another change now allows Section 529 educational plans to be used for tuition expenses at elementary and secondary schools.  Section 529 plans could only be used for college and university expenses under the earlier law.

Several versions of the Tax Cuts and Jobs Act were considered by Congress, and the process to arrive at a final bill saw many provisions come and go.  The provisions that were not in the final bill could be considered by Congress at a future time.  Earlier versions of the bill would have required additional reporting requirements by donor advised funds.  Proposed legislation did not contain mandatory payouts for donor advised funds, but it is conceivable that it could be in future proposals.  Another proposed change that did not make it in the final bill was a flat tax of 1.4% on private foundation net investment income, instead of a combination of 1% and 2% rates under current law.  Probably the most controversial change that was not included in the final bill was a partial repeal of the Johnson Amendment that would have applied only to churches.  Under the proposal, the content of a sermon could not be used as the sole basis for finding that a church violated the ban on political campaign involvement.

The income tax landscape has changed significantly with the new tax law.  The attorneys of Bea & VandenBerk are experienced in advising tax-exempt organizations about complying with federal tax law.    If you have questions about the new tax law or need advice about compliance, we invite you to contact our office.

This article is provided for general information and is not intended to be legal advice for any specific situation. If you are in need of specific advice or legal representation, please do not hesitate to contact us.

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