Congress took its first steps toward tax reform when both the House and the Senate released versions of their changes to the tax code. The House passed its version of the Tax Cuts and Jobs Act, while the Senate Finance Committee approved its version of a tax reform bill on November 16. Provisions vary significantly between the House and the Senate versions of the tax reform plan, but they share one element in common: they both have provisions that will affect not-for-profit organizations.
Proposed updates to individual tax brackets, employment tax-related provisions, and estate planning are among several areas that may have an impact on charitable giving and other tax-related matters.
Measuring the Estate Tax & Individual Tax Impact
Both the House and the Senate bill increase the estate tax threshold to nearly $10 million, indexed for inflation. The House bill eliminates the estate tax starting in 2024.
Charitable contribution planning is currently a leading strategy to reduce the value of a high-dollar estate and minimize the impact of the estate tax. Many estates use charitable lead trusts and other planning vehicles to make tax-free donations to not-for-profit organizations of their choosing. If fewer estates are subject to the estate tax, there will be less of an incentive to make substantial contributions to a not-for-profit organization or an educational institution.
Individuals may also be willing to give to charitable causes in order to lower their individual tax burden. When individuals itemize their tax deductions in lieu of taking a standard deduction, they can deduct charitable contributions of up to 50 percent of their adjusted gross income (limitations apply in some circumstances). The House and Senate tax reform bills keep the deduction for charitable contributions, and actually increase the limitation on cash contributions to 60 percent of adjusted gross income. Both bills would also repeal the exception to the contemporaneous written acknowledgement requirement for contributions of $250 or more when the donee organization files the required return.
But both bills also create more incentives for individuals not to itemize their tax deductions. The bills do away with the popular deduction for state and local income taxes, and increase the standard deduction to $12,000 ($24,000 for married couples). These forces both work against an individual’s ability to make use of the itemized deduction for charitable contributions. Additionally, individuals may not be as incentivized to give to charitable organizations because both bills establish lower tax rates for many individuals, making tax deductions less valuable (although the tax cuts to individuals expire after 2025 in the Senate plan).
Not-for-profit organizations that rely on donor contributions should assess how the estate tax and individual tax changes could affect the amount of support they receive and begin to evaluate whether changes to budgeting and planning may be needed.
Not-For-Profit Executive Compensation
Changes would also affect executive compensation. Public companies have historically faced a provision to limit executive pay with Sec. 162(m). The provision states publicly held companies cannot take more than a $1 million deduction for the annual compensation for certain executives. Both versions of the tax reform plan would extend Sec. 162(m) limitations to impact not-for-profit organizations. Not-for-profit organizations would be subject to an excise tax of up to 20 percent of the amount over $1 million paid to a covered employee in the taxable year and an excise tax of 20 percent on excess “parachute payments” paid to employees, regardless of whether they were covered employees.
Higher Education & Foundations
Provisions outlined in both the House and the Senate bills would affect higher education institutions. Both bills call for a new 1.4 percent excise tax on net investment income to be applicable to private colleges and universities. The tax would be applied to educational institutions that have more than 500 students and assets (other than those used directly in carrying out the institution’s educational purposes) of more than $250,000 per full-time student for tax years beginning after 2017.
The House plan also makes changes to tax-free housing, changing the maximum amount excluded from gross income to be $50,000. The maximum exclusion amount is phased out, starting with employees who make over $120,000, and is phased out completely at $220,000. Lowering the maximum amount excludible from income makes it highly likely that housing would be taxable for heads of universities, and for certain other not-for-profit organizations. The Senate bill does not address the employer-provided housing exclusion.
Other Provisions Affecting Not-For-Profits
In the Senate plan, income from the license of an organization’s name or logo would be considered unrelated business income and subject to tax for all not-for-profit organizations. The House plan did not include such a provision; however the House plan approved rolling back the Johnson Amendment, which limits a not-for-profit’s participation in political speech.
How Not-For-Profit Organizations Can Prepare for Tax Reform
As the plan for comprehensive tax reform takes shape, not-for-profit organizations will want to monitor the developments closely. Tax reform isn’t set in stone just yet. The tax bill is currently on the Senate floor for debate and may go to a vote later this week. At present, the legislation is opposed along party lines and several Republican Senators have expressed ambivalence about components of the bill, which may make getting the votes needed to pass more challenging than what the House encountered with its bill. Furthermore, once the Senate approves its bill, it will need to reconcile the changes to the House bill in order for the tax reform plan to become law.
The goal is to pass a reconciled tax reform bill through both chambers before Christmas. It remains to be seen whether provisions that were excluded from the Senate bill, like the employer-provided housing exclusion and the Johnson Amendment repeal, will find their way into the reconciled bill. We will keep you up-to-date as more details emerge. For comments or questions about how tax reform may impact your organization, please don’t hesitate to contact us.
Craig Klein is a Managing Director in the Tax Group at CBIZ Tofias. Craig can be reached at firstname.lastname@example.org or 617.761.0509.