Back in December, Congress passed, and the President signed into law, tax legislation as outlined below. Many provisions of this law directly impact Not-For-Profit entities and other provisions may have an indirect impact. The following summary of those provisions should be considered when planning for tax reporting for 2016.
On December 18, 2015, President Obama signed the legislative package consisting of the Consolidated Appropriations Act of 2016 and the Protecting Americans from Tax Hikes Act of 2015 (the "Act") into law. The Act includes extension of certain expired tax benefits as well as other changes to the tax law. From the viewpoint of many charitable organizations, the majority of the provisions of the Act related to not-for-profit organizations target extensions of various donation benefits. Unlike prior extensions, the Act does not have an expiration date for most of the provisions described below. Thus, such provisions have been made permanent in the sense that future legislation is not necessary to extend the provisions. In some cases, the Act not only extends a provision but modifies prior law. There were also provisions that relate to general compliance or perceived abuses. The following are highlights of the legislation. Additional details may need to be considered for a specific situation.
TARGETED CONTRIBUTION PROVISIONS
Individual Retirement Account Distributions
The Act permanently extends the ability of individuals at least 70 ½ years of age to exclude from gross income qualified charitable distributions of up to $100,000 from Individual Retirement Accounts. Since this provision excludes the IRA distribution from the donor’s income, it also prohibits the donor from claiming a charitable contribution for the donation. The effective date for the provision is taxable years beginning after December 31, 2014. Unlike prior extensions, there are no transition rules that allow any 2016 distributions to be electively treated as 2015 distributions. The donor must obtain the substantiation (acknowledgement letter) required for charitable contributions or the exclusion will not apply.
RubinBrown Observation Incremental benefits of excluding the IRA distribution from adjusted gross income (AGI) may occur at various levels of income. For example, itemized deductions for medical expenses are allowed only to the extent the expenses exceed a percentage of AGI. In some cases, a lower AGI will result in lower Medicare Part B and prescription drug premiums once taxpayer income (including tax exempt interest) exceeds $85,000 for single and $170,000 for joint filers. Perhaps the most common benefit will be amelioration of the phase out of itemized deductions for taxpayers with AGI over $259,400 (single) and $311,300 (joint). Not only might the qualified IRA distribution increase the amount of itemized deductions allowed, but it is a method to ensure that a donor’s otherwise taxable income is reduced by the full amount of the distribution. Due to the complexity of the tax code, maximum benefit becomes more likely by excluding a qualified IRA distribution from income and foregoing the itemized deduction compared to taking a taxable distribution and then hoping to claim a charitable contribution deduction in the same amount.
Expenses of Elementary and Secondary School Teachers
The Act permanently extends an above-the-line deduction (for AGI) for qualifying expenses of up to $250 incurred by elementary and secondary teachers. Beginning in 2016, eligible expenses may include costs of professional development. The $250 limit will be indexed for inflation. The effective date for extending the expired law is taxable years beginning after December 31, 2014. The expansion of eligible expenses and indexing is effective for taxable years beginning after December 31, 2015.
RubinBrown Observation For expenses in excess of $250, there may be a tax deduction available for taxpayers with sufficient itemized deductions.
S Corporation Basis Rule for Contributions of Property
The Act permanently extends a provision that the adjusted tax basis of donated property, rather than the fair market value of donated property, is the amount by which shareholders are required to adjust their stock basis.
RubinBrown Observation The Act is extending relief for owners of S corporation stock so that such shareholders are treated similarly to partners in a partnership. For example, assume a one-shareholder S corporation donates land with a fair market value of $500,000 and a tax basis of $100,000. Prior to this provision, the shareholder's basis in the S corporation stock would decrease by the $500,000. The provision only requires a basis reduction of $100,000 in this example. The amount of the basis reduction could affect the amount of non-taxable cash distributions or deductible operating losses in a future year as well as the gain on a sale of the stock. Without this provision, S corporation shareholders could be worse off than a partner in a partnership making a similar gift. This is because the partnership rules generally only require a reduction to basis in the amount of the tax basis of the property.
Contributions of Capital Gain Real Property Made for Conservation Purposes
Individuals contributing appreciated property are generally limited in their deduction to 30% of AGI and a 5-year carryover of unused deductions. The Act permanently extends special rules providing for a 50% limitation (100% for qualified farmers and ranchers) and a 15-year carryover.
RubinBrown Observation The Act does not affect the basic provisions allowing a charitable deduction by individuals or corporations for qualified conservation contributions. Qualified conservation purposes include historic preservation, open space, outdoor recreation and protection of natural habitat. The donation may be of the entire property, a remainder interest or a qualifying restriction (easement).
Contributions of Food Inventory
The Act makes permanent the enhanced deduction for food inventory for the care of the ill, needy or infants. The contribution must be from the trade or business of the taxpayer and the food must be "apparently wholesome". For taxable years beginning after December 31, 2015, further modifications that are generally favorable to the donor will take effect.
RubinBrown Observation The deduction continues to be available to individuals as well as C corporations. For tax years beginning after December 31, 2015, the 10% limitation will increase to 15% for taxpayers other than C Corporations. C Corporations will have a modified 15% of taxable income limit for food inventory contributions.
UNRELATED BUSINESS INCOME TAX
Certain Payments Made to Controlling Exempt Organizations
The Act makes permanent a provision that modifies the definition of unrelated business income. Interest, rents, annuities or royalties paid by a controlled entity to a controlling exempt organization are generally taxable as unrelated business income. The extended provision exempts such payments from tax to the extent they are comparable to an arm's length transaction and meet certain other qualifications.
RubinBrown Observation The Act does not change the limited scope of payments to which this rule applies. The payment will only qualify if it is pursuant to a binding written contract in effect on August 17, 2006 or a renewal of such a contract under substantially similar terms.
W-2 FILING CHANGES
Acceleration of Due Date for Filing with the Social Security Administration
The Act will accelerate the 2017 due date of 2016 and subsequent Forms W-2 and 1099-MISC for nonemployee compensation. All of these information returns will be due to the SSA (or IRS in the case of 1099 MISC) on January 31, beginning in 2017. Also, beginning in 2017, electronic filers who had until March 31 to file under prior law, will be subject to the January 31 due date for electronically transmitting the returns to SSA. Extensions of time to file the Form W-2 are no longer automatic. After January 1, 2017, a single 30 day extension will require a detailed explanation of why you need additional time and be signed under penalties of perjury. The IRS has indicated that extensions will only be granted in extraordinary circumstances.
Safe Harbor for de minimis Errors
After 2016, taxpayers may not be subject to penalties for filing incorrect information returns and such forms need not be corrected unless the recipient requests a corrected form. The de minimis amounts apply when errors are less than $100 for any single amount except for withholding or backup withholding (a lower threshold of $25 applies).
Truncation of Social Security Numbers
The Act authorizes the IRS to issue regulations that will permit (or require) the truncation of Social Security numbers on employee copies of W-2’s. There are currently regulations for Form 1099 for taxpayers’ copies, but legislation was needed to expand it to the wage statements.
RubinBrown Observation These provisions reflect the need to reduce identity theft and refund fraud (including earned income tax credit fraud). This also fits into a longer term goal of the IRS of being able to immediately verify amounts reported by tax return filers against the amounts reported by various payors. Previously, the matching of amounts on W-2’s and 1099’s may not occur until months after the return has been filed and a refund issued. The Act requires the IRS to delay refunds related to the earned income tax credit or the additional child tax credit until February 15, beginning in 2017.
PROVISIONS RELATED TO TAX EXEMPTION
Right to Appeal Adverse Determination
The Act effectively codifies May 19, 2014 IRS guidance concerning the appeals process for adverse determinations. Previously, some determinations made by the national office (EO Technical) could not be considered by Appeals to the extent the EO Technical had issued “technical advice” on an issue. An organization that receives a proposed adverse determination with regard to an application that has been transferred to EO Technical now may request a conference with EO Technical in addition to requesting Appeals Office consideration.
RubinBrown Observation The IRS incorporated the 2014 guidance into the revenue procedure that covers exempt organization rulings issued at the beginning of each year.
Declaratory Judgment Provision Expanded
Since the Tax Reform Act of 1976, 501(c)(3) organizations were given the ability to have the Tax Court (and certain other courts) rule that they qualified for tax exemption. This remedy is available if an adverse determination is made, if the IRS fails to issue a determination within a 270 day window, or the IRS proposes revocation of exempt status. Organizations must exhaust all administrative remedies before seeking a declaratory judgment. Effective with the “date of enactment” (December 18, 2015), any Section 501(c) or 501(d) (religious and apostolic organizations) meeting the criteria may file for a declaratory judgment.
RubinBrown Observation Although this may largely be a result of the controversy surrounding “tea party” applications for exemption under Section 501(c)(4), it will benefit all types of 501(c) organizations – both at initial application and in the event of an adverse outcome of an IRS examination. Without access to declaratory judgments, organizations are at a disadvantage, particularly if there was no tax liability due to lack of taxable income. Generally, without access to a declaratory judgment, the way to access the court system was a suit for refund of tax paid or contest of a deficiency assessed by the IRS.
Section 501(c)(4) Notice of Formation
The Act provides a new requirement for organizations intending to operate as 501(c)(4) organizations to notify the IRS within 60 days of formation. The notice is to consist of the name, address, taxpayer identification number, date and state of formation and a statement of purpose. The IRS may extend the 60 day deadline for reasonable cause. Organizations that did not file a Form 1024 (exemption application) or Form 990 by December 18, 2015 are required to file the new notice within 180 days of December 18, 2015. There is a potential penalty of up to $5,000 for failure to file the notice timely. The IRS is authorized to require as part of the first Form 990 filed by the organization additional information supporting the claim of exempt status under Section 501(c)(4). Providing this information will not result in a determination letter, but the organization will also have the option of requesting a determination letter.
RubinBrown Observation The IRS issued Notice 2016-09. Among other provisions, this guidance extends the due date for the initial notice to the IRS. The extended due date is 60 days from the date regulations are issued. New organizations should wait until the regulations are issued before submitting the information. If formal IRS recognition is desired Form 1024 (or any replacement issued by the IRS) may be filed.
The Joint Committee on Taxation explanation of the Act further supports the position that requesting an initial determination letter is optional for organizations such as 501(c)(4) (civic/social welfare organizations), 501(c)(5) (agricultural or labor organizations, etc.) and 501(c)(6) (business leagues, etc.). This is in contrast to the IRS web site from November of 2015 that states in part, “to be recognized as tax exempt under section 501(a), most organizations must file an application for recognition of exemption with the IRS.”
No Gift Tax on Donations to Exempt Organizations
The Act removes a mostly theoretical possibility that gift tax would apply to donations of money or property to organizations described in sections 501(c)(4), 501(c)(5) and 501(c)(6). An explicit exception already existed for most charitable donations.
RubinBrown Observation In March of 2011, the IRS suspended several examinations related to the application of gift tax to contributions to 501(c)(4) organizations. The IRS had not significantly raised this issue in several decades prior to 2010. It seems unlikely that the IRS will pursue this issue for donations prior to the date of enactment.
IRS Funding Eliminated for Work on Regulations on 501(c)(4) Activities
The Act prohibits the IRS from spending any of its budget for the year ending September 30, 2016 on rules related to qualification standards for section 501(c)(4) organizations.
RubinBrown Observation This is in response to proposed regulations regarding political activities that were proposed in 2013 and withdrawn in the middle of 2014. It may not, however, provide any refuge for organizations under examination. The Act also prevents the Securities and Exchange Commission from spending funds on rules related to public company reporting on contributions.
The legislation provides some certainty for donors and organizations, at least for the near future. Congress has inserted provisions related to perceived IRS meddling in politics. However, the legislation provides no clarification of what the limits on political activities should be for various types of organizations. Meanwhile, various penalties are created or increased to “pay” for the benefits in the legislation. There continues to be an undercurrent that significant tax reform is needed. This means that it is possible that future legislation will be introduced in the name of "tax reform" with wide-ranging changes to deductions, benefits and compliance.
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.
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