As this summary is being written, the Tax Cuts and Jobs Act (the Act) is approaching passage by Congress and signature by the President. The changes in the Act will affect organizations in a variety of ways. The following highlights are based on the drafts of the bill and of the conference report. As with past tax acts, there are likely to be “technical corrections” passed in future legislation. While technical corrections are often minor, occasionally the changes are material.
Exempt Organization Provisions
Unrelated business income will need to be calculated separately for each trade or business carried on. The provision is intended to prevent losses from one activity offsetting income from another activity. The transition rules for Net Operating Losses (NOL’s) arising in tax years beginning before January 1, 2018 appear to be taxpayer friendly (however, see below for a new limit on NOL’s). The provision is effective for tax years beginning after December 31, 2017.
Unrelated business income is increased by the amount of certain fringe benefits. The Act requires unrelated business taxable income to include most expenses paid or incurred by a tax exempt organization for qualified transportation fringe benefits, a parking facility used in connection with qualified parking or any on-premises athletic facility. In other words, if a for-profit business cannot deduct such expenses under the amendments made by the Act, then a tax exempt organization will generally have to include such amounts in unrelated business taxable income. It appears that the exclusion from the employees’ wages is unchanged. The new law applies to amounts paid after December 31, 2017.
Tax rates on unrelated business income should reflect the changes in corporate and trust rates.
Some private colleges and universities are subject to an excise tax on the investment income of their endowment funds and other sources. A tax of 1.4% is to apply to investment income if certain assets have a fair market value of at least $500,000 per student. A recent article in the Chronicle of Higher Education identified 27 institutions that had 2014 endowment assets over this threshold. Given the probable appreciation of assets and potential inclusion of assets not classified as endowment (but not directly used for the institution’s exempt purpose), the number of institutions affected may be over 50. There will also be rules that take into account the assets and investment income of related parties. The provision is effective for tax years beginning after December 31, 2017.
A new excise tax will apply to tax-exempt organization executive compensation. An excise tax of 21% will apply to certain of the highest paid employees who receive pay in excess of $1 million during a taxable year or who receive an “excess parachute payment” at separation even if the covered employee’s pay does not exceed $1 million. The excise tax is paid by the employer. Employees in medical professions may be excluded from “covered employees” under certain conditions. The provision applies for tax years beginning after December 31, 2017.
Interest on advance refunding bonds will be taxable for refunding bonds issued after December 31, 2017.
Charitable Deduction Provisions
The Act will increase the individual limit on annual charitable contributions as a percentage of Adjusted Gross Income (AGI). The limit will increase to 60% of AGI for cash contributions made in tax years beginning after December 31, 2017 and before January 1, 2026.
The Act repeals the special rule that automatically allows 80% of a contribution made for university athletic seating rights to be deductible as a charitable contribution. This change is effective for contributions made in tax years beginning after December 31, 2017. For individuals, this will generally be effective January 1, 2018.
With regard to substantiation of contributions to be eligible for a charitable contribution deduction, the Act repeals an old provision that allowed the IRS to create donee reporting of contributions directly to the IRS. The repeal is effective for contributions made in tax years beginning after December 31, 2016. The IRS proposed issuing rules to implement this alternate method in September 2015. There was significant backlash to having charities collect donor Social Security Numbers. The effect of the repeal is that donors over $250 must continue the current practice of obtaining qualified acknowledgements from the donee before filing their returns.
Tax rates for the individual income tax brackets will be reduced with a top rate of 37% compared to the current top rate of 39.6%. Since there are other changes to the tax base, especially with respect to deductions and alternative minimum tax, the degree to which the Act will result in a reduction of tax may vary greatly depending on the taxpayer. The change in rates generally applies as of January 1, 2018 and is slated to end after December 31, 2025.
The standard deduction is increased to $24,000 for joint returns and $12,000 for single filers generally beginning as of January 1, 2018 and ending after December 31, 2025.
Personal exemptions are not allowed for tax years beginning after December 31, 2017 and before January 1, 2026.
The home mortgage interest deduction is generally not changed for existing acquisition indebtedness. The deduction for new loans after December 31, 2017 will generally be limited to the interest on $750,000 of acquisition indebtedness. The deduction for home equity indebtedness will be suspended beginning after December 31, 2017 and before January 1, 2026. Generally, taxpayers will not be able to claim a deduction for interest on home equity indebtedness after December 31, 2017.
The state and local tax deduction is capped at $10,000. Unlike earlier proposals, the $10,000 may include state income taxes or sales tax in addition to property taxes. The new provision is effective beginning for tax years after December 31, 2017 and before January 1, 2026.
Miscellaneous itemized deductions subject to the 2% floor under current law are suspended after December 31, 2017.
The medical expense deduction is retained with some temporary changes.
The moving expense deduction is suspended for tax years beginning after December 31, 2017 and before January 1, 2026. Likewise, the exclusion for qualified moving expense reimbursement is suspended.
The education savings plan rules are changed to allow payment of certain expenses up to $10,000 per year in connection with attendance of a student at a public, private or religious elementary or secondary school. The definition of eligible expenses was narrowed before the final Senate vote. This provision is effective after 2017.
Alternative Minimum Tax (AMT) for individuals is retained but is significantly modified. The AMT exemption amounts increase by approximately 30%. More important, the phase out of the AMT exemptions begins at $1 million for married taxpayers filing jointly and at $500,000 for single taxpayers. These phase-out thresholds are substantially higher than current law. These Act provisions generally apply to tax years beginning after December 31, 2017 and before January 1, 2026.
The estate tax is retained. However, the amount exempt from the tax is increased to $10 million for decedents dying after 2017 and before 2026.
Business Provisions of Interest
The tax rate for corporations under the Act will be 21% effective for taxable years beginning after December 31, 2017. Presumably this is the rate that will apply to exempt organizations filling Form 990-T that are subject to corporate rates. As this is a flat tax, the 15% bracket for the first $50,000 of unrelated business taxable income will not apply any longer.
Local lobbying expenses will no longer be deductible effective for expenses paid or incurred on or after the date of enactment (which could be in late 2017). There is a corresponding amendment to the provision for tax-exempt organizations such as trade organizations to include local lobbying in the dues notice to members. Previously, local activity was treated differently than state or federal lobbying.
Net Operating Losses are limited to 80% of taxable income, and the Act eliminates most NOL carrybacks. New NOL’s are to be available for carryover indefinitely. The changes are effective for taxable years ending after December 31, 2017.
An interest deduction limitation provision generally limits the interest deduction to 30% of taxable income before interest expense. There is a small business exception as well as a transitional rule for certain expenses. The limitation applies to tax years beginning after December 31, 2017.
Entertainment expenses are further limited. Certain expenses that were 50% deductible will become 100% nondeductible. Other expenses that were fully deductible will be limited to a 50% deduction. The effective date is generally for expenses paid or incurred after December 31, 2017.
A Partner basis adjustment will be required for charitable contributions and foreign taxes for partnership taxable years ending after December 31, 2017. For the charitable contribution adjustment, the excess of fair market value over adjusted basis will not be part of the reduction of basis.
Proposals Not Included
The proposed modification relaxing the prohibition of political statements by 501(c)(3) organizations is not included in the Act.
The proposal that would have generally required the first-in first-out rule for disposition of securities was dropped from the final bill. Donors (as well as sellers) of appreciated securities may be able to continue to designate certain tax lots of securities as part of their tax planning strategies.
A proposal to limit the employer-provided housing exclusion limitation to $50,000 with a phase out for highly compensated individuals was dropped.
The private foundation excise tax on investment income is unchanged. A blended rate of 1.4% was proposed.
The nontaxable nature of graduate student tuition waivers was not changed.
Qualified employer tuition reimbursement plans are still tax free.
No change was made for the mileage rate for charitable use of a personal vehicle.
The proposed coordination of deferral limits for section 457 plans with the combined 403(b)/401(k) deferral limit was dropped.
Private activity bond reforms were not enacted.
Due to Senate parliamentary requirements, the “Tax Cuts and Jobs Act” short title is not in the official text of the Act. It is only referred to as 'An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.' in the final legislative text.
If you have questions regarding changes in the Tax Cuts and Jobs Act or if you would like more information, please contact one of RubinBrown's Colleges & Universities or Not-For-Profit professionals.
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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