Tax Reform Implications for Nonprofits

David Heinen, Vice President for Public Policy and Advocacy, North Carolina Center for Nonprofits

November 16, 2017

This fall, Congress is in the process of rewriting the Internal Revenue Code with the dual goals of lowering individual and corporate income tax rates and simplifying our nation’s tax laws. This tax overhaul has major implications for 501(c)(3) nonprofits. 

A quick note on the status of tax reform...

The U.S. House of Representatives passed its tax reform plan, known as the Tax Cuts and Jobs Act (H.R. 1), on November 15. The Senate Finance Committee approved its own (and very different) version of tax reform, also known as the Tax Cuts and Jobs Act, on November 15, and the full Senate is expected to vote on it after Thanksgiving. For the latest on nonprofit issues in the tax plan, check out the Center’s chart comparing the many key nonprofit provisions in the two plans.

Here are some highlights (or lowlights) of nonprofit provisions being considered by Congress:

Politicizing 501(c)(3) organizations

The House plan would significantly weaken the Johnson Amendment, which protects the public’s trust in nonprofits by keeping partisan politics out of 501(c)(3) organizations. The provision in the House bill would give all 501(c)(3) nonprofits a partial (and vaguely worded) exemption from the prohibition on partisan political intervention. The provision would allow nonprofits to endorse candidates for office “as long as the speech is in the ordinary course of the organization’s business and the organization’s expenses related to such speech are de minimis.” This major change to Section 501(c)(3) of the Internal Revenue Code would be effective from 2019 through 2023. The Senate plan recognizes the importance of nonprofit nonpartisanship and makes no changes to the Johnson Amendment.

The Center strongly opposes the House provision, which would divert money from nonprofits’ missions into partisan politics and would damage the public’s trust in nonprofits by transforming 501(c)(3) organizations into Democratic nonprofits and Republican nonprofits.

Reducing charitable giving

Both the House and Senate tax plans would double the standard deduction. While both plans technically preserve the charitable deduction, the higher standard deduction would mean that only about 5% of Americans would itemize their taxes – down from about 30% who currently use itemized deductions. new analysis from the nonpartisan Tax Policy Center estimates that this change would reduce charitable giving by between $12 billion and $20 billion per year.

Neither bill includes a universal, non-itemizer deduction for charitable contributions, which could help nonprofits offset the revenue they would lose if most taxpayers lost the ability to claim a tax deduction for their charitable contributions. Last month, U.S. Representative Mark Walker (R-NC) introduced the Universal Charitable Giving Act (H.R. 3988), a bill that would extend the charitable deduction to all taxpayers, not just the 30% of taxpayers who currently use itemized deductions. Senator James Lankford (R-OK) recently introduced an identical bill in the Senate. The Center encourages Congress to follow Representative Walker’s lead in using tax reform to strengthen – rather than weaken – investment in the work of charitable nonprofits. 

Making other changes for charitable deductions

Both the House and Senate tax plans would raise the limit of cash donations that individuals can deduct from 50% of adjusted gross income (AGI) to 60% of AGI and would eliminate the “Pease limitation” on itemized deductions that creates limits for high-income individuals and couples. Of course, these changes would only benefit the small percentage of taxpayers who would still itemize their deductions.

Eliminating a key financing option for nonprofits

The House tax plan would eliminate all tax-exempt private activity bonds, including qualified 501(c)(3) bonds. A variety of nonprofits, including schools, hospitals, museums, and affordable housing organizations, use these bonds to finance building and renovation projects. The Senate bill makes no changes to private activity bonds.

Punishing nonprofits that are the victims of excess benefit transactions

The Senate tax plan would make significant changes to “intermediate sanctions” on excess benefit transactions between nonprofits and their board members or executive staff. Currently, these excise taxes are only imposed on the “disqualified persons” (i.e.the nonprofit board members or executives who receive the benefits). The Senate plan would also impose penalties on the nonprofit itself, essentially taking resources away from the communities served by the nonprofit – which have already been penalized by the transaction that unjustly enriched a nonprofit insider at the expense of the nonprofit’s overall budget. 

In addition, the Senate plan would downgrade the “rebuttable presumption of reasonableness” with “due diligence standards.” Translation: Nonprofits would have less confidence in the comparability data they use in setting executive compensation. Furthermore, the Senate plan would protect board members from liability when they rely on professional advice in setting executive compensation or entering into contracts with board members. This could ultimately make it more difficult for nonprofits to attract and retain quality board members.

The House plan makes no changes to intermediate sanctions rules.

Broadening unrelated business income tax (UBIT)

The Senate tax plan would treat income from licensing a nonprofit’s name or logo as unrelated business income that is subject to UBIT. It also would treat each business activity of a nonprofit separately for UBIT purposes, which could make it more difficult for some nonprofits to offset unrelated business income with expenses incurred in generating that income.

The House tax plan would limit the research exemption from UBIT to apply only to income from research that is made freely available to the public and requiring nonprofits to pay UBIT on transportation fringe benefits to employees and employee access to on-site gyms and athletic facilities. 

Under both bills, nonprofits would also pay a lower tax rate on UBIT, since both plans would lower the maximum corporate income tax rate from 35% to 20%. Also, under either bill, only the first $1,000 of unrelated business income would be exempt from taxation, so the proposed changes to UBIT would affect many nonprofits of varying sizes.

Adding disclosure requirements for donor advised funds

The House plan would require nonprofits with donor advised funds (DAFs) to disclose annually their policies on inactive DAFs and the average amount of grants made from their DAFs. This change is not included in the Senate plan. Notably, neither tax plan would add new payout requirements from DAFs.

Simplifying (but increasing) the private foundation excise tax

The House tax plan would establish a streamlined private foundation excise tax of 1.4%, which is between the two current rates of 2% and 1%. While this would simplify taxes for private foundations, it would also constitute a net tax increase for foundations. This would mean that foundations would have less assets available to invest in the work of charitable nonprofits. The Senate plan would retain the existing two-tiered private foundation excise tax.

Indexing the volunteer mileage rate

The House tax plan would adjust the volunteer mileage rate for inflation. This rate has been fixed at 14 cents per mile for many years. This change could foster more volunteerism by allowing nonprofit volunteers to be reimbursed for more of their actual costs when traveling on behalf of nonprofits. The Senate plan would keep the volunteer mileage rate at 14 cents per mile.

Taxing nonprofit colleges and universities

Both the House and Senate plans would create a new 1.4% excise tax on net investment income of nonprofit colleges and universities with assets of at least $250,000 per full-time student. This could create a slippery slope to tax investment income and endowments of all 501(c)(3) nonprofits.

Repealing or weakening the estate tax

The House tax plan would double the exemption from the estate tax (to about $11 million for individuals and about $22 million for couples) for six years and then repeal the estate tax in 2023. The Senate plan would keep the estate tax but double the exemption. These changes are significant for nonprofits because charitable donations and bequests are exempt from the estate tax. A higher exemption – or full repeal of the estate tax – would mean that fewer estates will make large bequests to nonprofits (or create new foundations) for tax purposes.

Taxing nonprofits with highly-compensated employees

Both the House and Senate plans would impose a new 20% excise tax on nonprofits that provide compensation of $1 million or more to any of their five highest-paid employees.

Changing donor substantiation rules

Both the House and Senate plans would repeal a tax law that exempts nonprofit donors from having a written acknowledgment from a nonprofit if the nonprofit provides the IRS with information about the contribution in its tax filings. This change could help prevent troublesome future IRS rulemaking that could create onerous new gift substantiation rules that would create operational and privacy concerns for nonprofits.

Eliminating the ACA individual mandate

The Senate plan would eliminate the individual mandate under the Affordable Care Act (also known as ACA or Obamacare). Many nonprofits are concerned that this change would lead to higher health insurance costs for nonprofits and would mean that thousands fewer North Carolinians would have health coverage, placing new unfunded burdens on a wide variety of nonprofit service providers. The House tax plan makes no changes to the ACA.