The following article is published by permission from Batts Morrison Wales & Lee (BMWL). BMWL is an accounting firm dedicated exclusively to serving nonprofit churches, charities, ministries, schools, foundations, and associations across the United States from their national headquarters in Orlando, Florida. BMWL provides audit and assurance, tax, and strategic advisory services (https://www.nonprofitcpa.com). The original article can be found on their website here.
The U.S. House of Representatives released a Bill on Thursday, November 2, setting forth the most significant proposed changes to federal tax law in more than 30 years. The legislation, representing a major overhaul of the U.S. tax system, contains numerous provisions directly and indirectly impacting nonprofit organizations. The House Bill is expected to be further negotiated, marked up, amended, and reconciled with a version expected to be produced by the Senate before final legislation is voted on by the House and Senate.
Below is a summary of the key provisions in the House Bill that would impact nonprofits.
The Tax Cuts and Jobs Act (the Bill) as currently drafted would:
- Reduce and simplify individual income tax rates. Under Section 1001 of the Bill, the current seven tax brackets for individual taxpayers ranging from 10% to 39.6% would be simplified into four wider brackets: 12%, 25%, 35%, and 39.6%. Although the initial tax bracket would be higher under the Bill, it is anticipated that more taxpayers will not pay any taxes (due to the proposed increase in the standard deduction). For married couples filing jointly, the 39.6% rate would apply to taxable income in excess of $1 million. [Effective for taxable years beginning after December 31, 2017.]
- Reduce corporate income tax rates. Under Section 3001 of the Bill, the current four tax brackets applicable to corporate taxpayers ranging from 15% to 35% would be simplified to a flat tax rate of 20% for corporations other than personal service corporations. Personal service corporations would be subject to a flat tax rate of 25%. The 20% flat rate would be applicable to unrelated business taxable income of exempt organizations, which could actually increase the taxes owed by exempt organizations with small amounts of taxable income. The new brackets would be effective for taxable years beginning after December 31, 2017.
- Repeal the exclusion for qualified tuition reduction plans. Under current law, qualified tuition reductions provided by educational institutions to their employees, their spouses, or dependents are excluded from the employees’ taxable income. Section 1204 of the Bill would repeal this exclusion. This provision would apply to amounts paid or incurred after December 31, 2017. The repeal of this exclusion would have a major impact on the employees of private schools and private and public institutions of higher education.
- Limit the exclusion for housing provided for the convenience of the employer. Under Section 1401 of the Bill, the exclusion from income of the value of housing provided to an employee for the convenience of the employer would be limited to $50,000 ($25,000 for a married individual filing a separate return). In addition, the $50,000 exclusion would be reduced for highly compensated individuals (those making $120,000 or more for 2017) by 50% of their compensation exceeding $120,000. The Bill does not provide for any similar reduction of the exclusion from income for the value of parsonages or clergy housing allowances provided to ministers. [Effective for taxable years beginning after December 31, 2017.]
- Allow churches and certain other religious organizations to make statements related to political campaigns. Section 5201 of the Bill would modify the “Johnson Amendment” that currently prohibits §501(c)(3) organizations from engaging in political campaign activity. Under the provisions of the Bill, churches, their integrated auxiliaries, and conventions and associations of churches would not be deemed to be engaging in prohibited political campaign activity solely because of the content of any homily, sermon, teaching, dialectic, or other presentation made during religious services or gatherings, but only if the preparation and presentation of such content is in the ordinary course of the religious organization’s regular and customary religious activities, and does not result in the religious organization incurring more than de minimis incremental expenses. Under the Bill as currently drafted, statements made outside the context of religious services or gatherings, such as those made on social media or in church newsletters, for example, would not appear to be covered by this provision. The Bill as drafted would keep intact the political campaign activity prohibition for all other types of §501(c)(3) organizations. [Effective date: immediate.]
- Increase the standard deduction. Under Section 1002 of the Bill, the standard deduction (for those taxpayers who do not itemize their deductions) would be approximately doubled from 2017 amounts to $12,200 for individual filers, $24,400 for married individuals filing joint returns and surviving spouses, and $18,300 for single filers with at least one qualifying child. These amounts would be adjusted for inflation beginning with the 2019 tax year. The increase in the standard deduction would be effective for taxable years beginning after December 31, 2017. Presumably, the proposed increase in the standard deduction is intended to offset the effect of the elimination of the personal exemption and most itemized deductions.
- Repeal the “Pease” limitation on itemized deductions. Section 1301 of the Bill would eliminate the overall limitation on itemized deductions (sometimes referred to as the “Pease” limitation) which currently reduces the itemized deductions of certain high-adjusted-gross-income (AGI) taxpayers. [Effective for taxable years beginning after December 31, 2017.]
- Limit the itemized deduction for mortgage interest on acquisition indebtedness and eliminate the itemized deduction for mortgage interest on home equity indebtedness. Section 1302 of the Bill would limit the itemized deduction for mortgage interest to interest incurred on acquisition indebtedness of up to $500,000 (currently limited to $1 million) and would also limit the deduction to interest on the taxpayer’s principal residence (currently, a deduction is allowed for interest on the taxpayer’s principal residence and one other residence of the taxpayer). Additionally, Section 1302 of the Bill would eliminate the itemized deduction for mortgage interest paid or accrued on home equity indebtedness. [These mortgage interest deduction limitations and eliminations would generally apply to interest on debt incurred (and, in certain cases, refinanced) after November 2, 2017.]
- Repeal the medical expense itemized deduction. Currently, taxpayers may take an itemized deduction for out-of-pocket medical expenses of the taxpayer, a spouse, or a dependent, subject to a floor of 10% of the taxpayer’s AGI. As currently drafted, Section 1308 of the Bill would repeal this deduction. This elimination would be effective for tax years beginning after December 31, 2017.
- Eliminate or limit itemized deductions for various types of state and local taxes. Currently, taxpayers may take an itemized deduction for either: (1) state and local income taxes, or (2) state and local sales taxes. Additionally, taxpayers may currently take an itemized deduction for real estate and personal property taxes. Section 1303 of the Bill would eliminate the current itemized deduction for state and local income or sales taxes. Section 1303 of the Bill would also generally eliminate the itemized deduction for personal property taxes and would limit the itemized deduction for real property taxes to $10,000 ($5,000 in the case of a married individual filing a separate return). These eliminations and limitations would be effective for tax years beginning after December 31, 2017.
- Eliminate the unreimbursed employee business expense miscellaneous itemized deduction. Currently, taxpayers may claim unreimbursed trade or business related expenses incurred as an employee as a miscellaneous itemized deduction, subject to a floor of 2% of the taxpayer’s AGI. As currently drafted, Section 1312 of the Bill would eliminate this deduction. This elimination would be effective for tax years beginning after December 31, 2017. If the deduction were to be eliminated, it would increase the significance of reimbursing employees for business expenses under an accountable plan.
- Increase the limitation for cash contributions to public charities and certain private foundations. Currently, donors may generally take an itemized deduction for charitable contributions of cash made to public charities, private operating foundations, and certain private non-operating foundations up to 50% of the donor’s AGI. Section 1306 of the Bill increases this limitation to 60% of the donor’s AGI. Other limitations continue to apply for gifts of certain noncash property and for contributions to most private non-operating foundations. This change would be effective for tax years beginning after 2017. The Bill continues to allow a 5-year carryover for contributions exceeding the 60% AGI limitation.
- Adjust the charitable mileage rate. Currently, for purposes of computing the charitable deduction for the use of an automobile, the standard charitable mileage rate is fixed by statute at 14 cents per mile. Section 1306 of the Bill indicates that the rate shall take into account the variable cost of operating an automobile. The specific impact of this change has not been determined. The change would be effective for tax years beginning after 2017.
- Repeal the exclusion for employer-provided educational assistance programs. Under current law, employer-provided educational assistance to employees under an educational assistance program is excluded from the employees’ taxable income up to a limit of $5,250 per year. The Bill would repeal this exclusion. This provision would be effective for tax years beginning after December 31, 2017. Note that the Bill does not eliminate the exclusion for amounts paid or reimbursed by an employer for education that maintains or improves skills required for the individual’s employment or meets the express requirements of the employer.
- Eliminate the exclusion for employer-provided adoption assistance programs. Section 1406 of the Bill would eliminate the current exclusion from employees’ income for amounts paid or expenses incurred by employers for qualified adoption expenses in connection with the adoption of a child by an employee under a written, adoption assistance program, subject to dollar and income limitations. As the Bill is currently drafted, amounts paid by employers to employees under qualified adoption assistance programs would be included in employees’ gross income. This elimination would be effective for tax years beginning after December 31, 2017.
- Eliminate the exclusion for employer-provided dependent care assistance programs. Section 1404 of the Bill would eliminate the current exclusion from employees’ income for amounts paid by employers for dependent care assistance provided to employees. This elimination would be effective for tax years beginning after December 31, 2017.
- Eliminate the deduction for moving expenses and the qualified moving expense reimbursement exclusion. Currently, taxpayers may claim a deduction for certain moving expenses incurred in connection with starting a new job. Additionally, taxpayers may currently exclude from income employer-paid qualified moving expense reimbursements. As currently drafted, Sections 1310 and 1405 of the Bill would eliminate the moving expense deduction and the qualified moving expense reimbursement exclusion. These eliminations would be effective for tax years beginning after December 31, 2017.
- Modify the net operating loss deduction rules. Section 3302 of the Bill would make multiple modifications to the net operating loss (“NOL”) deduction rules. As currently drafted, the Bill would eliminate the NOL carryback (except for certain eligible disaster losses) and create an indefinite NOL carryforward. The Bill would annually increase the indefinite NOL carryforward amount by an interest factor. Additionally, the Bill would generally limit the allowable NOL deduction to 90% of taxable income. Section 3302 of the Bill would define “indefinite net operating loss” as a net operating loss arising in a taxable year beginning after December 31, 2017.
- Increase the estate tax exemption and eventually repeal the estate tax. Under current law, property of a decedent’s estate is generally subject to an estate tax, with an exemption of approximately $5 million. Sections 1601 and 1602 of the Bill would increase the exemption to approximately $10 million (indexed for inflation) for years beginning after 2017, and the estate tax would be repealed for years beginning after 2023. This increased exemption and eventual repeal of the estate tax would reduce the tax benefit associated with bequests to nonprofit organizations.
- Terminate the new markets tax credit. Under current law, certain qualifying taxpayers may claim a tax credit (called the “new markets tax credit”) for investments in qualified community development entities which generally serve low-income communities and individuals. Under Section 3406 of the proposed Bill, no additional new markets tax credits will be allocated after 2017.
- Eliminate the deduction for the cost of certain fringe benefits provided to employees, and eliminate the deduction for entertainment expenses. Section 3307 of the Bill would eliminate deductions for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. The Bill would also eliminate the deduction for transportation fringe benefits (including parking), benefits in the form of on-premises gyms and other athletic facilities, and for amenities provided to an employee that are primarily personal in nature, except to the extent that such benefits are treated as taxable compensation to an employee. The current deduction for meals (limited to 50%) remains unchanged. [Effective for amounts paid or incurred after December 31, 2017.]
- Impose an excise tax on certain executive compensation. Under Section 3803 of the Bill, a nonprofit organization would be subject to a 20% excise tax on compensation in excess of $1 million paid to any of its five highest paid employees during the year, including former employees. Compensation includes cash wages as well as the cash value of benefits (except for payments to certain retirement plans), and includes compensation from related organizations and government entities. Notably, the definition of wages used in the current draft of the Bill does not appear to include wages for services performed by a duly ordained, commissioned, or licensed minister of a church in the exercise of his/her ministry or by a member of a religious order in the exercise of duties required by such order. [Effective for tax years beginning after December 31, 2017.]
- Assess an excise tax on the net investment income of certain private colleges and universities. Section 5103 of the Bill would assess a new excise tax of 1.4% on the net investment income of certain private colleges and universities with large endowments. This would be effective for tax years beginning after December 31, 2017.
- Modify private foundation excess business holding rules. Section 5104 of the Bill would create a very limited exception from the excess business holding prohibition for private foundations. This would be effective for tax years beginning after December 31, 2017.
- Add additional reporting requirements for donor advised fund sponsoring organizations. Section 5202 of the proposed Bill would require donor advised funds to report their average percentage payout annually and to disclose certain policy information. This change would be effective for returns filed for tax years beginning after December 31, 2017.
- Simplify the excise tax rate on private foundation investment income. Under Section 5101 of the proposed Bill, the excise tax on net investment income would be assessed at a single rate of 1.4% rather than the current two-tier system (with rates of either 1% or 2%, depending on the average level of distributions made during the previous five years.) This provision would be effective for tax years beginning after December 31, 2017.
- Treat certain fringe benefits provided by nonprofit entities to their employees as unrelated business taxable income. Under Section 3308 of the Bill, nonprofit entities would be taxed on the value of providing their employees with transportation fringe benefits, parking facilities used in connection with qualified parking, and on-premises gyms and other athletic facilities, by treating the funds used to pay for such benefits as unrelated business taxable income. This provision would be effective for amounts paid or incurred after December 31, 2017.
- Eliminate private activity tax-exempt bond financing for §501(c)(3) projects. Provisions in Section 3601 of the Bill would eliminate private activity tax-exempt bond financing. According to bond counsel with whom we have communicated, these provisions would eliminate the ability for §501(c)(3) organizations to obtain new tax-exempt bond financing to fund projects. These provisions would be effective for bonds issued after December 31, 2017.