Nonprofit Report - June 2018
Tax Cuts and Jobs Act - More Changes
By: Maame A. Amponsah, Esq.
The Tax Cuts and Jobs Act (the “Act”) that went into effect on January 1, 2018 significantly impacts nonprofit organizations. The Act changes how unrelated business income to calculate UBIT must be calculated, requires employer paid excise tax on annual compensation in excess of $1 Million and on excess parachute payments paid to certain employees, and alters the tax treatment of employer paid expenses for transportation, parking expenses and athletic facilities. We have addressed those changes in other articles in our Newsletter. In this article, we will discuss how the Act gives rise to possible changes in charitable giving, establishes new tax withholding tables for employees and assesses an excise tax on certain university endowments. The Act did not, however, repeal the Johnson Amendment, which was on the table for elimination in earlier versions of the Act.
The Act nearly doubled the standard deduction for taxpayers: singe/married filing separately - $12,000 (previously, $6,500); married filing jointly - $ 24,000 (previously, $24,000); and heads of household - $18,000 (previously, $9,350). This increase in standard deductions along with new limits on other deductions such as state and lower taxes, will result in fewer taxpayers itemizing deductions. Multiple sources estimate that less than 10% of taxpayers will continue to itemize (decrease from previously 1/3 of Americans who itemized deductions). A charitable deduction is only available to those taxpayers who itemize, effectively eliminating the tax benefit of charitable giving for most taxpayers.
The significant decrease in the number of taxpayers who may itemize may cause charitable organizations to experience a considerable decrease in charitable giving in the future. This loss of revenue to charities will greatly impact organizations’ operations and may result in the elimination of many jobs.
The good news, however, is that the Act increases the limit on cash donations for individual taxpayers who do itemize deductions. Previously, this limit was 50% of the individual’s adjusted gross income (AGI). The limit has been increased to 60% of each individual’s AGI.
What can charities do to avoid the predicted decline in giving? While it may be difficult to identify specific acts to avoid the predicted decline, charities will need to sharpen fundraising efforts to encourage donors to focus on the furtherance of the organization’s mission despite the lack of individual tax incentives for donations.
The Act established new withholding tables for employees. The 2018 withholding tables reflect the Act’s new standard deductions, eliminates personal exemptions and includes updated tax rates and brackets. A new updated Withholding Calculator can be found on the IRS.gov website. Employers (including nonprofit organizations) must use the new withholding tables and employees may wish to revise and resubmit their W-4s to their employers.
Nonprofit College and University Endowments
The Act institutes a new excise tax of 1.4% on realized gains on investments of nonprofit colleges and universities with assets of at least $500,000 per full-time student and more than 500 full-time students. According to the National Association of Independent Colleges and Universities, this tax will impact approximately 35 institutions across America. In addition, the Act eliminated the ability of taxpayers to deduct 80% of a donation made for the right to purchase tickets for college events, including athletic events. Going forward, no deductions will be available for individuals purchasing tickets to college events.
There was much speculation as to whether the Act would eliminate the Johnson Amendment. The Johnson Amendment prohibits all 501(c)(3) tax-exempt organization from endorsing or opposing political candidates. However, the repeal of the Johnson Amendment was removed from the Final GOP Tax Bill. As such, the Johnson Amendment remains intact, at least for now. Public charities should continue to ensure that their activities do not endorse/oppose political candidates for public office.
How the Tax Cuts and Jobs Act Affects Nonprofit Executive Compensation
By: Jordan M. Halle, Esq.
The Tax Cuts and Jobs Act created Section 4960 of the Internal Revenue Code that imposes a new 21% excise tax on certain tax-exempt entities (including any organization exempt under Section 501(c), (d), 401(a) or 115) on (i) the annual compensation (including benefits and deferred compensation) paid to its five (or more) highest-paid employees in excess of $1,000,000 and (ii) excess parachute payments paid to the same class of employees.
The 21% excise tax (the “Excise Tax”) is imposed on the amount of “remuneration” over $1,000,000 paid to a “covered employee” during the applicable taxable year. An individual is a “covered employee” if he or she is an employee (or former employee) who is one of the five highest compensated employees of the organization for the taxable year or was such an employee of the organization for any preceding taxable year beginning after December 31, 2016.
Remuneration, for purposes of Section 4960, means all amounts treated as wages for federal income tax withholding purposes paid to an employee for services, including the cash value of all benefits. Generally, this means that the taxable amount for determining the Excise Tax includes:
- (i) salaries, fees, bonuses, and commissions;
- (ii) the value of fringe benefits;
- (iii) amounts vested, even if not yet received, and taxable under § 457(f), related to deferred compensation; and
- (iv) amounts paid with respect to the covered employee paid by any related organization of the applicable tax-exempt organization (in which case, the excise tax is prorated among the various employers).
“Remuneration” does not include, among other exclusions from wages, (i) parachute payments (discussed below), (ii) Roth contributions, (iii) Section 457(b) governmental plan contributions, or (iv) compensation for medical services provided by medical professionals, including doctors, nurses and veterinarians.
The Excise Tax imposed on “excess parachute payments” applies to “parachute payments,” which are payments contingent upon the separation from service of the covered employee. The present value of all parachute payments does not need to be in excess of $1,000,000 to apply. Rather, a payment is considered an “excess parachute payment” if the total present value of all parachute payments exceeds three times the covered employee’s average W-2 compensation over the preceding five years; the so-called, “base amount.” The excise tax applies to parachute payments to a covered employee in excess of the base amount.
Although there is both an excise tax on compensation over $1,000,000 and parachute payments, those two taxes operate independently, such that one may apply even if the other does not.
Traps for the Unwary
There are certain aspects of Section 4960 that may not be obvious at first glance:
- When an employee becomes a top-five earner, they retain that designation for life. Mergers, for example, could increase the number of executives to whom the Excise Tax applies with respect to a given organization. In other words, the excise tax could apply to the compensation of far more than five employees as Section 4960 may initially suggest.
- Although the Excise Tax only applies for tax years beginning after December 31, 2017, the measuring period for whether a person is one of the top five most highly compensated employees of a tax exempt organization begins for any taxable year beginning after December 31, 2016.
- The exception for wages paid to medical professionals is limited to the extent that those professionals provide medical services. For example, wages paid to a doctor who takes on hospital administration duties or teaching would not be exempt.
At this time, it is unclear how the IRS intends to require nonprofits to report and pay the excise tax. Nonetheless, organizations should review their compensation arrangements to determine whether there will be an impact for taxable years beginning after December 31, 2017.
Organizations must identify their “covered employees” for 2018 and 2017 and review existing executive compensation and severance arrangements to determine whether payments to any covered employees in 2018 or future years could result in the imposition of the Excise Tax, whether on remuneration or excess parachute payments. Then, to the extent possible, the organization should consider modifying such arrangements to avoid triggering the tax.