How New Tax Laws Affect Nonprofits
updated May, 2018
On December 22, President Donald Trump signed into law a tax reform plan (H.R. 1) that cuts individual and corporate income tax rates and makes a variety of other changes to the Internal Revenue Code. Several parts of the tax plan affect the work of nonprofits.
Limiting the impact of the charitable deduction
While the tax plan technically preserves the charitable deduction, it nearly doubles the standard deduction, which means that very few taxpayers will itemize their taxes in 2018 and future years. 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. Economists estimate that this change will reduce charitable giving by between $12 billion and $20 billion per year and could lead to the loss of 220,000 or more jobs in the nonprofit sector. While economists and researchers can estimate the big picture impact of this tax change on charitable giving, it is difficult to assess exactly how it will affect any individual nonprofits. For many nonprofits, the one certainty is that they will need to rethink their fundraising strategies for individual donors.
One small silver lining is that the tax plan eases two limits on charitable deductions for those taxpayers who still itemize their deductions. Specifically, the law increases the limit of cash donations that individuals can deduct from 50% of adjusted gross income (AGI) to 60% of AGI. It also eliminates the “pease limitation” on itemized deductions that creates limits for high-income individuals and couples.
The tax plan also doubles the exemption from the estate tax (to about $11 million for individuals and about $22 million for couples). Charitable donations and bequests are exempt from the estate tax, so this change could would mean that fewer estates will make large bequests to nonprofits (or create new foundations) for tax purposes.
Taxing certain tax-exempt nonprofits
Three provisions in the tax plan create new taxes on some 501(c)(3) nonprofits:
- The new law treats each business activity of a nonprofit separately for the purposes of unrelated business income tax (UBIT). This could result in more UBIT liability for some nonprofits because there will be less opportunity to offset income with related expenses. However, the tax rate that nonprofits pay on UBIT will go down from 35% to 21%, corresponding to the reduction in the corporate income tax rate.
- The tax plan imposes a new 1.4% excise tax on net investment income of a few nonprofit colleges and universities with assets of at least $500,000 per full-time student and more than 500 full-time students. This could create a slippery slope to tax investment income and endowments of all 501(c)(3) nonprofits.
- The tax plan also imposes a new 21% excise tax on nonprofits that provide compensation of $1 million or more to any of their five highest-paid employees. This could set a precendent for state or local governments taxing nonprofits based on executive compensation, possibly at a much lower level than $1 million per year.
Adding to the national debt
The tax plan is projected to add $1.5 trillion to the national debt over the next decade, although this estimate is only about $1 trillion if economic growth from tax rate reductions is included in the projection. Congress will likely need to address the growing deficit by reducing federal spending. Social safety net programs and other government programs that work with nonprofits will likely be targeted for significant cuts through the budget process and through welfare and entitlement reform.
Changing donor substantiation rules
The tax plan repealed a law that exempted nonprofit donors from having a written acknowledgment from a nonprofit if the nonprofit provided 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 tax plan effectively eliminates the individual mandate under the Affordable Care Act (also known as the ACA or Obamacare) after this year. Many nonprofits are concerned that this change would lead to higher health insurance costs for nonprofits and would mean that thousands of fewer North Carolinians would have health coverage, placing new unfunded burdens on a wide variety of nonprofit service providers.
What’s not in the tax plan?
The final tax plan signed by the President didn’t include several key nonprofit items that were considered in earlier versions, including:
- A provision to weaken the “Johnson Amendment” and allow foundations, churches, and charitable nonprofits to seek tax-deductible contributions to engage in partisan political activity. The House had considered a provision that 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 deminimis.” This major change to Section 501(c)(3) of the Internal Revenue Code would have been effective from 2019 through 2023. This would damage the public’s trust in foundations and charities and divert tax-deductible contributions from nonprofits’ work, forcing nonprofits to rely more on foundation grants for support. While this provision was defeated in large part due to strong and unified advocacy by nonprofits, Congress could still try to use its appropriations bill or other legislation to weaken the Johnson Amendment this year.
- Elimination of 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.
- Changes to intermediate sanctions on excess benefit transactions. The Senate considered a provision to punish nonprofits for being the victims of these types of transactions and to remove the “rebuttable presumption of reasonableness” that protects nonprofits when they use comparability data to set executive compensation.
- Other changes to UBIT rules, including taxing nonprofits on some research activities and on income from licensing their names and logos.
- Indexing 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.
- A simplification of the private foundation excise tax to a single 1.4% rate. This would simplify tax payments for private foundations but also would represent an overall increase in these taxes.
- Changes to donor advised fund (DAF) rules. Proposals have included increased disclosure requirements and payout requirements for foundations and nonprofits with DAFs.
TAX REFORM CONCERNS
- Several proposals include limitations on the deduction. For example:
- The House Republican Blueprint and President Trump’s Tax plan propose to vastly increase the number of taxpayers who take the Standard Deduction. This vastly DECREASES taxpayers who itemize – from 30% to 5%. Therefore, the charitable deduction will not be available to 95% of taxpayers.
- The Trump plan also places a hard cap on itemized deductions ($100,000 individual/$200,000 couples, joint filing).
- The nonpartisan Tax Policy Center estimates the Trump plan would reduce giving by 4.5 to 9%.
- American Enterprise Institute estimates the Trump plan could eliminate more than $17 BILLION in annual giving.
- Other proposals have proposed a floor on the charitable deduction (such as the tax reform discussion draft from former Ways & Means Chairman Dave Camp.) Floors send a signal that smaller gifts are less valued – a particularly troubling message to middle- and lower-income donors.
- The Congressional Budget Office indicated that a floor of 2% of Adjusted Gross Income (AGI) would reduce annual charitable giving by $3 billion.
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