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Most tax reform headlines have been focused on how it impacts individuals and for-profit businesses, but lost in the shuffle were provisions passed that non-profit leaders should take note of. Doeren Mayhew’s non-profit CPAs have highlighted three ways tax reform could significantly impact a non-profit’s finances and operations.
As a result of the passing of the Tax Cuts and Jobs Act, non-profits are now forced to be liable for excise tax on highly compensated executives and certain investment income.
Attempting to put non-profits on the same wavelength as taxable organizations, a new 21 percent excise tax will now be applied to “covered employees” with excessive compensation. Subject to the tax will be an organization’s five highest-compensated employees, current or former, with excessive compensation of more than $1 million. Certain severance payments (parachute payments), even those less than $1 million, will also be subject to the same tax. Some exclusions do apply for licensed nurses, doctors and veterinarians.
It’s important to note that not only is the compensation from the non-profit organization count towards the $1 million threshold, but also the compensation paid from both tax-exempt and taxable related entities.
With most highly compensated executives being covered by employment contracts, non-profits will need to make the decision to either pay the tax or reduce compensation, potentially risking the loss of their top talent.
Private College and University Investment Income
The net investment income of some private colleges and universities is now subject to a new 1.4 percent excise tax. Institutions with at least 500 students, with over 50 percent located in the United States, and prior year assets of at least $500,000 per full-time student will be hit with this new tax. Assets used to directly carry out the school’s educational purposes are excluded.
Starting this year, non-profits must calculate unrelated business income (UBI) on each “unrelated trade or business” activity individually, rather than the previous aggregated method. With this change, non-profits operating multiple unrelated activities will no longer be able to offset losses from one activity by gains from more profitable activities.
Net operating losses (NOLs) occurring before Jan. 1, 2018, are not subject to the new rule and may be used to offset income from any business activities. Contrary to that, moving forward NOLs created in years beginning after Jan. 1, 2018, may be carried forward, but can only be applied to future profits from the same activity that produced the loss.
Although there may be some reprieve from the new rule depending upon how the Internal Revenue Service will define “unrelated trade or business” activity, certain fringe benefits won’t escape UBI tax any longer. As of Jan. 1, 2018, the fringe benefits relating to qualified transportation, including parking facilities, will need to be classified as UBI, which may result in unexpected tax liabilities.
New law states that transportation, including commuter vehicles and transit passes for mass transportation vehicles, paid for by the organization for its employees will now be included in UBI.
Despite organizations now having to pay UBI taxes for these benefits, the benefits will continue to be tax free for employees—but subject to monthly limits.
Raising the most concern for non-profits are the changes designed to impact individuals. With the increase in the standard deduction and limitations placed on certain deductions, the number of people who will continue to itemize their deductions and look at donating as a tax incentive will undoubtedly decrease. Making matters worse is the doubling of the estate and gift tax exclusion. In the past, estate beneficiaries typically favored bequeathing more to charities in lieu of paying estate tax. According to the Council on Foundations, the passage of these new provisions could result in the decrease of $16 billion to $24 billion in charitable giving every year.
Even though charitable giving is motivated primarily by compassion and generosity rather than the availability of tax incentives, the after-tax cost may affect the amount your donors are willing to give. Here are five ways your organization can continue to inspire giving and deal with the changes from tax reform.
Keep the giving spirit alive – Reach out to your donor base and stress the importance of their support to carrying out the mission. Show the impact their gifts have made to your organization and how future donations will be just as impactful. Don’t focus on the tax advantages.
Prepare for bunching – More taxpayers may choose to begin “bunching” their donations to itemize them every other year instead of giving annually. Determine what impact this might have on your cash flow and plan accordingly.
Manage your cash flow – Historically, many individuals would make charitable contributions at the end of the year to reap the tax benefits before the Dec. 31 deadline. With fewer people itemizing deductions this may shift your cash-flow trends. Proper management will help deal with any unforeseen fluctuation.
Track UBIT – With the new unrelated business activities rules, you’ll benefit from having an accounting system in place that can adequately track revenues and expenses by each individual activity.
Seek out suggestions from a non-profit CPA – Although the idea of having taxable income is often undesirable for non-profits, leveraging the 21 percent taxable income rate could help supplement existing activities. Continue the creative and innovative search for sources of revenue with the help of a non-profit CPA.
Tax reform has undoubtedly left some challenges behind in its path for non-profits to deal with. But, you don’t have to deal with them alone. Doeren Mayhew’s non-profit CPAs and advisors stand ready to help you implement the changes and develop strategies to keep your mission funded. Contact us today.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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