The Tax Cuts and Jobs Act passed by the House and the Senate Mark approved by the Senate Finance Committee each contain numerous proposals that would affect tax-exempt organizations, in some cases materially. Below we highlight some of the provisions that are of relevance to public charities and certain other exempt organizations.
Excise tax on “excessive” executive compensation. Both the House Bill and Senate Mark would introduce a new 20% excise tax on compensation above $1 million paid by tax exempt organizations to their highest paid employees in any tax year after December 31, 2017—the top five employees under the House bill, and the top three under the Senate plan. Once an employee is covered by the limit, the employee remains covered so long as the employee receives compensation from the organization. The excise tax also applies to severance and other termination-related payments to any of these employees if the payments have an aggregate present value of at least three times the employee’s annual base compensation. The excise tax would be payable by the tax exempt organization.
Excess benefit transactions. Current law imposes excise taxes on certain “disqualified persons” who are in a position to influence certain charitable organizations and who enter into “excess benefit transactions” with those organizations. Under regulations, a disqualified person benefits from a rebuttable presumption that no such excess benefits have been provided if the charitable organization conducts benchmarking for its compensation arrangements and has a governing body approve them in advance.
The Senate Mark would impose an entity level tax on any charitable organization that enters into an excess benefit transaction in the amount of 10% of the excess benefit unless the organization’s participation in the transaction is not willful and is due to reasonable cause. The Senate Mark would also eliminate the rebuttable presumption, but provide that the same conduct establishes a minimum standard of due diligence that would excuse the organization from the entity-level excise tax. Although the IRS could seek to impose tax on a disqualified person for the same transaction, it may be difficult in practice if the transaction is supported by an organization’s satisfaction of these standards. An organization that establishes to the satisfaction of the IRS that other reasonable procedures were used to ensure that no excess benefits are provided would also not be subject to the entity-level tax.
The Senate proposal also extends the application of these rules to labor organizations and business leagues and treats investment advisors and athletic coaches as disqualified persons.
Changes to unrelated business taxable income regime. Although tax-exempt organizations are not taxed on their receipt of donations and grants or on income generated in furtherance of their exempt purposes under current law, they are taxed on their unrelated business taxable income (“UBTI”), which generally includes trade or business income and certain debt-financed investment income. The House and Senate proposals each provide modifications to the current regime, but the Senate Mark could have significant consequences on the way in which exempt organizations structure their operations that generate UBTI.
- Expansion to State Instrumentalties: The House legislation would clarify that the UBTI rules apply to state pension funds and other organizations that are instrumentalities of the states, who may argue that that this change cannot apply on Constitutional grounds.
- Narrowing of Exemption for Research: The House bill would limit the current exemption from UBTI for all research income generated by an organization operated primarily for purposes of carrying on fundamental research the results of which are freely available to the general public so that it applies only to income derived from research which is freely available to the public.
- Segregation of UBTI Losses: The Senate Finance Committee’s tax reform proposal would prohibit tax-exempts from using deductions from one unrelated trade or business to offset UBTI from another unrelated trade or business. Under current law, an exempt organization that operates multiple unrelated trades or businesses aggregates income from all such activities and is permitted to aggregate all deductions from such activities to compute UBTI.
- Royalties from License of Name or Logo: The Senate Mark would treat income from the licensing or sale of an organization’s name or logo as UBTI.
Excise tax on private universities. Both the House and Senate Marks include a 1.4% excise tax on the net investment income of private colleges and universities with at least 500 students and endowments that are at least $250,000 per student. In making the latter determination and calculating the amount of the tax, colleges and universities are required to include the assets and income of related organizations.
Modifications to the Johnson amendment. The House bill (but not the Senate Mark) would effectively repeal the “Johnson Amendment,” under which a 501(c)(3) organization is completely barred from any direct or indirect participation in a political campaign. The proposal provides that 501(c)(3) organizations will not lose their tax-exempt status if they make political statements in the ordinary course of the organization’s regular and customary activities in carrying out its exempt purpose and such activity does not result in more than a de minimis incremental expense.
Other. The House bill and Senate Mark introduce several other proposals of interest to exempt organizations. The House bill would reduce the base rate of tax on private foundation investment income and limit the ability of private museums to qualify for an exemption from tax on undistributed earnings. The Senate Mark would repeal of the exclusion from income for interest on State and local bonds issued to advance refund another bond, relax the excise tax on private foundations that hold substantial shares of a corporation engaged in a trade or business that is not functionally related to the private foundation’s charitable purpose, repeal the tax-exempt status of professional sports leagues, and deny the deduction for amounts paid in exchange for college athletic seating rights.