The Tax Reform Act of 2014 Could Significantly Impact Exempt Organizations
On February 26, 2014, Ways and Means Committee Chairman Dave Camp (R-MI) released the “Tax Reform Act of 2014” (the Draft)— almost 1,000 pages of proposed legislation including provisions that, if enacted, present a landslide of changes that could profoundly affect tax-exempt organizations and charitable giving.
This proposal arrives after three long years, during which the Committee held more than 30 hearings on tax reform and formed 11 separate bipartisan groups in order to conceive a bill that, according to some, is capable of “fixing” the tax code by diminishing its size and complexity.
Although only a draft, it is significant that there was input from a bi-partisan group and from the public. Also, the fact that the Joint Committee on Taxation, “scored” the provisions, indicating whether a particular provision will raise revenue, lose revenue or is revenue neutral, means that the Draft has additional momentum. While the Draft’s many provisions will be debated throughout the year ahead, and it’s doubtful that it will even be voted on in 2014, it’s crucial that tax-exempt organizations and charities stay on top of the process and understand the possible ramifications of the bill’s many provisions.
We encourage all organizations to carefully examine the new legislation to understand the scope of its proposed reform, as there are provisions that could potentially alter the tax obligations of nonprofits at a fundamental level.
To help reduce its complexity and provide insights, we’ve broken down the Draft into a few major sections:
Recent News Topics
Specifically, the bill proposes the following changes around these popular topics concerning nonprofit and charitable giving:
Implications for Colleges and Universities and other Private Institutions
- Repealing the tax exemption for professional sports leagues—including the NFL;
- Imposing a 25 percent excise tax on compensation paid over $1,000,000 by exempt organizations to their five highest paid employees;
- Allowing donors to deduct charitable gifts made up until April 15th on the prior year’s tax return;
- Imposing a 2 percent Adjusted Gross Income (AGI) floor on deductible charitable contributions; and
- Limiting the deduction of certain appreciated property to the donor’s adjusted basis in the property.
Some of the proposals appear to be aimed specifically at colleges and universities. For example, the Draft would repeal the rule that provides a charitable deduction of 80 percent of the amount paid for the right to purchase tickets for college athletic events.
Another provision for private colleges and universities is an excise tax based on these institutions’ investment income. If enacted, it would be similar to a rule that taxes the investment income of private foundations. Under the provision, private colleges and universities would be subject to a 1 percent excise tax on net investment income. The provision would only apply to schools with investment assets valued at the close of the preceding tax year of at least $100,000 per full-time student.
Tax Exempt Bonds
Hospitals and private colleges and universities (and other private institutions that use tax exempt financing) could be impacted, as the Draft aims to eliminate future tax-exempt Private Activity Bonds (PABs) under the rationale that the federal government should not subsidize the borrowing costs of private institutions.
Unrelated Trade or Business Provisions
Over the past year or so, both Congress and the IRS have grown increasingly concerned about organizations using perpetual losses from certain activities to offset income from one or more separate unrelated
activities. The issue is, in fact, significant: the College and University Compliance Program Final Report examined 34 schools and found that more than $170 million of losses had been disallowed. At the Congressional hearing discussing the report, representatives wanted to know if the underreporting of UBI is widespread. And, in fact, the IRS is currently conducting a program now to look at organizations that reported significant gross UBI but paid no UBI tax.
In response to these developments, instead of having to monitor losses and determine the motives of every activity, the Draft legislation proposes that the unrelated business taxable income of each activity would be computed separately, and that the loss from one unrelated business activity could not be used to offset the income from another unrelated trade or business activity. Any unused loss would be subject to the general rules for net operating losses (NOLs) (i.e., such losses may be carried back two years and carried forward 20 years). The provision would generally be effective for tax years beginning after 2014. However, NOLs generated prior to 2015 could be carried forward to offset income from any unrelated trade or business. Meanwhile, NOLs generated after 2014 could only be carried back or forward to offset income with respect to the unrelated trade or business from which the net operating loss arose.
Other unrelated business taxable income (UBTI) provisions would treat name and logo royalties as UBTI. Under this provision, any sale or licensing by a tax-exempt organization of its name or logo (including any related trademark or copyright) would be treated as a per se unrelated trade or business, and royalties paid with respect to such licenses would be subject to UBTI. Many nonprofits that have affinity credit cards or license their name for apparel could be impacted. Again, these provisions could impact colleges and universities significantly. Also, new rules are proposed on sponsorship payments and research.
Another area that Congress and the IRS have been focusing on is compensation of exempt organization executives. As stated above, one of the provisions of the draft legislation would impose a 25 percent excise tax on compensation paid over $1,000,000 by exempt organizations to their five highest paid employees. The rationale for this provision is that since the Federal government is subsidizing tax exempt organizations with tax exemption there should be some accountability as to the use of their resources. There is no current limit on excessive compensation paid by a tax-exempt organization to its senior management other than the limitation on private inurement, which could result in revocation, only harming the organization and the community it serves. On the other hand, the deduction allowed to publicly traded corporations for compensation paid with respect to chief executive officers and certain highly paid officers is limited to no more than $1 million per year.
Currently, if a 501(c)(3) public charity or a 501(c)(4) organization pays excessive compensation (more than fair market value) to an individual who can substantially influence the organization (i.e., a Disqualified Person, or “DP”) the DP is subject to a 25 percent excise tax on the excess amount. If the “excess benefit” is not corrected, which means paying back the excess with interest, the individual then faces a 200 percent tax. When these taxes are imposed, any manager who knowingly participated in the transaction is subject to a 10 percent excise tax, as well. However, the manager may avoid the excise tax if they rely on advice provided by an appropriate professional, such as legal counsel, certified public accountants or accounting firms with expertise regarding the relevant tax law matters; and (3) qualified independent valuation experts who hold themselves out to the public as appraisers or compensation consultants.
A tax-exempt organization can currently establish a rebuttable presumption of reasonableness with respect to compensation arrangements and property transfers if certain requirements are met. Establishing the rebuttable presumption shifts the burden to the IRS to prove that the compensation is not reasonable.
The Draft legislation would make some significant changes to these rules:
- Intermediate Sanctions would apply to IRC 501(c)(5) (unions) and 501(c)(6) (chambers of commerce and trade associations) organizations;
- A 10 percent tax would be imposed on the tax-exempt organization when the excess benefit excise tax is imposed on a DP;
- Managers could not rely on the professional advice safe harbor;
- The rebuttable presumption would be eliminated;
- The provision would expand the definition of disqualified persons to include athletic coaches and investment advisors (again, colleges and universities would be impacted).
There are various provisions that impose greater penalties for not properly reporting and disclosing, changes to private foundation rules and the reduction of the excise tax on the net investment income of private foundations to a uniform one percent.
While it is still early in the process, and we have no way to accurately predict whether any of these provisions will become law, the fact that 2014 is an election year could render many of these provisions difficult to move forward. Regardless, organizations should begin to familiarize themselves with the pending legislation now and should think about contingency plans should any of these provisions go into effect.