New Tax Law Will Have Significant Impact on Tax-Exempt Organizations

President Donald Trump signed into law a sweeping reconciliation tax bill, commonly known as the “One Big Beautiful Bill Act” (OBBBA) at a July 4 signing ceremony, capping a furious sprint to finish the legislation before a self-imposed Independence Day holiday deadline. The Senate had approved the bill in a 51-50 vote on July 1 after making a number of last-minute changes following intense bicameral negotiations. The House then voted 218- 214 on July 3 to send the bill to the president’s desk.

With the legislation now final, tax-exempt organizations should focus on assessing its impact and identifying planning opportunities and challenges. The OBBBA introduces both tax cuts and tax increases that would affect nearly all businesses and investors. The Joint Committee on Taxation (JCT) scored the bill as a net tax cut of $4.5 trillion over 10 years using traditional scoring. Under the current policy baseline the Senate used for purposes of the reconciliation rules, that cost drops to just $715 billion. The Senate scored the provisions against a baseline that assumes temporary provisions have already been extended, essentially wiping out the cost of extending the tax cuts in the Tax Cuts and Jobs Act (TCJA).

Several areas of the final bill have tax implications for tax-exempt organizations, summarized below.


Section 4960 Excise Tax on “Excess” Compensation

The OBBBA expanded the group of individuals covered by the Section 4960 excise tax on compensation over $1 million paid by certain tax-exempt organizations. Under the act, all employees and former employees of the organization are now subject to Section 4960, not just the top five highly compensated employees in the current year or prior years. The final bill kept the language in Section 4960 that limits the group of individuals covered to those who were employees of the organization during taxable years beginning after December 31, 2016. The amendment to Section 4960 will apply to tax years beginning after December 31, 2025. 

  • This provision will have a significant impact on tax-exempt organizations that pay more than $1 million in remuneration to more than five individuals or provide certain severance payments to an employee (even one earning significantly less than $1 million).
  • Tax-exempt organizations should begin to look at future planning opportunities in structuring compensation, severance, and retirement agreements to mitigate the impact of the expansion of the scope of individuals covered under Section 4960.
  • The exceptions for licensed medical professionals providing medical services and non-highly compensated employees as defined under Section 414 remain available.  

Section 4968 Excise Tax “Endowment Tax”

The OBBBA will have a significant impact on the excise tax imposed on net investment income of applicable education institutions under Section 4968. Under prior law, the excise tax rate was calculated using a flat 1.4% rate. The OBBBA increases the rate, utilizing a new tiered structure. For applicable institutions with student adjusted endowments:

  • Over $500,000 but not exceeding $750,000, the rate remains at 1.4%
  • Over $750,000 but not exceeding $2,000,000, the rate is increased to 4%
  • Over $2,000,000, the rate is increased to 8%

For purposes of Section 4968, “student adjusted endowment” is the aggregate fair market value of the institution’s assets (as determined at the end of the preceding taxable year), other than assets that are used directly in carrying out the institution’s exempt purpose, divided by the number of students at the institution. The original House bill included a provision that would have excluded foreign students from the total number of students, but that provision was removed from the final version of the act.

The OBBBA also updated the definition of applicable educational institution to exempt institutions with fewer than 3,000 tuition-paying students in the preceding tax year. This amount was increased from 500 tuition-paying students prior to the act.  

The OBBBA also requires institutions to include student loan interest from a loan made by the institution (and any related organization) and federally subsidized royalty income as gross investment income. This amendment overrides the existing regulations under Section 4968.

The amendment to Section 4968 will apply to tax years beginning after December 31, 2025. 

The OBBBA will have a significant impact on institutions with the largest per-student endowments; however, the rates are lower than those in President Trump’s original proposal -- 35% -- and the original House bill, which included tiered rates of 1.4%, 7%, 14%, and 21%.

The increase in the tuition-paying student threshold from 500 to 3,000 is a positive change that will decrease the number of institutions subject to the tax, specifically those with a relatively small number of tuition-paying students.

Educational institutions will need to closely monitor their enrollment and assets, as small fluctuations in the student-adjusted endowment may have a significant impact on the institution’s tax rate in the new tiered rate structure. 

Institutions that will face a significantly higher tax rate beginning in 2026 may want to consider reverse planning strategies to recognize income before the change takes effect. 

For purposes of this section, the assets and investment income of any related organization are treated as assets and net investment income of the educational institution; therefore, it is important to closely monitor and coordinate any activities of related organizations to anticipate and reduce potential tax exposure.

The OBBBA also directs the Secretary of the Treasury to issue regulations and other guidance necessary to prevent avoidance of tax under this section.

Direct Pay and Energy Credits

The OBBBA retained the “direct pay” mechanism under Section 6417 for tax-exempt organizations and state, local, and tribal governmental entities. The direct pay (or elective pay) process allows the entities described above to receive a cash payment for clean energy tax credits they qualify for but are unable to use due to the entities having no tax liability.  However, the act curtailed and eliminated many of the clean energy credits. 

Here is a brief summary of some of the key clean energy credits impacted by the OBBBA:

  • The alternative fuel vehicle refueling property credit (Section 30C), which includes EV chargers, is not available for property placed in service after June 30, 2026.
  • The qualified commercial clean vehicle credit (Section 45W), for which no credit is available with respect to vehicles acquired after September 30, 2025. 
  • The technology-neutral clean electricity investment credit (Section 48E) for certain wind and solar facilities is terminated for property that does not begin construction within one year of enactment (by July 4, 2026) or is not placed in service by December 31, 2027. For other facilities, and for energy storage (battery) technology, the current credit phaseouts that begin in 2032 generally apply (although the potential for a later phaseout was eliminated). 
  • Revisions to the Section 48E clean electricity investment credit include higher phased-in domestic content requirements and new material assistance restrictions for projects sourcing from certain Chinese supplies and other foreign entities of concern (for projects beginning construction after 2025). However, the revisions contain no provision accelerating the phaseout of the investment tax credit available for geothermal energy property under Section 48, as the House bill proposed. 
  • The transferable deduction for installation of certain energy-efficient property in buildings owned by certain government or tax-exempt entities (Section 179D) is no longer available for property beginning construction after June 30, 2026.

Tax-exempt organizations with planned clean energy projects should quickly assess their eligibility under the new restrictions and timelines. The ability to receive direct refundable credits has made energy projects more economically compelling for many tax-exempt organizations, and it may be prudent to accelerate some activity to avoid new restrictions or phaseouts.

Employee Retention Tax Credit     

The bill makes several changes to the employee retention credit (ERC), including:

  • Barring ERC refunds after the date of enactment for claims filed after January 31, 2024;
  • Extending the statute of limitations on ERC claims to six years; and
  • Increasing preparer and promoter penalties on ERC claims. 

The provision presumably will affect only refund claims that have not been paid by the IRS. The legislative language provides that no credit or refund “shall be allowed or made after the date of enactment” unless the claim was filed on or before January 31, 2024. The IRS had been slow to process claims, perhaps in anticipation of this provision, which had been included in a failed 2024 tax extenders bill. The provision is now estimated to raise only $1.6 billion, much less than the $77 billion estimated under the 2024 version. The difference may be the result of refunds that have already been paid, although it remains unclear how fast the IRS is processing claims filed after January 31, 2024.

Corporate and Individual Charitable Contributions

 

Corporations


1.0% Floor on Charitable Contributions Deduction

The OBBBA amends Section 170(b)(2)(A) to permit corporations to claim a charitable contribution deduction only to the extent it exceeds 1% of taxable income (up to the current 10% cap).   Excess contributions as well as contributions disallowed by the 1% floor can be carried forward for up to five years. However, if the aggregate corporate charitable contributions do not exceed 10% of taxable income, there will be no carryforward of charitable contributions disallowed due to the 1% floor. 


Individuals


0.5% Floor on Charitable Contributions Deduction

The OBBBA amends Section 170(b)(1) to allow individuals to claim a charitable contribution deduction only if all of the contributions exceed 0.5% of the individuals’ adjusted gross income (AGI). The act did not change current percentage limitations (related to type of contribution or organization that receives the contribution), but it does create a new limit on the value of itemized deductions that will affect charitable contributions. The value of itemized deductions is essentially capped so that the maximum benefit achievable is equivalent to offsetting income taxed at a top rate of 35%, rather than at the higher individual marginal rate of 37%. For individuals in the top bracket, this in effect creates a 2% tax on charitable deductions that would otherwise offset income at the 37% rate.

Any excess charitable contributions, along with the contributions disallowed by the 0.5% floor, can be carried forward for five years. If an individual’s total contributions do not result in a carryover amount, there is no carryover of contributions disallowed due to the 0.5% floor.  


60% Limitation on Individual Charitable Contribution Deductions

The OBBBA makes the current 60% deduction limitation of AGI permanent for charitable contributions of cash made by individuals to public charities (as well as certain private foundations as defined in Section 170(b)(1) (F)). This limitation was originally enacted as part of the Tax Cuts and Jobs Act (TCJA) and would have expired at the end of 2025. The act also amends the application of the 60% limit. This amendment appears to potentially allow individuals to deduct up to 60% of AGI even if they make total cash contributions to public charities that are less than 60% of AGI and also make charitable contributions of noncash property to eligible donees that are not public charities. 


Reinstatement of Partial Charitable Contribution Deduction for Nonitemizer Individuals

The OBBBA amends and permanently reinstates the partial deduction for charitable contributions for individuals who do not itemize deductions on their individual tax returns. The maximum amount is increased to $2,000 for married filing jointly taxpayers and $1,000 for all other taxpayers. The deduction is available only for cash contributions made to certain charitable organizations. It does not include noncash contributions, contributions made to donor-advised funds, supporting organizations, and to most types of private foundations. 

All changes for both corporations and individuals are effective for tax years beginning after December 31, 2025. 

The OBBBA includes both favorable and unfavorable provisions impacting charitable contributions.  The provisions may have funding implications for tax-exempt organizations that rely on contributions.

Corporate contributions were previously capped at 10% of taxable income but the OBBBA includes a 1% floor that limits the deductibility of corporation contributions. This floor could result in a reduction in corporate contributions received.  

Individual contributors will be limited to amounts exceeding a .5% floor, which may result in an overall reduction in contributions from individual donors, with the potential to impact funding for tax-exempt organizations that rely on contributions.  

The reinstatement of the partial deduction for individuals that do not itemize and increases the maximum contribution amounts may result in increased charitable contributions from individuals that do not meet the threshold to itemize on their personal returns.

Tax-exempt organizations should consider how these changes will impact their donor base and ultimately the total funding received from corporate and individual contributors. The available tax deduction for nonitemizers may entice taxpayers to make charitable contributions that they had not previously made, potentially providing additional funding to tax-exempt organizations.

Tax Credit for Contributions to Scholarship-Granting Organizations

The OBBBA allows a credit for contributions by individuals to a scholarship-granting organization. A scholarship-granting organization is a Section 501(c)(3) organization, excluding private foundations, that provides scholarships to 10 or more students, spends at least 90% of its income on scholarships for eligible students, and limits scholarships to qualified elementary or secondary education expenses. Scholarship-granting organizations must be identified to the Secretary of the Treasury by a participating state in an annual listing (issued by January 1). Eligible students include a member of a household with income that is not greater than 300% of area median gross income and is eligible to enroll in a public elementary or secondary school. The maximum credit for any tax year shall not exceed $1,700 (with a carryover period limited to five years) and must be reduced for any state tax credit received. To avoid a double benefit, no charitable contribution deduction is allowed for amounts claimed as a credit under this provision.

Scholarships for qualified elementary or secondary education expenses will not be included in the scholarship recipient’s gross income.

This provision is effective for tax years beginning after December 31, 2026. 

The potential benefits of this provision may be limited depending on whether states voluntarily elect to participate in this program. This election must be made by the governor of the state or by an individual, agency, or entity designated under state law to make such elections on behalf of the state with respect to federal benefits. The burden is on the states to determine that scholarship-granting organizations meet the requirements described in this section. Each participating state must release a list of qualified organizations no later than January 1 of each year.

Increase in State and Local Tax (SALT) Cap for Individuals

The OBBBA provides a temporary increase in the cap on deducting SALT as itemized deductions.  The act temporarily increases the SALT cap to $40,000 (for married filing jointly taxpayers) beginning in 2025, with subsequent annual increases of 1% for tax years 2026 through 2029.  The SALT cap is reduced by 50% for filers other than married filing jointly. Beginning in 2030, this SALT cap will revert to $10,000.  For tax year 2025, the increased SALT cap begins to phase out when modified AGI exceeds $500,000 for married filing jointly taxpayers, with a 50% reduction for other filers. This phaseout amount increases 1% annually after 2025. The allowable SALT deduction amount will not result in a limitation amount of less than $10,000.

This provision will benefit individuals residing in states with high state taxes and will result in an increase in the overall number of taxpayers eligible to itemize on their personal tax returns. This may indirectly benefit tax-exempt organizations by enticing taxpayers to make charitable contributions, which would be more likely to result in a tax benefit. 

Next Steps

The Act includes a limited number of provisions that will directly impact tax-exempt organizations and many others that will indirectly impact these organizations. Additionally, the Medicaid provisions included in the OBBBA may present challenges to tax-exempt organizations in the healthcare sector.  

While many of the OBBBA’s provisions will negatively impact tax-exempt organizations, it is important to recognize that many of the proposals included in the original House bill but struck from the final package would have had a more negative impact on the nonprofit sector. These include the potential revocation of tax-exempt status based on an organization’s support for terrorist organizations, increased excise tax rates for private foundations, the treatment of qualified transportation fringe benefits as unrelated business income, stricter rules for exemption of research income from unrelated business income, and the inclusion of name and logo royalties in unrelated business income.  

Tax-exempt entities should assess the impact of the changes that did survive and consider mitigation strategies. 


Please visit BDO’s Nonprofit Tax Services page for more information on how BDO can help.