Tax Reform & Its Impact on Tax-Exempt Organizations

Congressional Republicans on Dec. 20 passed the most sweeping overhaul of the tax code since 1986, delivering a much-needed legislative victory to the GOP and President Trump before the holidays. The bill was signed into law by President Trump on Dec. 22. Most changes are generally effective as of 2018.

Throughout the legislative process, ASAE and many other associations opposed a number of provisions that ended up being stripped from the final bill and, as expected with any issue as complex as tax reform, there are still a few provisions that are in the law that associations and other tax-exempt organizations need to be aware of.

Provisions Stripped from Final Bill:

Taxation of royalty income: This provision was in the original Senate bill but was removed after opposition from ASAE and hundreds of other associations. ASAE and others contended that royalties should not be taxed when the organization has entered into a licensing arrangement for use of its name or logo but is not actively involved in the marketing or administration of the product or service connected with the arrangement.

Royalties are a significant source of non-dues revenue or non-contributed revenue that can be reinvested in education, skills training, standard-setting, research and other activities critical to the mission of a tax-exempt entity. Thanks to our community’s collective advocacy work, passive income from royalties will not be subject to UBIT.

Non-qualified deferred compensation plans: This provision was originally in both the House and Senate bills and would have eliminated 457 plans for associations and other nonprofit employers. ASAE and others made the case that these deferred compensation arrangements are offered to many employees of tax-exempt organizations as a means of supplementing their retirement income. Since nonprofit employers can’t offer performance stock options to key employees, 457 plans are an important benefit in attracting top talent. The provision was removed from both bills before passage.

Intermediate sanctions: This provision was originally in the Senate bill and would have applied intermediate sanction rules to 501(c)(6) groups and eliminated the “presumption of reasonableness” for nonprofit organizations that practice due diligence in setting compensation arrangements. ASAE and others argued that this proposal would have given the IRS the power to determine what constitutes an excess benefit transaction and removes the safe harbor for nonprofit organizations that follow reasonable, responsible processes for determining compensation, including review by a governing body or committee; use of appropriate data as to comparability; and adequate documentation supporting the decision on compensation at the time it was made. It was removed from the Senate bill before passage.

Noteworthy Provisions Included in Final Bill:

Excise tax on executive compensation: Associations and other tax-exempt organizations will be subject to a 21 percent excise tax on executive compensation over $1 million paid to the five top-earning executives. Compensation includes salary and the cash value of most benefits, including those that have vested but haven’t been received yet by the executive. Compensation also includes payments contingent on the executive’s separation that are at least three times the executive’s base compensation – also known as “parachute payments.” ASAE will continue to press for a grandfather clause on existing contracts and employment agreements for tax-exempt entities, as was given to for-profit corporations in the bill. Alternatively, ASAE will pursue a phase-in period for the excise tax.

Separate computation of UBIT: This provision in the bill requires that unrelated business taxable income be separately computed for each business activity. In other words, associations are prevented from offsetting losses from one business with income from another business. ASAE believes a sensible work-around on this provision is to route UBIT activity through a for-profit subsidiary that can net the profits and losses of each business. ASAE will provide additional guidance in this area for organizations that do not have a for-profit subsidiary.

Fringe expenses: The bill subjects tax-exempt organizations to UBIT on the value of certain employee fringe benefits including transportation, parking and on-premises athletic facilities. The bill also stipulates that no deduction is allowed for activities generally considered to be entertainment, amusement or recreation. ASAE is seeking clarifying language on a provision that eliminates the deductibility of membership dues paid to clubs which are exempt from tax under Internal Revenue Code Section 501(c)(7) or which are for-profit entities. We believe this provision is aimed at membership to country clubs or other private clubs, and is not intended to impact the deduction of membership dues paid to a trade or professional association, but we prefer to see the language clarified and not left to interpretation by the IRS.

Supplementary Issues:

The law includes several other provisions of interest to certain tax-exempt entities, most notably:

Charitable contributions: The tax bill increases the adjusted gross income (AGI) limit on the charitable contributions deduction from 50% to 60% for cash gifts. However, the final bill roughly doubles the standard deduction to $12,000 for individuals and $24,000 for couples. With a higher standard deduction, fewer taxpayers will itemize their deductions on their tax returns and therefore won’t receive a benefit for giving to charity, which some charities fear could reduce giving.

Local lobbying expenses: The bill eliminates the deduction for lobbying expenses regarding legislation before local government bodies. As a result, these expenses will need to be included in the calculation of non-deductible membership dues or proxy tax liability.

Johnson Amendment: A provision in the House bill would have effectively repealed the Johnson Amendment, which prohibits churches and other 501(c)(3) groups from participating or intervening in political campaigns. The provision was removed from the final bill because it conflicted with the Senate’s Byrd rule, which prevents reconciliation bills from containing provisions that aren’t fiscal in nature. Efforts to repeal the Johnson Amendment to allow church leaders and others to engage in political speech are expected to continue.

Excise tax on investment income of private colleges and universities: The tax bill imposes a 1.4% excise tax on the net investment income of private colleges and universities that have more than 500 full-time equivalent students and assets of at least $500,000 per full-time equivalent student.