Unrelated Business Taxable Income
Revenue derived from activities that are not substantially related to a nonprofit's exempt purpose is called unrelated business taxable income. This type of income is reported on Form 990-T. A nonprofit that operates multiple unrelated activities is allowed to combine and report these activities on Form 990-T under 2017 tax law. Therefore, any losses from unrelated activities can be used to offset gains from profitable activities.
This has changed with the passing of the Tax Cuts and Jobs Act. Now, losses from one unrelated activity cannot be used to offset income from another unrelated activity. Net operating losses (NOLs) created in years beginning January 1, 2018 may be carried forward, but can only be applied to future profits from the same activity that produced the loss. NOLs created in a taxable year beginning before January 1, 2018 are not subject to this limitation. Taxable activities are subject to the new 21% corporate flat tax rate. This provision begins for tax years beginning after December 31, 2017.
Excess Executive Compensation
A 21% excise tax applies to amounts greater than $1 million paid to a covered employee, plus any additional parachute payment paid by the nonprofit. Covered employees are a tax organization's five highest compensated employees, including former employees. This rule applies to tax years beginning after December 31, 2017. Exemptions and limitations do apply.
Investment Income of Private Colleges and Universities
A 1.4% excise tax applies to net investment income for certain private colleges and universities. Qualifying colleges and universities must have at least 500 tuition-paying students, more than 50% of students must be located in the U.S., and have assets of at least $50,000 per student. Assets exclude those directly used to carry out the school's exempt purpose.
Net investment income is calculated by subtracting expenses from gross investment earnings. This rule applies to tax years beginning after December 31, 2017.
Estate Tax Exemption
The gift and estate tax exemptions increased to $10 million per individual, indexed for inflation. This provision expires for decedents dying and gifts made before 2026. Currently, only about 1 in 500 estates is large enough to be taxed. The amount of taxable estates would drop substantially with the increased exemption. As of now, some individuals prefer increasing their charitable giving rather than paying estate taxes. With the increased exemption, large estate gifts could decrease with the elimination of charitable giving incentives.
The standard deduction is increased to $12,000 for individuals and $24,000 for married couples. These amounts will be adjusted for inflation. Many nonprofit organizations are concerned that fewer taxpayers will itemize deductions, therefore, charitable giving will decrease. According to a study done by Indiana University Lilly Family School of Philanthropy, this concern could lead to an annual decrease in charitable giving ranging from $4.9 billion to $13.1 billion. Other estimates go as high as $20 billion.
Prior to the passing of the Tax Cuts and Jobs Act, individuals could deduct 50% of adjusted gross income (AGI) of their cash contributions to certain charities and private foundations as an itemized deduction. Now, individuals can deduct up to 60% of AGI of their cash contributions. This could be an incentive to inspire additional giving. This rule applies to tax years beginning after December 31, 2017 and before January 1, 2026.
Despite changes made to the tax law, there is hope that donors will continue to give to missions and organizations they care about. Here are five suggested action steps you can take as a member of a nonprofit organization to further inspire giving.
- Reach out to your donor base. Let them know how important they are to your mission. Show the impact their gifts have made to your organization, the positive outcomes that were achieved, and how future gifts are essential to meeting your goals.
- Focus on the impact a gift has to your organization, rather than the tax advantages of a charitable gift.
- Taxpayers may choose to "bunch" their donations and other itemized deductions every other year. Determine how this could impact your cash flow and plan accordingly.
- If fewer people itemize deductions, December 31 won't be as important of a deadline for taxpayers to make donations. If you receive a large percentage of donations in December, be aware that cash flow could shift or lessen going forward. Manage funds accordingly.
- If you have multiple unrelated business activities, make sure your accounting system can adequately track revenues and expenses by each individual activity.
This is a broad overview of some key issues and changes included in the Tax Cuts and Jobs Act that may impact your nonprofit organization. To learn more about how recent tax reform could impact you, your funds and your donor base, please contact your Beene Garter professional.
You May Also Be Interested In:
- Overview of the Tax Cuts and Jobs Act
- Guide to Financial Governance for Nonprofit Board Members
- 10 Tax Items in the Bipartisan Budget Act of 2018
- 10 Tax Reform Changes Individuals Should Know