The Tax Bill: How Does It Affect Maine Nonprofits?
Reprinted with permission from The Maine Nonprofit Law E-Bulletin January 2017, by Robert H. Levin, Attorney-at-Law with the Law Office of Robert H. Levin. Note: MANP’s partners at the National Council of Nonprofits are hosting a free webinar on Thursday, January 11, Now What: How the New Federal Tax Law Impacts Charitable Nonprofits.
Well, the tax bill is in the books, like it or not. If you ask me, it’s one of the worst pieces of legislation our country has enacted in years, for all kinds of policy reasons. But let’s focus on how it affects nonprofit organizations.
Reduced Annual Charitable Giving Incentives – The standard deduction has been increased through at least 2025 to $12,000 for individuals and $24,000 for couples. This means that many fewer people (from 30% of all taxpayers to about 5%) will itemize their deductions, and itemizing is where the charitable deduction is claimed. Moreover, the marginal tax rates were decreased across the board, including the top rate from 39.6% to 37%. One credible study predicts that these changes will reduce annual charitable giving by $5 billion to $13 billion. Moreover, nonprofits will be increasingly reliant on the wealthy for giving, accelerating a recent trend. For a very smart take on this meta-issue, read here.
Reduced Incentives for Charitable Bequests – The estate tax exemption has been doubled to about $11 million for individuals and $22 million for married couples, effective through 2025. This represents a huge gift to the elite 0.1%, such as the 20 or so Maine residents who would owe any estate taxes in 2017. Given the pressing challenges our nation faces and the already yawning gap between the ultra-rich and everyone else, the evisceration of the estate tax is nothing short of tragic. Moreover, like the standard deduction and marginal rate changes discussed above, reducing estate tax liabilities shrinks the incentives for making charitable bequests.
Indirect Effects: Reduced Funding For Nonprofits – Credible estimates suggest that the bill will lead to at least $1 trillion in deficits over the next 10 years. And it is no secret that Republicans would like to continue reducing government outlays. Because many charities receive federal government grants (often indirectly through state-level regrant programs), they will be harmed when those grants are slimmed down or eliminated altogether in the coming years.
Indirect Effects: Reduced Funding for Individuals Served by Nonprofits – The same budgetary pressures that will crimp funding for nonprofits will also result in lower federal funding for services that help those served by nonprofits. Environmental, health care, educational, and many other programs will be under the chopping block in the coming years, and thus the need for nonprofits to fill in the gaps will be higher than ever.
Unrelated Business Income Tax Rate Changes – Nonprofits that earn income from a trade or business that is unrelated to their exempt purpose must pay Unrelated Business Income Tax (UBIT). The UBIT rate is tied to the corporate tax rate, which is changed substantially in the tax bill. The corporate tax rate used to be tiered: 15% on the first $50,000 of income, 25% for income between $50,000 and $75,000, rates generally in the 34-38% range for income over $75,000. Now there is a flat 21% rate starting with the first dollar of income. This means that for nonprofits with a modest amount of unrelated business income ($90,000 or less), and this group constitutes the vast majority of nonprofits that owe any UBIT, they will pay the higher 21% rate and will owe more tax. For those few nonprofits earning in excess of $90,000 or so in UBIT, they will owe less tax.
Other UBIT Changes – In addition, the bill tweaks UBIT by requiring that nonprofits calculate their taxes on each trade or business separately, and no longer aggregate profits and losses of each activity. In addition, UBIT is increased by the amount of certain nondeductible fringe benefit expenses for transportation, parking, or the use of on-premises athletic facilities. These changes are not likely to affect many Maine nonprofit organizations, but where applicable they could have a big impact.
Slight Increase in Deduction Threshold For Cash Gifts – Under longstanding law, the deduction for cash gifts to 501(c)(3) public charities and private operating foundations has been limited to 50% of an individual taxpayer’s adjusted gross income. Through 2025, this limit is increased to 60%. The carryforward period remains at 5 years. This provision will affect only the rare person who donates in cash such a large portion of their income in any given year.
Suspension of Pease Limitation on Higher Income Donors – In recent years, itemized deductions were reduced by 3% of the amount of a taxpayer’s adjusted gross income above a certain level (in 2017, over $262,500 for individuals and $313,800 for joint filers). Under the tax bill, this provision (known as the “Pease Limitation”) is suspended through 2025. This suspension somewhat increases the ultimate value of charitable contribution deductions for high-end donors, and offsets the reduced giving incentives from the lower marginal tax rates mentioned above.
New Tax on Investment Income of Colleges – The law establishes a new 1.4% tax on net investment income of private nonprofit colleges and universities with assets of at least $500,000 per full-time student and more than 500 full-time students. From the outset, the tax is expected to apply to approximately 30 private colleges, and it’s doubtful that any of these are in Maine. However, some in the nonprofit sector fear that the tax will be expanded in future years to more colleges and to other kinds of nonprofits.
New Tax on Compensation Over $1 Million – The tax law establishes a new 21% tax on compensation above $1 million paid by any 501(c) organization (as well as 527(e)(1) political organizations such as Political Action Committees) to any of its five highest-paid employees. Certain severance payments (referred to as “parachute payments”) are also taxed at this rate. Doctors and other licensed medical professionals are generally exempted, although hospital administrators are covered. This new tax is expected to affect hospitals, colleges, and other large nonprofits by slowing the increase of top-tier salaries. None of Maine’s colleges pay anywhere near $1 million to their highest-paid employees, and so would not be affected in the foreseeable future. But many of Maine’s hospitals do pay over $1 million to their top administrators.
What Didn’t Make It Into the Bill
Campaigning Restrictions – At least for now, Republicans were thwarted in their attempt to weaken restrictions on political campaigning by 501(c)(3) organizations. A last-minute ruling by the Senate Parliamentarian forced that provision out of the final bill. Although the nonprofit sector’s umbrella groups, including the Maine Association of Nonprofits, were uniformly against this measure, evangelical churches have pushed it for years, and so expect the issue to come around again in 2018. Read more here.
Retirement Plan Incentives – The original Senate-passed bill included a provision that would have restricted savings incentives currently available to employees of nonprofit organizations that offer 403(b) retirement plans. Although I was profoundly disappointed by Senator Susan Collins’ decision to vote for the bill, credit where it’s due: Her intervention was integral in getting this provision removed from the final bill. Read more here.
Other Provisions That Were Considered But Rejected – Congress considered many other provisions that would have tightened the rules for private foundations in particular. Although these did not make it into the final bill, advisers and principals of private foundations should be aware of these measures in the event that they come back around in future legislation.