The Tax Cuts and Jobs Act of 2018 went into effect on January 1, 2018. The new law makes some changes that affect tax-exempt (nonprofit) organizations. Except as otherwise noted, these changes are effective now and will sunset at end of 2025, unless changed in the future by Congress. Among these changes are:
Tax on High Compensation:
New Excise Tax On Tax-Exempt Employers For Payments of Excess Executive Compensation The new law imposes a 21% excise tax on organizations recognized as tax-exempt under Code Section 501(c), political organizations, and certain types of governmental employers and cooperatives that pay compensation for a taxable year in excess of $1 million to any “covered employee.”
Covered employees are a very small group of individuals and only include:
- The 5 highest compensated employees of the organization for the current taxable year; or,
- Any person who was a covered employee for any prior taxable year, beginning with the first taxable year beginning after 12/31/16.
New Excise Tax on Certain Severance Payments A parachute payment is any payment (including a severance payment) to a covered employee if the payment is contingent on the employee’s separation from employment with the employer and the value of such payment equals or exceeds 3 times a base amount. If there is a parachute payment, the excise tax applies to the amount of the parachute payment in excess of 1 times the base amount. The base amount is determined with reference to the employee’s average annual compensation prior to separation.
What types of compensation count towards the $1M threshold?
The baseline definition is any taxable “wages” reportable on IRS Form W-2 for federal income tax withholding purposes to the covered employee. Special adjustments apply for certain types of contributions to and distributions from retirement programs and payments to licensed medical professionals that relate directly to performance of medical services.
Unrelated Business Income Tax: Under prior law, a tax-exempt organization could aggregate all of the profits and losses from its various unrelated business operations, so that losses resulting from one unrelated business could offset the profits from another. Under the new tax law, the profits and losses from one unrelated business activity cannot be used to offset the profits and losses of another unrelated business activity. As a result, tax-exempt organizations will need to separately account for profits and losses from different lines of businesses.
The rate of tax on unrelated business income has dropped to a flat rate of 21 percent. Tax-exempt organizations engaged in unrelated business activity should seek advice about how to best separate and manage different business activities. In particular, it may make sense for organizations to create taxable subsidiaries in order to aggregate profits and losses.
Higher AGI Limits for Cash Gifts to Public Charities: The new law raises the deduction limitations for cash contributions to public charities from 50% to 60% of an individual’s adjusted gross income. There is still a five-year carryover for unused cash contribution deductions that are otherwise subject to the new 60% limitation.
No More Charitable Deduction for the Right to Purchase Premium Athletic Tickets: Previously, the college and university donors who made contributions in exchange for the right to obtain priority seating for sports events could fully deduct 80 percent of their donation, even if the market value of the seating priority exceeded 20 percent of the gifts’ value. The new law eliminates any deduction for contributions that entitle the donor to purchase tickets to sporting events.