On Dec. 22, 2017, President Donald Trump signed the Tax Cut and Jobs Act (the Act) into law. The Act is the most comprehensive change to the U.S. tax code since 1986. In some way, the new rules affect almost every individual, business, and tax-exempt entity. Most of the provisions of the Act are effective for tax years beginning after Dec. 31, 2017.

Some of the top changes affecting tax exempt organizations beginning after Dec. 31, 2017 are provisions affecting charitable contributions, excise tax on employee compensation and endowments, unrelated business income modifications, unrelated business income tax being imposed on fringe benefits, and advance refunding of bonds.

Charitable Contributions

There are several changes within the Act that might affect the amount of contributions available to the charitable sector in the foreseeable future. With the nearly doubling of the standard deduction, the number of households that are expected to itemize will decrease from approximately 30% to 5%. With this removal of a primary tax incentive to donate, there is expected to be a decrease in charitable giving, as many individuals will no longer benefit from the deduction on their tax returns. The estimated reduction in contributions across the charitable sector is estimated to be $26 billion in contributions per year. The impact might be lessened by the increase in the charitable deduction limit for cash contributions from 50% of adjusted gross income to 60%. The Act also disallows payments made by donors to a college or university in exchange for the right to purchase tickets at college athletic events.

Furthermore, the Act increased the threshold for taxable estates and gifts from $5 million to $11.2 million and will eventually result in the repeal of the tax as of Dec. 31, 2025. The increase in the threshold lessens the incentive to donate portions of estates to charity, as more property can be transferred to the beneficiaries tax free.

Excise Tax on Employee Compensation

The provision to tax compensation in excess of $1,000,000 for top executives of tax-exempt organizations seems designed to put tax-exempt organizations on par with taxable entities. The top five highest compensated employees of exempt organizations will now be subject to a 21% excise tax on taxable wages in excess of $1,000,000. Taxable wages do not include qualified plan benefits such as IRC section 125 benefits or amounts set aside for contributions. Taxable wages do, however, include non-qualified plan deferrals when vested, whether or not payments have been made.

These highest compensated employees, deemed "covered" employees, are evaluated on an annual basis, starting with the year ending Dec. 31, 2017. Covered employees are defined as each year's top five highest-compensated employees and must be assessed both on an entity-by-entity basis and as part of a controlled group. Predecessor organizations must also have their executives' compensation examined. Once an employee meets the covered employee definition, he or she will always be labeled a covered employee, and future years' compensation will be taxed if it exceeds the threshold, whether or not the employee is one of the top five highest compensated employees for that year. As such, it is entirely possible that an organization might have to pay excise tax on more than five employees' compensation in a given year.

Payments upon separation of service, commonly referred to as "parachute payments" of covered employees, will also bear an excise tax if in excess of certain thresholds, based on a calculation that is three times the employees' most recent five-year average compensation. Any amount of the present value of the payment stream that is over the calculated amount will be subject to the 21% excise tax.

Excise Tax on Endowments

Another provision, which was not unexpected for many, was the introduction of a 1.4% excise tax on net investment income for private colleges and universities. Educational institutions with at least 500 students must pay the excise tax if the organization's "nonrelated" assets (those not directly used in carrying out the organization's education purposes) are valued at the close of the preceding tax year as being at least $500,000 per full-time student. The number of students is based on the daily average of full-time students. Part-time students are counted on a full-time equivalent basis. Net investment income is determined under rules set out in IRC section 4940(c), which was originally designed for private foundations. Based upon these requirements of the Act, this provision is expected to have a limited application across the higher education sector and estimated to implicate fewer than 30 colleges across the country.

Unrelated Business Income Modifications

For tax years beginning after Dec. 31, 2017 (except when there is a net operating loss (NOL) carryover from a tax year beginning before Jan.1, 2018), tax-exempt organizations may not use losses from one unrelated trade or business to offset income from another unrelated trade or business. Income or loss from each unrelated business activity will have to be calculated separately. The Act currently does not define what is considered to be a separate activity, and therefore distinguishing various activities might be difficult until the U.S. Department of the Treasury or the IRS provides more guidance. For example, a taxable loss on investment income cannot be netted against taxable rental income. Absent further guidance from the IRS, organizations will need to use professional judgement in isolating the current unrelated activities. The process might include auditing the unrelated activities to determine if all expenses and allocations are reasonably assigned to each activity (overhead allocations need to be activity specific), tracking any NOLs created before Jan. 1, 2018, and tracking segregated NOL schedules for each activity on a prospective basis.

Other UBI impacts is the new 21% corporate tax rate which will be applied to the overall taxable income. The Act also limits the NOL deduction to 80% of current year net income from the activity that generated the loss, and the Act disallows any NOL carryback but allows indefinite carry forwards.

Unrelated Business Income on Fringe Benefits

Effective for amounts paid or incurred after Dec. 31, 2017, the Act requires tax-exempt organizations to report the costs of certain fringe benefits as unrelated business income (UBI) where the benefits are provided by the organization to their employees and are not included in the employees’ taxable income. The stated intent of the change is to make the tax treatment of these fringe benefits consistent with that of for-profit entities, which would not be able to deduct these benefits under the Act. The fringe benefits subject to this provision are qualified transportation (commuter highway vehicle, transit passes), parking reimbursements, and on-site gyms. Assuming the employer intends to continue providing these benefits, there are three possible approaches: (1) continue to pay the fringe benefit and report the UBI on the Form 990-T; (2) make the benefit taxable to the employee by including it in wages on the Form W-2; or (3) provide an additional taxable amount of compensation to “gross up” for the resulting taxes to be paid by the employees.