United States

Is there really a tax cut in the TCJA for exempt organizations?

INSIGHT ARTICLE  | 

The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, changed the corporate taxation system from a progressive, or graduated, system of taxation where taxpayers with higher incomes are taxed at higher rates to a flat 21 percent tax rate. To many corporate taxpayers, this change will result in a reduction in the annual corporate tax burden.

Generally speaking, most exempt organizations with unrelated business taxable income (UBTI) are subject to the corporate tax rate regimen (one exception is tax-exempt organizations structured as trusts for tax purposes).  Initially, one might assume that the 21 percent flat tax rate is great news and that the change in corporate tax rates will lower the overall corporate tax burden for all corporate taxpayers; however, similar to many provisions in the tax code, this is not always the case.

As part of the prior progressive corporate tax system, income was taxed under graduated income tax rates as follows: 

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Under the TCJA, the former progressive income tax rates have now been replaced by a flat tax of 21 percent from the first dollar of taxable income. As you can see from above, the 21 percent has not only replaced the 25 percent, 34 percent, and 35 percent tax rates applicable to corporate entities with taxable income greater than $50,000, but the flat 21 percent rate has also replaced the 15 percent tax rate that was applied to corporations with taxable income of $50,000 or less.

In fact, as the old rates were progressive, the 21 percent rate has increased the tax burden on organizations with less than $50,000 in taxable income. This increase is the result of the removal of the 15 percent tax rate on the first $50,000 of income. The following table shows the breakeven taxable income amount ($90,385) where taxable income greater than $90,385 will result in a tax savings, but any taxable income less than that amount will result in a greater tax liability under the new 21 percent flat tax:

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As is illustrated in the previous table, an organization with taxable income of $1 to $50,000 will pay 6 percent more tax on that income under the new 21 percent rate. Up to $75,000 an organization will pay 2.67 percent more tax under the new corporate tax rate system. Once an organization has taxable income greater than $90,385, there is a resulting decrease in the tax liability to the organization as a result of the new corporate flat tax system.

While the new tax law’s 21 percent flat rate will have a positive tax expense impact for organizations taxed as corporations with taxable income greater than $90,385, the loss of the graduated tax rates will result in an increased tax expense for those organizations with taxable income less than $90,385. It is important to review prior year’s taxable income to see if there is a need to budget for a tax liability increase as a result of the corporate flat tax.

In addition to the change from marginal rates to a flat tax rate, corporate exempt organizations filing Federal Form 990-T with a fiscal year beginning before Jan. 1, 2018 and ending after Dec. 31, 2017, will pay federal income tax using a blended tax rate and not the flat 21 percent tax rate under the TCJA that generally applies to tax years beginning after 2017. Fiscal year filers will have a second calculation that will need to be performed for the 2017-18 fiscal year. Corporations will determine the federal income tax by first calculating their tax for the entire tax year using the graduated tax rates in effective prior to TCJA and then calculating their tax using the new 21 percent rate, subsequently proportioning each tax amount based on the number of days in the tax year when the different rates were in effect. The sum of these two amounts is the corporation’s federal income tax for the 2017-18 fiscal year. Please see our whitepaper, Fiscal Year Blended Tax Rate for Exempt Corporations Filing Form 990-T, for further discussion of this topic.

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