Exempt organization provisions in the Senate tax reform proposal
Proposed tax changes that could affect tax-exempt organizations
TAX ALERT |
On Nov. 9, 2017, the Senate Committee on Finance released its version of the Tax Cuts and Jobs Act following the release of the House proposal. The following summary provides the proposed tax changes that could affect tax-exempt organizations.
Excise tax based on investment income of private colleges and universities
Like the House proposal, there is a provision in the Senate proposal that provides for an excise tax on the investment earnings of endowments of colleges and universities and their related and supporting organizations.
Under the proposal, an excise tax is imposed on an applicable educational institution for each taxable year equal to 1.4 percent of the net investment income of the institution for the taxable year. Net investment income is determined using rules similar to the rules of section 4940(c) (relating to the net investment income of a private foundation). In addition, for the purposes of the proposal, an applicable educational institution is an institution:
- That has at least 500 tuition-paying students during the preceding taxable year;
- That is an eligible education institution as described in section 25A of the Code;
- That is not described in the first section of section 511(a)(2)(B) of the Code (generally describing state colleges and universities); and
- The aggregate fair market value of the assets of which at the end of the preceding taxable year (other than those assets which are used directly in carrying out the institution’s exempt purpose) is at least $250,000 per student.
For these purposes, the number of students of an institution is based on the daily average number of full-time students attending the institution, with part-time students being taken into account on a full-time student equivalent basis.
For purposes of determining whether an institution meets the asset-per-student threshold and determining net investment income, assets and net investment income include amounts with respect to an organization that is related to the institution. An organization is treated as related to the institution for this purpose if the organization:
- Controls, or is controlled by, the institution;
- Is controlled by one or more persons that control the institution; or
- Is a supported organization or a supporting organization during the taxable year with respect to the institution.
If passed, this provision is effective for tax years beginning after Dec. 31, 2017.
Name and logo royalties treated as unrelated business taxable income
A part of the Camp proposals released in 2014, this provision is not present in the House proposal of the bill even after markups ending on Nov. 9, 2017. This provision modifies the unrelated business income tax (UBIT) treatment of the licensing of an organization’s name or logo generally to subject royalty income derived from such a license to UBIT.
Specifically, the proposal amends section 513 (regarding unrelated trades or businesses) to provide that any sale or licensing by an organization of any name or logo of the organization (including any trademark or copyright related to a name or logo) is treated as an unrelated trade or business that is regularly carried on by the organization. In addition, the proposal amends section 512 (regarding unrelated business taxable income) to provide that income derived from any such licensing of a name or logo of the organization is included in the organization’s gross unrelated business taxable income, notwithstanding the provisions of section 512 that otherwise exclude certain types of passive income (including royalties) from unrelated business taxable income.
This provision will be effective for tax years beginning after Dec. 31, 2017.
Unrelated business taxable income separately computed for each trade or business
This provision was a part of the 2014 Camp tax reform legislation, and is not currently in the House version of the bill after markup ending on Nov. 9, 2017.
Under the provision, and for an organization with more than one unrelated trade or business activity, the proposal requires that unrelated business taxable income first be computed separately with respect to each trade or business and without regard to the specific deduction generally allowed under section 512(b)(12). The organization’s unrelated business taxable income for a taxable year is the sum of the amounts (not less than zero) computed for each separate unrelated trade or business, less the specific deduction allowed under section 512(b)(12). A net operating loss deduction is allowed only with respect to a trade or business from which the loss arose.
The result of the proposal is that a deduction from one trade or business for a taxable year may not be used to offset income from a different unrelated trade or business for the same taxable year. The proposal generally does not, however, prevent an organization from using a deduction from one taxable year to offset income from the same unrelated trade or business activity in another taxable year, where appropriate.
This provision would be applicable for tax years beginning after Dec. 31, 2017.
Repeal of tax-exempt status for professional sports leagues
The proposal strikes from section 501(c)(6) the phrase “professional football leagues (whether or not administering a pension fund for football players.” In addition, the proposal amends section 501(c)(6) to provide that section 501(c)(6) “shall not apply to any professional sports league (whether or not administering a pension fund for players)” effective for tax years beginning after Dec. 31, 2017.
Modification of taxes on excess benefit transactions (intermediate sanctions)
Under the proposal, if an initial tax is imposed on a disqualified person under the intermediate sanctions rules of section 4958, the organization is subject to an excise tax equal to 10 percent of the excess benefit, unless the participation of the organization in the transaction is not willful and is due to reasonable cause. No tax on the organization is imposed if the organization:
- Establishes that the minimum standards of due diligence were met with respect to the transaction; or
- Establishes to the satisfaction of the Secretary that other reasonable procedures were used to ensure that no excess benefit was provided.
Eliminate rebuttable presumption and establish due diligence procedures
The proposal eliminates the rebuttable presumption of reasonableness contained in the intermediate sanctions regulations. Under the proposal, the procedures that presently provide an organization with a presumption of reasonableness (i.e., advance approval by an authorized body, reliance upon data as to comparability, and adequate and concurrent documentation) generally will establish instead that an organization has performed the minimum standards of due diligence with respect to an arrangement or transfer involving a disqualified person. Satisfaction of these minimum standards will not result in a presumption of reasonableness with respect to the transaction.
This provision was actually written a number of years ago and was originally housed in the ACA, passed in 2010, but it was removed during that bill’s reconciliation process.
Eliminate certain special rules for knowing behavior by organization managers
The proposal eliminates the special rule that provides that an organization manager’s participation ordinarily is not “knowing” for purposes of the intermediate sanctions excise taxes if the manager relied on professional advice. Although the proposal eliminates the special rule, whether an organization manager relies on professional advice is a relevant consideration in determining the manager knowingly participated in an excess benefit transaction.
The proposal also eliminates the special regulatory rule that provides that an organization manager ordinarily does not act knowingly for purposes of the excess benefit transaction excise tax if the organization has met the requirements of the rebuttable presumption procedure.
Treat investment advisors and athletic coaches as disqualified persons
The proposal modifies the definition of a disqualified person for purposes of the intermediate sanctions rules. First, a person who performs services as an athletic coach for an organization that is an eligible educational institution (within the meaning of section 25A of the Internal Revenue Code) is treated as a disqualified person with respect to the organization.
Second, the proposal (1) expands to all organizations that are subject to the intermediate sanctions rules the present-law rule that treats investment advisors to donor advised funds as disqualified persons, and (2) modifies the definition of investment advisor for this purpose. For all applicable tax-exempt organizations (including sponsoring organizations of donor advised funds), the term investment advisor means, with respect to an organization, any person compensated by the organization, and who is primarily responsible, for managing the investment of, or providing investment advice with respect to, assets of the organization. For a sponsoring organization of a donor advised fund, the term investment advisor also includes any person who is an investment advisor with respect to a sponsoring organization under present law, i.e., a person (other than an employee of the organization) compensated by such organization for managing the investment of, or providing investment advice with respect to, assets maintained in donor advised funds owned by the sponsoring organization.
Application of intermediate sanctions rules to section 501(c)(5) and section 501(c)(6) organizations
This aspect of the changes above was actually a part of the Camp 2014 tax reform proposed legislation and is included in the Senate proposal of the bill. The proposal extends application of the section 4958 intermediate sanctions rules to tax-exempt organizations described in sections 501(c)(5) (labor and certain other organizations) and 501(c)(6) (business leagues and certain other organizations). The provision is effective for tax years beginning after Dec. 31, 2017.
Denial of deduction for amounts paid in exchange for college athletic seating rights
This provision is in the House proposal of the bill which amends section 170(l) to provide that no charitable deduction shall be allowed for any amount described in paragraph 170(l)(2), generally, a payment to an institution of higher education in exchange for which the payor receives the right to purchase tickets or seating at an athletic event.
Other provisions in the Senate version of the TCJA applicable to tax-exempt organizations
Increase percentage limit for charitable contributions of cash to public charities
This proposal mirrors the House bill’s proposal and increases the income-based percentage limit described in section 170(b)(1)(A) for certain charitable contributions by an individual taxpayer of cash to public charities and certain other organizations from 50 percent to 60 percent. The proposal is effective for contributions made in taxable years beginning after Dec. 31, 2017.
Excise tax on excess tax-exempt organization executive compensation
As in the House version of the bill, an employer is liable for an excise tax equal to 20 percent of the sum of the (1) remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee by an applicable tax-exempt organization for a taxable year, and (2) any excess parachute payment (under a new definition for this purpose that relates solely to separation pay) paid by the applicable tax-exempt organization to a covered employee.
Accordingly, the excise tax applies as a result of an excess parachute payment, even if the covered employee’s remuneration does not exceed $1 million.
For purposes of the proposal, a covered employee is an employee (including any former employee) of an applicable tax-exempt organization if the employee is one of the five highest compensated employees of the organization for the taxable year or was a covered employee of the organization (or a predecessor) for any preceding taxable year beginning after Dec. 31, 2016. An “applicable tax-exempt organization” is an organization exempt from tax under section 501(a), an exempt farmers’ cooperative, a federal, state or local governmental entity with excludable income, or a political organization.
Remuneration means wages as defined for income tax withholding purposes, but does not include any designated Roth contribution.
However, remuneration of a covered employee that is not deductible by reason of the $1 million limit on deductible compensation is not taken into account for purposes of the proposal.
Under the proposal, an excess parachute payment is the amount by which any parachute payment exceeds the portion of the base amount allocated to the payment. A parachute payment is a payment in the nature of compensation to (or for the benefit of a covered employee) if the payment is contingent on the employee’s separation from employment and the aggregate present value of all such payments is three times or more the base amount. The base amount is the average annual compensation includible in the covered employee’s gross income for the five taxable years ending before the date of the employee’s separation from employment. Parachute payments do not include payments under a qualified retirement plan, a simplified employee pension plan, a simple retirement account, a tax-deferred annuity, or an eligible deferred compensation plan of a state or local government employer.
The employer of a covered employee is liable for the excise tax. If remuneration of a covered employee from more than one employer is taken into account in determining the excise tax, each employer is liable for the tax in an amount that bears the same ratio to the total tax as the remuneration paid by that employer bears to the remuneration paid by all employers to the covered employee.
The proposal applies to taxable years beginning after Dec. 31, 2017.
Provisions in the House proposal not in the Senate proposal
The Senate proposal is silent on a number of provisions including the changes proposed by the House including:
- The calculation of the housing allowance
- Repeal of the tuition reduction plans under section 117(d)
- Repeal of education assistance plans under section 127
- The applicability of the unrelated business income tax for tax-exempt entities tax exempt under both 501(a) and 115(1)
- Repeal of private activity bonds (although the repeal of refunding bonds are included in the Senate version)
- Treatment as unrelated business income certain benefits provided to employees
- Flat tax to private foundation net investment income of 1.4 percent
- Art museum operating rules for favorable private operating foundation treatment
- Additional reporting requirements for sponsoring organization of donor advised funds