No one likes to talk about corporate taxes, especially those in the nonprofit industry who feel as though taxes are primarily a concern for the for-profit world. However, the new tax law passed in December 2017, known as the Tax Cuts and Jobs Act (and also known as PL 115-97/HR 1), contains four provisions that directly impact nonprofits. These four provisions are:
- Executive Compensation,
- University Endowments,
- Unrelated Business Income Tax, and
- Fringe Benefits.
Executive Compensation
With the passage of the new tax law, there is now an excise tax on excess executive compensation. Essentially, Section 501(c) and 501(d) organizations will now have to pay an annual 21% excise tax on employee compensation in excess of $1M. This rate of 21% is the top corporate income tax rate under the new law, and it’s assumed that large trade associations, universities, and hospitals will be most affected by this provision given that they are most likely to pay such high salaries.
The way the law is structured, the current top five (5) highest paid employees, irrespective of position or title, whose compensation is in excess of $1M will be subject to this 21% excise tax. However, the taxes don’t stop there. As these five employees fall out of the top five in future years, they are still part of the group of employees that are subject to this excise tax provided they are making over $1M, along with any new employees that may have joined the top five. So, the group of employees subject to this tax isn’t limited to just five employees – it can grow as those in the top five change year-over-year. The good news is that licensed professionals providing medical services, including doctors and veterinarians, are excluded and should not be counted in this employee group.
When calculating employee compensation, this will be the total of current compensation, deferred compensation, and excess parachute payments (an excess parachute payment relates to the present value of the parachute payment that is equal to or exceeds three times the base salary amount). Also included in the compensation is remuneration for services as determined for income tax withholding purposes and amounts required to be included in gross income under IRC section 457(f) — but excluding designed Roth contributions.
This provision is also applicable to political organizations under 527(e)(1) and organizations whose income is excluded under IRC section 115(1), as well as related entities (such as parent organizations).
University Endowments
Under the new tax law, there is a 1.4% excise tax for endowment investment income. This applies only to colleges and universities with endowments of at least $500K per student, and it is limited to institutions with at least 500 students and where more than 50% of the college/university’s student body is located in the US. However, this provision does not apply to state colleges and universities.
Unrelated Business Income Tax (UBIT)
As was the case before the new tax law, all income generated from unrelated business activities will be subject to UBIT; however, now at a lower tax rate of 21%. But there is a catch! Starting January 1, 2018, all income generated from unrelated business activities have to be calculated separately and the new 21% tax rate will apply to the income on each of those individual activities. Therefore, you will be unable to net the activities and pay the 21% on the whole amount as was the case before the new tax law. Thus, if you have an operating loss on one unrelated business activity, that loss carries forward to the next year as opposed to being netted against the profit-making activities for that year.
Fringe Benefits
Perhaps an area that will affect many nonprofits, certain fringe benefits are now subject to the 21% UBIT rate. These fringe benefits include qualified transportation, parking, and on-premises athletic facilities. The cost of these benefits, if provided by the employer, should be calculated and a 21% UBIT paid on them by the employer.
There are other concerns with the new tax law and its impact on nonprofits. One such concern is that the increase in the standard deduction could cause less people to donate to nonprofits going forward since there would be no need or incentive for them to itemize their deductions. In addition, the limit on the amount that a contribution can be deducted has increased from 50% of an individual’s adjusted gross income (AGI) to 60%, charitable deductions for amounts paid for college athletic event seating rights has gone from 80% to 0%, and the indexed Estate Tax exemption has doubled from $5.5M to $11M.
Needless to say, there is a lot of uncertainty in the tax community about how the IRS will apply some of these rules as the new law was put together rather quickly, left a lot of room for interpretation, and was issued without going through the proper questioning period. Given that, it is always best to reach out to a tax accountant or your organization’s audit firm before making any assumptions.
References
James Willis is a nonprofit finance and operations executive who has worked in the nonprofit field for more than 15 years, holding such positions has Chief Financial Officer, Controller, VP of Finance, Director of Finance, and Budget Manager. He is also the Director of an outsourced accounting and financial services firm specializing in nonprofits. Connect with James on LinkedIn www.linkedin.com/in/jamesawillis
FAQs
Federal and state tax laws and policies govern many of the operations of charitable nonprofits. 501(c)(3) charitable nonprofit organizations typically are exempt from paying income and property taxes and donations to their work are deductible on federal and most state tax returns.
What is the exemption of nonprofit organizations from federal income tax? ›
Nonprofit organizations are exempt from federal income taxes under subsection 501(c) of the Internal Revenue Service (IRS) tax code. A nonprofit organization is an entity that engages in activities for both public and private interest without pursuing the goal of commercial or monetary profit.
What are some specific examples of things a non-profit 501(c)(3) cannot engage in if they want to keep their IRS status? ›
6 Types of 501c3 Violations
- Private Benefit & Inurement. 501c3 rules can be broken in cases where an individual is unfairly benefiting from the organization's operations. ...
- Excessive Lobbying. ...
- Political activity. ...
- Unrelated Business Income. ...
- Failure to Submit Annual Reports. ...
- Operation in accord with stated exempt purpose(s)
Actually, no! These terms are often used interchangeably, but they all mean different things. Nonprofit means the entity, usually a corporation, is organized for a nonprofit purpose. 501(c)(3) means a nonprofit organization that has been recognized by the IRS as being tax-exempt by virtue of its charitable programs.
What are the basic rules of a 501c3? ›
Exemption Requirements - 501(c)(3) Organizations
To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual.
What is exempt from federal income tax under section 501c3? ›
Organizations organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational, or other specified purposes and that meet certain other requirements are tax exempt under Internal Revenue Code Section 501(c)(3).
Are all nonprofit organizations in the United States tax-exempt? ›
Non-profit status may make an organization eligible for certain benefits, such as state sales, property, and income tax exemptions; however, this corporate status does not automatically grant exemption from federal income tax.
How can a nonprofit lose its 501c3 status? ›
If an organization does not file its Form 990 for three (3) consecutive years, the organization's 501(c)(3) status will be revoked.
What disqualifies a 501c3? ›
Earning too much income generated from unrelated activities can jeopardize an organization's 501(c)(3) tax-exempt status. This income comes from a regularly carried- on trade or business that is not substantially related to the organization's exempt purpose.
How to lose your 501c3? ›
6 Ways to Lose Your 501(c)(3) IRS Tax-Exempt Status (Without Really Trying)
- private benefit / private inurement,
- lobbying,
- political campaign activity,
- unrelated business income (UBIT),
- annual reporting obligation, and.
- operation in accordance with the stated exempt purpose(s).
Disadvantages of Receiving 501(c)(3) Charitable Nonprofit Status
- Initial and Ongoing Costs. Creating a nonprofit organization takes time, effort, and money. ...
- Ongoing Paperwork. ...
- Shared Control. ...
- Public Scrutiny.
To perform a fundraising campaign for a charitable cause, you don't always need to be registered by 501(c)(3). Even if you can accept donations without being a nonprofit, all you need is a valid reason. There are additional ways to accept donations without being a nonprofit, aside from the tax exemption.
How much money can a nonprofit have in the bank? ›
The short answer is that there is no limit to the amount of money nonprofits can keep in reserves. As long as it can be proved that funds are being used to advance the nonprofits' mission, then the money can be directed as the nonprofit wishes.
What is the difference between a 501c3 and a 503c? ›
A 501(c) organization and a 501(c)3 organization are similar in designation, however they differ slightly in their tax benefits. Both types of organization are exempt from federal income tax, however a 501(c)3 may allow its donors to write off donations whereas a 501(c) does not.
What can 501c3 spend money on? ›
A 501c3 organization can spend funds only related to its tax-exempt philanthropic purposes. As we discussed above, if the nonprofit falls under one of these categories- charitable, educational, religious, scientific, literary, or other specified purposes, then it is only under this category that they can make spends.
What can non-profits not do? ›
Public charities cannot engage in any kind of partisan political activity, directly or indirectly. PACs can be formed by 501(c)(4)s (social welfare organizations) and 501(c)(6)s (trade associations and business leagues), but 501(c)(3)s may not create their own committees.
Are organizations exempt from tax under section 501 A? ›
Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the ...
Do you pay federal taxes if you work for a non profit organization? ›
Nonprofit organizations may include religious, educational, or charitable organizations and may not be required to pay federal taxes. However, if you are an employee of a nonprofit organization you must pay Social Security taxes on your earnings of $108.28 or more.
How to be exempt from federal taxes? ›
Who Does Not Have to Pay Taxes? Generally, you don't have to pay taxes if your income is less than the standard deduction, you have a certain number of dependents, working abroad and are below the required thresholds, or are a qualifying non-profit organization.
Are you exempt from federal withholding, yes or no? ›
You can claim exemption from withholding only if both the following situations apply: For the prior year, you had a right to a refund of all federal income tax withheld because you had no tax liability. For the current year, you expect a refund of all federal income tax withheld because you expect to have no liability.
