Author: Thomas M. Denson, III, CPA, Partner | Not-for-Profit Industry Team
In February 2014, the House of Representatives Ways and Means Committee released “The Tax Reform Act of 2014,” a tax reform package that included a number of potential changes to tax exempt organizations. These changes could result in significant new tax liabilities on not-for-profits.
In our June article on Proposed Changes for Not-for-Profits, Ginny Belcher summarized the proposed changes to Unrelated Business Income Tax (UBIT) that are included in the Tax Reform Act of 2014. In this article, we provide a summary of the Act’s proposed changes to Excise Taxes and Intermediate Sanctions.
In 1996, Congress enacted what is now referred to as “intermediate sanctions” to provide the IRS with a more effective enforcement tool to guard against inappropriate payments and benefits given to tax-exempt organization leaders and insiders. In cases where excessive benefits are paid to certain insiders of 501(c)(3) and 501(c)(4) organizations, an excise tax may be imposed on those that benefit as well as organization managers who approved the benefits.
Proposed New Rules
The Tax Reform Act of 2014 proposes new changes to the current rules regarding intermediate sanctions. The most significant change is a 25 percent excise tax on executive compensation over 1 million dollars (including parachute payments) to be paid by the organization. This proposed tax applies to any of the five highest compensated not-for-profit employees within the organization. If the new rule takes effect, it will bring not- for-profit organization compensation rules in line with the tax-deductibility rules already in place for public companies.
Other proposed changes include:
› Excise Taxes and Intermediate Sanction will also apply to 501(c)(5) and 501(c)(6) organizations.
› Not-for-profit organizations will be liable for an additional 10% excess benefit tax if certain minimum standards of due diligence or other procedures were not followed
› Removal of the ‘rebuttable presumption of reasonableness’ law which provides a presumption that a transaction is not excessive if certain procedures are followed.
› Removal of the ‘professional advice’ safe harbor for managers who approve a transaction after relying on professional advice
› Expansion of the definition of an insider to include athletic coaches and investment advisors (note: the tax code refers to insider as ‘disqualified person’)
Several other changes that are proposed to excise tax rules include:
› If donor-advised funds have not been distributed within five years, a tax equal to 20 percent of the undistributed portion will be imposed.
› One percent excise tax on private educational institutions that have assets of at least 100,000 dollars per full-time student based on fair market value
› For private foundations:
- A 2.5 percent excise tax on the amount involved in self-dealing as well as elimination of the special rule that a manager’s participation is usually not “knowing” for purposes of self-dealing excise taxes.
- Excise tax on net investment income for private foundations is lowered to 1 percent
- Repeal of the exception for private operating foundation that fail to distribute income
Although they do not expect to vote on these changes this year, many of these proposed changes could find their way into future legislation, which could change the tax obligations of not-for-profits.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.