Excise Tax Changes Impact Tax Exempt Organizations
Posted on 02.08.18
By Virginia R. (Ginny) Belcher, CPA, Senior Tax Manager
The Tax Cut and Jobs Act (TCJA) contains several provisions that impact tax exempt organizations for tax years beginning after December 31, 2017. These new provisions may make some exempt organizations that have never been taxpayers pay federal and state tax.
Excise Tax on Tax Exempt Organization's Excess Compensation:
Prior to the new law, exempt organizations were subject to a reasonableness test for executive compensation and were prohibited from private inurement. The new law imposes an excise tax on compensation in excess of $1 million to a “covered” employee. Compensation is the sum of (a) remuneration (other than an excess parachute payment) over $1 million paid to a covered employee for a tax year; plus (b) any excess parachute payment paid by the organization to a covered employee. A “covered employee” is defined as any current or former employee of an applicable tax exempt organization if the employee is (a) one of the five highest compensated employees of the organization for the tax year, or (b) was a covered employee of the organization, or any predecessor of the organization for any tax year after December 31, 2016.
Excise Tax on Private College's Investment Income:
Before the Tax Cut and Jobs Act, private colleges and universities were treated as public charities as opposed to private foundations and were not subject to excise tax on their net investment income. However, under the new law certain colleges and universities that meet a specific size and asset requirement will be required to pay an excise tax on their net investment income. Net investment income is the institution’s gross investment income minus expenses incurred to produce this income. The tax is 1.4% of their net investment income and applies only to institutions with a least 500 students, more than half of whom are in the U.S, and which have assets of at least $500,000 per student. Assets directly used to carry out the institution’s exempt purpose are not included for this purpose. The number of students is based on a daily average of “full-time equivalent” students.
How to Compute Unrelated Business Taxable Income:
Under the old law, tax-exempt organizations computed its unrelated business income tax by reducing its gross unrelated business income by deductions directly connected with that income. If they had more than one unrelated trade or business, they could combine all income and deductions from all trades or businesses. This allowed losses from one trade or business to offset income from another trade or business thereby reducing overall unrelated trade or business income. Under the new law, exempt organizations can no longer use losses from one unrelated trade or business to offset income from another. Gains and losses are calculated and applied to each unrelated trade or business separately. However, net operating losses from pre-2018 years that are carried forward are not subject to the new calculation and are used to reduce any current year unrelated business taxable income.
As you can see, the Tax Cuts and Jobs Act may turn formerly tax-exempt organizations into tax-paying organizations. The excise tax on excess compensation, the excise tax on private college’s investment income, and the new unrelated business income tax calculation have added another level of complexity to tax-exempt organizations. Keiter is monitoring the additional commentary and IRS guidance in order to advise our clients on the implications of these new laws.