27 January 2022 - Article
Many changes proposed in the tax reform bills advanced by the House of Representatives and Senate, particularly those pertaining to private foundations, failed to make it into the final legislation approved by Congress and signed into law by the President. The following is a summary of what's in and what's out:
60% of AGI limit on cash contributions – IN!
Under current law, the deduction for charitable contributions by individuals is limited to a specified percentage of a donor's adjusted gross income, which varies based on the type of property contributed and the status of the recipient organization. The consensus bill expands the current limitations, allowing individuals to deduct cash contributions to public charities, donor advised funds and private operating foundations up to 60% of their adjusted gross income. As under current law, any excess contributions over the 60% limit can be carried forward and deducted in each of five succeeding years.
Deduction relating to amounts paid for right to purchase tickets – IN!
The consensus legislation repeals the current rule allowing a charitable deduction for 80% of amounts paid for the right to purchase tickets to college athletic events.
Charitable deductions from ESBT income – IN!
The consensus legislation contains a new provision which addresses charitable deductions by electing small business trusts (“ESBTs”). Under the new provision, the unlimited charitable deduction available to non-grantor trusts under Section 642( c ) is made expressly inapplicable to contributions made from S income earned by an ESBT. Instead, contributions from S income earned by an ESBT are subject to the percentage and other limitations that apply to individuals under Section 170.
Penalty tax on excessive compensation paid by nonprofits – IN!
A new penalty tax provision will be applied to excessive compensation paid to certain highly-paid employees of non-profit organizations, including all 501( c )(3) organizations. The tax applies to employees who are among the organization's five most highly-paid, taking into account an aggregation rule covering employees doing work for several related organizations, and generally applies a 21% excise tax on compensation in excess of $1 million annually, as well as certain severance payments in excess of three times the employee's annual salary. Importantly, payments of nonqualified deferred compensation are subject to the tax only when a risk of forfeiture lapses, meaning a lump-sum payment of deferred compensation accrued over many years could potentially trigger the excess compensation tax.
The “Harvard” tax – IN!
The consensus bill also includes a new excise tax on the investment income of private colleges and universities equal to 1.4% of the institution's net investment income is imposed. The tax would apply generally to private colleges and universities having more than 50% of their students living in the US, and whose endowments exceed $500,000 per full time student. Third party analyses have estimated that this take will apply to only 30 colleges and universities nationwide.
Rules relating to UBIT – Senate and House provisions are both IN!
The new law provides a statutory rule that unrelated trades or business of charities are treated separately for purposes of determining taxable income and loss for a non-profit. Effectively, this means that each activity is place into a separate basket such that gains of one activity cannot be offset by losses of another activity. The bill also increases unrelated business taxable income by the amount of certain fringe benefit expenses for which a deduction is disallowed.
Revised private foundation excise tax – OUT!
The House Bill included a provision that would have changed the excise tax rates on the investment income of private foundations from the two tiered 2%-1% tax to a blended 1.4% rate on all investment income. This change failed to make the final bill, which means that private foundations remain subject to the two tiered 1%-2% tax rates.
Private art museums – OUT!
The House Bill would have required art museums claiming status as private operating foundations to be open to the public for at least 1,000 hours annually. This provision was likely an outgrowth of an inquiry last year by the Senate Finance Committee, which expressed concern that some private art museums were not providing sufficient public benefit to merit the preferential tax treatment afforded to their donors. This requirement failed to make it into the final legislation.
“Newman's Own” exception – OUT!
Newman's Own Inc., the popular food manufacturer that has donated all of its after-tax profits to charity since its founding in 1982, was transferred to Newman's Own Foundation after Paul Newman's death in 2008. As a private foundation, the Newman's Own Foundation is subject to the “excess business holdings” rule, which limits the stake it can hold in a for-profit business under penalty of a 200% excise tax. Following nearly a decade of aggressive lobbying by Newman's Own Foundation, the House version of the tax reform bill would have amended the excess business holdings rule to provide a special exception where four criteria are met: (i) a foundation owns all of a for-profit business' voting stock, (ii) the foundation did not acquire its interests by purchase, (iii) the for-profit business distributes its net operating income to the foundation within 120 days of the close of its tax year, and (iv) the for-profit business' directors and executives are not foundation insiders. Unfortunately for the Newman's Own Foundation (and other business owners interested in charitably-focused succession plans), this provision failed to make it into the consensus bill.
Political statements by religious organizations – OUT!
The House Bill would have qualified the so-called “Johnson Amendment,” which prohibits charitable organizations from “participating in, or intervening in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office,” to allow charitable organizations to make political statements in the ordinary course of business so long any associated expenditures were de minimus. This provision was left out of the consensus bill.
Increased reporting by donor advised funds – OUT!
Unlike private foundations, which are required to make annual donations of 5% of their non-charitable use assets, donor advised funds are not currently required to make annual distributions. The House Bill would have continued this rule, but would have required organizations maintaining donor advised funds to report the average value of grants made each year as a portion of their endowments and to report whether they have a policy in place regarding the frequency and minimum level of distribution required with respect to donor advised accounts. This provision was left out of the consensus bill.