Proposed Tax Legislation: Implications for Tax-Exempt Organizations

The Committee’s proposed legislation is part of the highly anticipated legislative package intended to extend expiring provisions of the 2017 Tax Cuts and Jobs Act (TCJA) and to implement other priorities of President Trump and the Republican Majority in US Congress. 

The provisions summarized below from the House Ways and Means Committee text could impact tax-exempt organizations.

The Ways and Means Committee is one of 11 House Committees that developed and reported legislation as part of the budget reconciliation process being used to advance tax reform and other key legislative priorities. The US House Budget Committee will hold a markup of the compiled legislation from the 11 Committees on May 16. The Budget Committee has announced it will accept written statements on the legislation between now and close of business on May 19. House leadership has announced plans for a floor vote on the compiled reconciliation legislation before Memorial Day.

Excise Tax on Net Investment Income of Private Foundations

Under current law, private foundations (other than exempt operating foundations) are subject to a 1.39% excise tax on their net investment income.[1] The Ways and Means Committee legislative text (proposal) replaces the flat 1.39% excise tax rate with a four-tiered structure based on the foundation’s total assets:

• Foundations with assets below $50 million: 1.39%.
• Foundations with assets between $50 million and $250 million: 2.78%.
• Foundations with assets between $250 million and $5 billion: 5%.
• Foundations with assets above $5 billion: 10%.

Under the proposal, assets of a private foundation are determined based on the fair market value of a foundation’s total assets, without reducing any liabilities. The total assets of a private foundation for this purpose also include the assets of a private foundation’s “related organizations.”[2] A related organization is any organization that controls or is controlled by the private foundation or is controlled by one or more persons that also control the private foundation. As drafted, this provision would include any related organization regardless of its tax status. It excludes, however, assets from related organizations that are not controlled by the private foundation if the assets are not intended or available for the use or benefit of the private foundation. When assets are “not intended or available for the use or benefit of the private foundation” is not defined. This could be particularly relevant for company sponsored foundations that control and provide ongoing support to the foundation.

Excess Business Holdings of Private Foundations

Under current law, Section 4943(c) of the Internal Revenue Code generally limits the holdings of a private foundation to 20% (and in some cases 35%) of the voting stock in a business enterprise that is treated as a corporation reduced by the amount of voting stock held by its disqualified persons.[3]

The proposal amends Section 4943(c)(4)(A) of the Code to allow a business enterprise to repurchase voting stock under certain conditions from a retiring employee who participated in the corporation’s Employee Stock Ownership Plan and for that stock to be considered as still outstanding stock when calculating a private foundation’s permitted holdings under the excess business holdings rules, up to a certain amount.[4] The proposal would not apply to stock buybacks within the first 10 years from when the plan is established.

Unrelated Business Taxable Income

The proposal includes three provisions that impact the determination of unrelated business taxable income (UBTI):

• Name and Logo Royalties: Under current law, royalty income is excluded from UBTI unless derived from debt-financed property or certain controlled subsidiaries.[5] The proposal would modify the royalty exception for UBTI by excluding income derived from any sale or licensing of an exempt organization’s name and logo.[6] The proposal would increase the UBTI of an exempt organization that receives royalty income from the sale or licensing of its name or logo. Similar provisions were proposed in 2014 and 2017.
• Parking Tax: Under current law, the amount paid or incurred for any qualified transportation fringe benefit (i.e., employee parking) is exempt from UBTI. The proposal would include in UBTI the cost of qualified transportation fringe benefits and parking facilities used in connection with qualified parking, with a carve-out for religious organizations.[7] This tax on the cost of providing parking to employees was initially enacted by the TCJA without the carve-out for religious organizations but was later repealed retroactively.[8]
• Research Income: Under current law, all income from any research conducted by an exempt organization whose primary purpose is to carry out fundamental research the results of which are freely available to the general public is exempt from UBTI on all income generated from all research activities.[9] The proposal would revise this exemption provision to exclude only income derived “from such research” and not income from research in general.[10]

Executive Compensation Excise Tax

Under current law, Section 4960 imposes an excise tax on exempt organizations who pay over $1 million in remuneration or who make an excess parachute payment to any “covered employee.” A “covered employee” generally includes any employee (or former employee) of an “applicable tax-exempt organization” if the employee is one of the five highest compensated employees for the current taxable year or was a covered employee in a prior year beginning after December 31, 2016.[11]

Under the proposal, the employees covered by the excise tax would be expanded to include any employee or former employee of the organization or any related person or governmental entity regardless of whether they are (or were) one of the five highest compensated employees and regardless of whether they are (or were) an employee of an “applicable tax-exempt organization.”[12]

Termination of Tax-Exempt Status for Terrorist Supporting Organizations

Under current law, Section 501(p) generally provides for the suspension of tax-exempt status for an organization designated as a “terrorist organization” or as “supporting or engaging in terrorist activity” pursuant to certain executive orders and federal laws. For example, Executive Order 13224 authorizes the US Secretary of the Treasury, “in consultation with the Secretary of State and the Attorney General,” to designate organizations as terrorist organizations.[13]

The proposal adds a definition of “terrorist supporting organizations” to Section 501(p) and defines a “terrorist supporting organization” as any organization designated by the Secretary of Treasury as having provided material support or resources to a terrorist organization.[14] The proposal provides the Secretary of the Treasury with the authority to designate an organization as a terrorist supporting organization without consulting with the Secretary of State and the Attorney General.

The proposal also requires the Secretary of the Treasury to provide notice to the organization prior to designating them as a terrorist supporting organization and provides for a 90-day cure period. During the 90-day cure period, the organization can demonstrate to the Secretary’s satisfaction that they did not provide material support or resources to a terrorist organization or, alternatively, made efforts to recoup the funds. The designation as a terrorist supporting organization can be appealed to the Internal Revenue Service’s Independent Office of Appeals, and the designation can also be legally challenged in US district court following exhaustion of the administrative process. The proposal exempts certain humanitarian aid provided with the approval of the Office of Foreign Assets Control.

College and University Endowment Tax

Under current law, Section 4968 imposes a flat 1.4% excise tax of the net investment income of certain private colleges and universities. Under the proposal, the flat 1.4% excise tax rate would be replaced with a four-tiered structure based on the institution’s student adjusted endowment:

• Institution’s student adjusted endowment between $500,000 and $750,000: 1.4%.
• Institution’s student adjusted endowment between $750,000 and $1,250,000: 7%.
• Institution’s student adjusted endowment between $1,250,000 and $2,000,000: 14%.
• Institution’s student adjusted endowment above $2,000,000: 21%.

The institution’s “student adjusted endowment” is determined based on the total fair market value of the institution’s assets (other than assets used directly in carrying out the institution’s exempt purposes) per “eligible student.”[15] For purposes of determining the institution’s total assets, the assets and net investment income of any related organization of the institution will be treated as assets of the institution. A related organization is any organization that controls or is controlled by the institution, is controlled by one or more persons that also control the institution or is a supported or supporting organization with respect to the institution.

An “eligible student” for this purpose means a student who is a “citizen or national of the United States, a permanent resident of the United States, or able to provide evidence from the Immigration and Naturalization Service that he or she is in the United States for other than a temporary purpose with the intention of becoming a citizen or permanent resident.”[16] Based on the definition of eligible student, institutions with more international students on temporary visas and undocumented students are more likely to become subject to the endowment excise tax or a higher excise tax rate.

The proposal excludes certain religious colleges or universities that have continuously maintained an affiliation with a church and have a mission that includes religious tenets, beliefs, or teachings.[17]

Charitable Deductions

• Individual Taxpayers: Under current law, only taxpayers who itemize are able to deduct their charitable contributions.[18] The proposal would temporarily reinstate a charitable contribution deduction for non-itemizing taxpayers, capped at $150 ($300 for joint returns) for cash contributions to certain qualifying charities for tax years 2025 through 2028.[19]
• Corporate Taxpayers: Under current law, corporate taxpayers are generally allowed a charitable contribution deduction up to 10% of taxable income, and charitable contributions exceeding the 10% limit can be carried forward and deducted in the following five tax years, subject to the same 10% limitation in each year.[20] The proposal would establish a new floor on charitable deductions for corporations equal to 1% of taxable income and impose new restrictions on the ability of corporations to carry forward disallowed charitable deductions to future years.[21] A corporate taxpayer with charitable contributions exceeding the 10% limitation can only add the amount disallowed under the 1% floor to the amount carried over to the subsequent year.

ArentFox Schiff’s Nonprofits and Associations and Government Relations Practices are closely monitoring the proposed tax legislation. For additional guidance, please contact your AFS attorney or any of the authors of this alert.