The phrase “nonprofit tax day” may sound like an oxymoron or punchline of a joke, but it’s real. Tax-exempt organizations must pay significant new taxes to the U.S. Treasury (and to some states) by May 15 if they operate on a calendar-year basis.
Many tax-exempts will be paying taxes for the very first time this year because of provisions in the 2017 federal tax law. That law imposes tax liabilities on charities, houses of worship, and other nonprofits to generate new revenue and offset tax cuts for for-profit corporations and individuals. Here are notable new taxes on nonprofits and what groups are saying and doing about them:
1. Nonprofit Transportation Benefits Tax
Perhaps the most notorious of the new taxes on tax-exempt organizations is the one that requires nonprofits to pay a 21-percent unrelated business income tax on expenses nonprofits incur in providing their employees with transportation fringe benefits, such as parking and transit passes. Yes, an income tax on expenses. In December 2018, the Treasury Department and the IRS issued partial guidance (Notice 2018-99) on how to calculate this new tax on parking expenses, but assumes that all expenses for bus and transit passes are subject to the tax. With both parking and transit benefits, the government will require the nonprofit employers to pay the 21-percent tax even on the amounts that employees request to be withheld from their paychecks for parking and transit pursuant to voluntary compensation reduction agreements.
In addition to previous protests, last month more than 600 tax-exempt organizations wrote Congresshighlighting that the interim guidance “is incomplete and raises more questions for tax-exempt organizations that struggle to comply,” and reiterating their call for the law’s repeal. There is zero support on Capitol Hill for the misguided tax on nonprofit transportation benefits; the House voted to repeal it last December and numerous bipartisan bills to repeal the tax are pending in the new Congress. And yet, charitable, religious, and other nonprofit organizations must divert dollars from their missions to first calculate and then pay this unjust and hopefully temporary tax. Learn more about advocacy efforts to repeal the nonprofit transportation benefits tax.
2. Separate “Trade or Business” Silo-ing Tax
New Internal Revenue Code Section 512(a)(6) increases the tax liability of nonprofit organizations by imposing unique allocation or accounting rules on revenue-generating operations that are not similarly imposed on for-profit businesses. Specifically, the new provision mandates that nonprofits “with more than 1 unrelated trade or business” compute their unrelated business income (and related losses) earned “separately with respect to each such trade or business.” This means that instead of aggregating their profits and losses from all of their unrelated business activities, nonprofits must now “silo” their revenues and expenses for each “separate” “trade or business” and pay the unrelated business income tax on each. Again, for-profit businesses are treated much better because they can continue to aggregate revenues expenses across several business lines, and thereby reduce their tax liabilities.
In a temporary ruling issued in August 2018 (Notice 2018-67), Treasury and the IRS acknowledged the frustration and confusion that nonprofits are experiencing, stating: “There is no general statutory or regulatory definition defining what constitutes a ‘trade or business’ for purposes of the Internal Revenue Code.” The Notice expressly provides that nonprofits may rely on a reasonable, good faith interpretation of the UBIT statutes in determining whether their organizations have more than one “trade or business.” It offered as a partial solution the option of nonprofits collecting revenues/expenses in groupings based on the complex North American Industry Classification System, an approach that works for some activities (e.g., advertising), but not others (e.g., facilities rentals). There are bipartisan bills in the House and Senateto repeal the tax, but damage has already been done in terms increased accounting costs and tax payments due on May 15. Learn more.
3. Highly Compensated Executives Excise Tax
On the surface, the 2017 tax law targeted million-dollar salaries by nonprofit executives, but the impact reaches many more organizations with much lower pay scales. Section 4960 of the tax code imposes a 21-percent excise tax on nonprofits for (a) the portion of certain employees’ compensation that exceeds $1 million and (b) what are deemed excess severance payments. The tax, payable by the nonprofit, applies to the compensation and some benefits of any employee who is or was one of the five highest-compensated employees of the exempt organization, or a related organization.
Surprising many, the IRS announced in interim guidance late last year (Notice 2019-09) that the tax goes much farther than anyone imagined, even to some nonprofits that pay their executives less than $1 million in compensation. The tax, as the IRS sees it, applies to deferred compensation severance packages on base salaries starting as low as $120,000. Also, the IRS will take into consideration all related organizations, which can include taxable, tax-exempt, and governmental entities. The rules are exceedingly complex but the bottom line is that many unsuspecting nonprofits are being hit by this tax that goes far beyond penalizing just higher education and health care (“eds & meds”) for paying competitive salaries to hire the most qualified talent to lead the significant work of nonprofits.
4. Higher Education Endowments Excise Tax
Another new provision in the 2017 tax law imposes on nearly 40 large higher education institutions a 1.4 percent excise tax on the net investment income from their endowments and other assets that generate income. For covered institutions, the law levies the tax on the aggregate fair market value of the assets that are not used directly in carrying out the institution’s exempt purpose. That means that investment returns not spent immediately on a narrow set of expenses are subject to the tax, regardless of donor and board restrictions, and additional priorities such as building reserves for new programs. The presidents of six Massachusetts universities targeted by the law warned in a recent letter, “The impact of this pernicious tax will grow significantly over time, as more institutions are affected, and the levy erodes our philanthropic resources.”
This tax on the endowment returns of certain institutions of higher education is unsound policy objectionable to all charitable organizations that have the foresight and ability to build reserves that are dedicated to advancing their missions. It could lead to politicians overstepping into the board rooms of independent nonprofits to dictate how informed fiduciary trustees must spend funds from reserves.
Until Now, “nonprofit tax day” was not a thing. By definition, tax-exempt organizations don’t pay taxes. For many charitable, religious, and other types of nonprofit organizations, May 15, 2019 is the beginning of a very dark chapter in U.S. tax policy history. With effective advocacy, these wrongs committed on organizations dedicated to the public good can be reversed and nonprofits can return their full attention to what they do best: solving problems in their communities.
Are any of these taxes diverting dollars from your nonprofit’s mission? Let us know.