The House and Senate negotiators emerged on Friday, December 15, 2017, with a compromise tax reform proposal that would overhaul the Internal Revenue Code for the first time since 1986. Nonprofit hospitals and other tax-exempt organizations breathed a sigh of relief when the conference committee decided to preserve private activity bonds and maintain the medical expense deduction, but the compromise proposal contains a number of potentially far-reaching provisions that will impact the governance and operations of charitable hospitals.
What’s In?
Individual Mandate
The conference committee bill would repeal the individual mandate imposed as part of the Affordable Care Act. The Joint Committee on Taxation (JCT) projects that eliminating the tax penalty imposed on individuals for failing to buy health insurance will save $338 billion over the next ten years. Repealing the mandate produces the estimated savings as a result of lower income individuals electing not to purchase health coverage and foregoing the accompanying Federal tax subsidies.
The American Hospital Association, the American Medical Association, and America’s Health Insurance Plans opposed repealing the individual mandate without an alternative health reform plan. These organizations argue that repealing the individual mandate will result in a significant increase in insurance premiums, leaving ten million without access to affordable health insurance.
Executive Compensation Excise Tax
Charitable hospitals and other nonprofit organizations will face a new 21-percent excise tax on the amounts in excess of $1 million that they pay to each of their five highest paid employees. The charitable hospital would remain liable for the excise tax in future years even if the individual no longer ranks as one of its top five highest paid. The excise tax will also apply to certain parachute payments that typically arise at retirement or severance.
The House and Senate had each passed a 20-percent executive compensation excise tax, but the conference committee increased the tax to 21 percent so that it equaled the new corporate tax rate. In a move likely to lessen the excise tax burden on some charitable hospitals, the conference committee proposed to exempt compensation paid to physicians in exchange for their professional services from the tax. However, if a physician is paid by a charitable hospital in any other capacity, such as serving as a chief executive officer, chief medical officer, or an employed medical director, the tax would apply. The executive compensation excise tax will become effective for tax years beginning after December 31, 2017.
Tax-Exempt Bonds – Advance Refunding
House and Senate negotiators spared private activity bonds from elimination in the compromise legislation, but they elected to retain a proposal to terminate advance refunding bonds issued after December 31, 2017. Taking this financing mechanism away from charitable hospitals and other nonprofit organizations is expected to generate $17.4 billion over the next ten years.
UBIT – Fringe Benefits
The conference committee retained a House proposal to tax charitable hospitals and other nonprofit organizations on the expenses they incur in providing employees with transportation benefits, parking facilities, and on-premises gyms and other athletic facilities. Under the tax reform legislation, the value of these fringe benefits would be treated as unrelated business income and would be subject to the corporate tax rate. The provision is designed to mirror changes in the deductibility of these fringe benefits by for-profit employers, and it would apply to any amounts paid or incurred after December 31, 2017.
UBIT – Calculation
The Senate proposal for charitable hospitals and other tax-exempt organizations to calculate unrelated business income separately for each line of business prevailed in the conference committee. This change means that gains from one activity could not be offset with losses from another. The IRS had previously expressed concern about tax-exempt organizations utilizing large losses from activities to reduce or eliminate any unrelated business income tax, and its agents had occasionally attempted to assert this position during audits of tax-exempt organizations. Calculating unrelated business income in this manner is expected to generate $3.5 billion over the next ten years. This revision will become effective for tax years beginning after December 31, 2017.
UBIT – Net Operating Loss Deduction
The conference committee limits the use of net operating losses in a more draconian fashion than what the House or Senate had originally proposed. The House and Senate had each proposed allowing net operating losses to offset only 90 percent of taxable income. The conference committee decided to limit net operating losses rising in tax years beginning after December 31, 2017, to 80 percent of taxable income. This change appears to be a significant component of how Congress will pay for the tax reform legislation as the JCT expects it to generate over $200 billion in the next ten years.
College Endowment Excise Tax
The compromise legislation also includes a 1.4-percent excise tax on the investment income that colleges and universities earn from holdings in their endowments. The new excise tax applies to tax years beginning after December 31, 2017, and it is expected to generate over $1.8 billion over the next ten years.
Deductibility of Medical Expenses
For 2017 and 2018, the conference agreement allows all taxpayers to deduct medical expenses exceeding 7.5 percent of adjustable gross income. In 2019, the threshold would return to its current 10 percent. The House bill had proposed eliminating this deduction entirely, but the Senate bill retained and expanded the provision. According to the JCT, expanding the current deduction to all taxpayers, as opposed to retaining the current law limiting the deduction to those age 65 and older, for 2017 and 2018 is projected to cost $4.6 billion over ten years.
What’s Out?
The final tax reform legislation did not include several controversial measures that the House had proposed. As noted earlier, the compromise legislation spares private activity bonds, and makes no further changes to the unrelated business income tax. Dual status entities, like many county hospitals, had feared a proposal that expressly sought to subject their business activities to the unrelated business income tax, and tax-exempt research organizations had faced a proposal that would have narrowed exclusions they utilize in calculating unrelated business income. Finally, the conference committee denied efforts by the House to allow charitable organizations to engage in political activities.
The House and Senate are expected to vote on the agreement early this week. The conference report can be found here.
