Republicans in the U.S. House of Representatives introduced the Tax Cut and Jobs Act, H.R. 1, on November 2, 2017, with the goal of overhauling the nation’s tax code for the first time in 31 years. The House Ways & Means Committee issued a statement introducing the bill saying the tax proposals would ensure tax-exempt organizations, including charitable hospitals, “focused on helping the American people – not as a for-profit business looking to pad their bottom line ….” The bill does not alter the community benefit standard or modify the requirements of Section 501(r) that tax-exempt, charitable hospitals must meet, but it proposes significant changes that, if enacted, could dramatically affect their operations. If passed, the changes imposed by the bill generally would be effective for taxable years beginning after December 31, 2017.

Key provisions of the bill for tax-exempt, charitable hospitals include the following:

• Foreclosing Financing Opportunities – Hoping to save $56.2 billion over the next 10 years, the bill eliminates private activity bonds issued after December 31, 2017, and limits the use of advance refunding bonds. These changes would increase borrowing costs for tax-exempt, charitable hospitals by taking away a key funding source for building or renovating facilities, expanding service lines, and investing in new technologies.
• Penalizing Certain Executive Compensation Arrangements – Commentary summarizing the House proposal questions whether high salaries paid by tax-exempt organizations divert resources away from charitable activities. The bill answers this question affirmatively by imposing a 20 percent excise tax on compensation in excess of $1 million. Tax-exempt organizations must pay the excise tax for each of their five highest paid employees who received more than $1 million in compensation during the tax year. If the employee received compensation from both the tax-exempt organization and other related organizations, the employee’s compensation would be aggregated for purposes of determining whether the $1 million threshold was met, and if so, the tax-exempt organization and each related organization would be responsible for paying its proportionate share of the excise tax. The excise tax would apply to the employee’s compensation in future years if he or she earned more than $1 million, even if the employee was no longer one of the five highest paid employees. Certain severance arrangements would also trigger excise tax liability.

Tax-exempt, charitable hospitals must already ensure that the compensation they pay to their executive leaders and other employees is consistent with fair market value, or the organizations can risk excise tax liability being imposed on these employees and potentially board members under the intermediate sanctions provisions of Code section 4958. This new, automatic excise tax suggests that Congress does not believe the intermediate sanctions regime has appropriately policed executive compensation.

• Expanding the Unrelated Business Income Tax – The authors of the bill cited perceived advantages that tax-exempt organizations have over for-profit competitors as reasons for expanding the scope of the unrelated business income tax (UBIT). For example, amounts incurred in providing employees with transportation fringe benefits, on-premises gyms, and parking facilities would be subject to UBIT to the extent a deduction for such expenses is not available. The bill also limits the use of net operating loss deductions in computing unrelated business income, and it clarifies that all entities with dual status (that is, an entity exempt from tax under more than one provision of the Code, one of which includes Section 501(a)), such as a governmental hospital that has received a determination letter under Section 501(c)(3), would be subject to UBIT. Finally, the bill narrows an existing exclusion from UBIT for organizations operated primarily for the purpose of carrying on fundamental research, the results of which are freely available to the general public. Current law excludes from UBIT all revenue attributable to any research performed by such organizations. The proposal, however, would limit the exclusion, so that only revenue attributable to the fundamental research performed by such organizations would be excluded from UBIT. In other words, revenue attributable to non-fundamental research would be subject to UBIT under the bill.
• Taxing University Endowments – House Republicans also impose a new 1.4 percent tax on investment income earned by private colleges and universities with at least 500 students and assets (other than those assets used directly for educational purposes) of $100,000 per full-time student. The Chronicle of Higher Education reported that the tax would affect approximately 140 colleges and universities. This proposal potentially could take financial support away from an academic medical center’s clinical care, teaching and research activities, particularly if the academic medical center is operated as a division of the college or university.

Rep. Kevin Brady (R-Texas), chairman of the House Ways & Means Committee, announced that the Committee would mark up the bill starting on November 6. Rep. Brady also stated that the House would not entertain amendments to the bill from the House floor. The Senate is expected to release its plan for tax reform this week, and many expect the Senate bill to feature similar provisions, including the excise tax on executive compensation.

The Tax Cut and Jobs Act is available here. A section-by-section summary of the bill is available here.