Tax Reform Act of 2014: Potential Impact on Tax-Exempt Organizations

Many of the provisions in the proposed Tax Reform Act of 2014 (“TRA 2014”) released earlier this year would adversely impact tax-exempt organizations.  For example, TRA 2014 would remove the long-time exclusion from unrelated trade or business income for royalty income from any sale or licensing by a tax-exempt organization of its name or logo, treat a sponsor’s payment as unrelated trade or business income if the tax-exempt organization uses or acknowledges the sponsor’s product lines, increase and create new penalties regarding return preparation, expand the reach of intermediate sanctions and self-dealing, repeal Type II and Type III supporting organizations, and impose a 2% adjusted gross income floor and other limitations on deductible charitable contributions.  Below is a summary of these and other proposed changes.

Unrelated Business Income Tax

The unrelated business income tax (“UBIT”) applies to income derived from a trade or business regularly carried on by a tax-exempt organization that is not substantially related to the performance of the organization’s tax-exempt functions.  The following proposals present significant changes to the UBIT rules:

  • Royalties - any sale or licensing by a tax-exempt organization of its name or logo (including any related trademark or copyright) would be treated as an unrelated trade or business and the royalties paid with respect to such licenses would be subject to UBIT.  This proposal would significantly narrow the current exclusion of royalties from UBIT.
  • No Offsets - tax-exempt organizations would be required to separately calculate the net unrelated taxable income of each unrelated trade or business, and would no longer be able to use a loss from one trade or business for a taxable year to offset a gain from a different unrelated trade or business for the same taxable year.  Any loss derived from an unrelated trade or business could be used to offset income only from that unrelated trade or business, and such losses could be carried back two years and carried forward 20 years. 
  • Research - income derived from fundamental research not made freely available to the general public would be subject to UBIT. 
  • Standard Deduction - the standard deduction against gross income subject to UBIT would increase from $1,000 to $10,000. 
  • QSPs - Qualified sponsorship payments (“QSPs”) would be affected in two substantial ways:
  • The QSP exception to UBIT would not include a payment from a sponsor in exchange for the tax-exempt organization using or acknowledging the sponsor’s product lines.  This type of payment would be treated as UBIT from advertising.
  • If a tax-exempt organization receives more than $25,000 of QSPs for any one event, any use or acknowledgement of a sponsor’s name or logo would be required to appear with, and in substantially the same manner as, the names of a significant portion of the other donors to the event.  Thus, for example, if a donor is listed as an exclusive sponsor of an event that generates more than $25,000 in QSPs, the donor’s contribution would be UBIT. 

Penalties

There are penalties imposed on a tax-exempt organization (and, in certain cases, individuals deemed to be responsible for such filings) when the organization fails to make certain required disclosures or file required information returns.  These penalties are generally not imposed if it is shown that the failure was due to reasonable cause.  TRA 2014 would double information return penalties and impose a manager-level accuracy-related penalty equal to 5% on the underpayment of UBIT, capped at $20,000.

Excise Taxes

Excise taxes apply if public charities and private foundations engage in certain transactions.  TRA 2014 broadened the scope of these excise taxes.

  • Excise taxes are imposed on excess benefit transactions between disqualified persons and public charities.  The excess benefit transaction tax regime is commonly referred to as the “intermediate sanctions” rules. 
  • Business Leagues - the excise tax on excess benefit transactions would be expanded to labor, agricultural, and horticultural organizations and business leagues, chambers of commerce, real estate boards, and boards of trade.
  • Organization Level Tax - when the excess benefit excise tax is imposed on a disqualified person, there would be an excise tax of 10% on the tax-exempt organization. This entity-level tax would be avoided if the organization follows the minimum standards of due diligence or establishes, to the satisfaction of the IRS, that other procedures were used to attempt to ensure there was not an excess benefit. 
  • No Safe Harbor - there would no longer be a presumption of reasonableness safe harbor for the tax-exempt organization when the organization satisfies the minimum standards of due diligence.  The procedures that currently establish a presumption of reasonableness will establish only that an organization has performed the minimum standards of due diligence with respect to an arrangement or transfer involving a disqualified person.
  • Reliance on Advice - there would be no professional advice safe harbor, meaning a manager’s reliance on professional advice, by itself, would not preclude the manager from being subject to the excise tax for participating in an excess-benefit transaction.  Professional advice would still be a relevant consideration in determining if the manager knowingly participated in an excess benefit transaction.
  • Excise taxes are imposed on acts of self-dealing between a disqualified person and a private foundation. 
  • Organization Level Tax - an excise tax of 2.5% would be imposed on a private foundation when the self-dealing tax is imposed on a disqualified person.  The tax rate would be 10% for cases in which the self-dealing involves the payment of compensation.
  • Reliance on Advice - foundation managers would no longer be able to rely on the professional advice safe harbor, meaning a manager’s reliance on professional advice would not preclude the manager from being subject to the excise tax for participating in a self-dealing transaction.  Professional advice would still be a relevant consideration in determining if the manager knowingly participated in a self-dealing transaction.
  • Donor Advised Funds - contributions to donor advised funds would need to be distributed for charitable purposes within five years.  The failure to make a timely distribution would subject the charitable organization to an annual excise tax equal to 20% of the undistributed funds.
  • Net Investment Income - the excise tax rate on private foundation net investment income would be reduced to 1% in all cases.
  • Colleges – private colleges and universities with assets valued at the close of the preceding tax year of at least $100,000 per full-time student would be subject to a 1% excise tax on their net investment income.  This would not apply to state colleges and universities.

Elimination of Type II and Type III Supporting Organizations

Currently, a supporting organization must maintain one of three relationships with the supported public charity.  The organization must be:  (1) operated, supervised, or controlled by a publicly supported organization (Type I); (2) supervised or controlled in connection with a publicly supported organization (Type (II); or (3) operated in connection with a publicly supported organization (Type III). 

  • Under TRA 2014, Type II and Type III supporting organizations would no longer satisfy the “relationship” test, and therefore would be treated as private foundations.

Charitable Contributions

Several proposals in TRA 2014 would affect individual giving incentives and charitable contributions. 

  • 15 Month Rule - individual taxpayers would be permitted to deduct charitable contributions made after the close of the tax year but before the due date of the return for the tax year (April 15 for calendar year taxpayers) covered by the return.
  • Percentage Limitations - adjusted gross income (“AGI”) limitations on deductible contributions would be simplified, but also reduced in some cases.  The 50% limitation for cash contributions and the 30% limitation for contributions of capital gain property to public charities and certain private foundations would be harmonized at a single limit of 40%.  The 30% contribution limit for cash contributions and the 20% limitation for contributions of capital gain property that apply to organizations not covered by the 50% limitation rule would be harmonized at a single limit of 25%. 
  • 2% Floor - an individual’s charitable contributions would be deductible only to the extent they exceed 2% of the individual’s AGI, known as a deduction “floor.” 
  • Property Contributions - the amount of any charitable deduction would generally be equal to the adjusted basis of the contributed property.  For the following types of property, the deduction would be based on the fair market value of the property less any ordinary gain that would have been realized if the property had been sold by the taxpayer at its fair market value:
  1. tangible property related to the purpose of the donee;
  2. any qualified conservation contribution;
  3. any qualified inventory contribution;
  4. any qualified research property; and
  5. publicly traded stock.
    • Thus, for example, fair market value based charitable deductions would no longer be available for contributions of real estate and closely held stock.

TRA 2014 will likely not be voted on this year, but many of its provisions will likely be included in future proposed legislation, because this proposal represents three years of work and more than 30 meetings under the leadership of the House Ways and Means Committee and the Joint Committee on Taxation.

 

Topics:  Charitable Donations, Corporate Taxes, Offsets, Royalties, Tax Exempt, Tax Reform, UBIT

Published In: Nonprofits Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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