The agreed to by the U.S. Senate and House in December and signed into law by the president on December 22 is over a thousand pages long. The bill is so long, in fact, that many members of Congress haven't read — and are unlikely to ever read — it in its entirety. Its impact on nonprofits and the charitable sector could be significant, however, which is why earlier this month we spoke with Laura Kalick, national non-profit tax consulting director for the nonprofit and nonprofit healthcare industry at BDO in Washington, D.C., about provisions in the new law most likely to affect nonprofits in 2018, and beyond.
Philanthropy News Digest: There are lots of things in the tax reform bill that are going to affect nonprofits and charities. In your view, what is the one provision likely to have the greatest impact on the sector?
Laura Kalick: Well, the one that's going to have the most impact is the doubling of the standard deduction and the limitation on deducting state and local taxes. These two provisions will likely result in a huge number of American taxpayers not itemizing their deductions and therefore not being able to deduct charitable gifts, which, as you know, is an important incentive for charitable giving. It's hard to know, of course, what people will do, but estimates from the likes of and the suggest that charitable giving in the U.S. may take a hit of as much as a $20 billion, which is pretty substantial.
PND: The bill includes two provisions likely to be popular among individuals who do itemize their returns. One is an increase in the charitable contribution deduction limit, and the other is repeal of the so-called Pease limitation. How are those changes likely to affect charitable giving?
LK: The Pease limitation was more of a concern for high-income taxpayers, in that it reduced the value of a taxpayer's itemized deductions by 3 percent for every dollar of taxable income above a certain threshold — something like $250,00 for an individual and $300,000 for a married couple. With its repeal, people whose total income exceeds those levels will now get the full benefit of their contributions, so in that sense it could be an incentive for higher income taxpayers to give more.
The other provision is of little help to anyone, in my opinion. Previously, you could deduct charitable gifts totaling up to 50 percent of your contribution base — essentially, your adjusted gross income (AGI). That's a pretty large number, and although I don't have the stats for you, it's a lot more than most people actually allocate to charity. A provision in the new tax bill raises the maximum to 60 percent of one's contribution base, which is an even bigger number and not something that is likely to apply to too many people in any given year. I would also note that in addition to being able to deduct contributions up to 50 percent of one's contribution base, if there are contributions in excess of that amount, they could have, under the old code, and still can be carried forward under special rules. So I believe that increasing the limit to 60 percent is likely to have little impact.
PND: The bill also doubled the estate tax exemption from $5 million to $10 million, indexed for inflation — a provision that, if nothing changes, is scheduled to expire in 2026. I'm thinking the impact of that provision on charitable giving is de minimus. Do you agree?
LK: I do. A $5 million estate is a good amount of money, and a $10 million estate is even nicer, but a lot of people who are in that category still would rather give their money to their children than to charity, and a doubling of the exemption isn't going to change people's behavior very much. Now, had Congress gone ahead and eliminated the tax entirely, as the House version of the bill proposed, I think we would have seen a profound effect on giving, in that it would have eliminated an important driver of charitable bequests.
PND: Are there other provisions in the bill that nonprofits and charities should know about?
LK: There are some big changes in the way unrelated business income is treated. In effect, what the legislation does is disallow the use of unrelated business income losses to offset gains from a different unrelated business activity. Organizations in the past would minimize their unrelated business income by netting the income and losses from one activity against those of another. For example, say you were a big nonprofit institution with a million dollars of advertising income, income that would have been taxed as unrelated business income, and you had an alternative investment in a partnership that generated big losses, say, a million dollars of losses. Under the old tax code, you could have offset the million dollars of losses against the million dollars of gain. But under the legislation signed into law recently, you will no longer be able to use your unrelated business losses to offset unrelated business gains from a different activity. Which means the million dollars of unrelated business income in the example I just gave will now be taxed, although at the new corporate rate of 21 percent.
What's interesting, though, is that the code retains the offset provision for regular C corporations, so exempt organizations might decide, if the amounts involved are large enough to justify it, to put their unrelated business activity income into a taxable subsidiary where gains from one activity can be used to offset losses from a different activity.
PND: What should individual nonprofit organizations be doing to prepare for these changes?
LK: Well, obviously, they need to review their budgets and see how much income they are raising in the form of charitable contributions, then try to project what kind of hit they can expect from the reduction in contributions from those who itemize and begin to take steps to make up the shortfall, whether that involves cutting expenses, or focusing more of their fundraising efforts on high-net-worth donors, or some other way. That's the first thing.
Second, if you have unrelated business activities that are losing money, you need to take a close business look at why those activities are generating losses and try to figure out how you can make the business profitable since you will not be able to use the losses to offset the gains from other unrelated activities.
And third — and this has to do with a provision in the bill I didn't mention but that could impact a lot of nonprofits — organizations need to see if they are providing free parking, other transportation benefits, and/or onsite athletic facilities to employees, because the new law provides that the costs associated with such fringe benefits will now be treated as unrelated business income.
There are other provisions that may affect them, as well. Maybe the best advice I can give is, talk to your accountant. And if you don't have one, get one.
— Mitch Nauffts