On February 26, 2014, Ways and Means Committee Chairman Dave Camp (R-MI) released draft legislation for the Tax Reform Act of 2014. Over the past three years, Congress has held more than 30 hearings in the process of developing this proposal. Also, Chairman Camp and Ranking Member Sander Levin (D-MI) formed 11 separate bipartisan Tax Reform Working Groups to focus on specific issues that included tax-exempt organizations and charitable giving.
While the Draft’s many provisions will be debated throughout the year ahead, and it’s doubtful that it will even be voted on in 2014, it’s crucial that tax-exempt organizations and charities stay on top of the process and understand the possible ramifications of the bill’s many provisions.
Some of the most significant highlights of the Draft Legislation include:
- Repealing the tax exemption for professional sports leagues
- Imposing a two-percent Adjusted Gross Income (AGI) floor on deductible charitable contributions
- Imposing a 25% excise tax on compensation paid over $1,000,000 by exempt organizations to their five highest-paid employees
- Expanding the reach of Intermediate Sanctions
- Tightening the rules on the unrelated trade or business income tax (UBIT)
- New and increased penalties related to return preparation
- Eliminating future tax-exempt private activity bonds.
Some other provisions aimed specifically at colleges and universities are:
- Repealing the rule that provides a charitable deduction of 80 percent of the amount paid for the right to purchase tickets for college athletic events.
- Imposing an excise tax based on investment income of private colleges and universities. This would be similar to a rule that taxes the investment income of private foundations. Under the provision, private colleges and universities would be subject to a one-percent excise tax on net investment income. The provision would only apply to schools with investment assets valued at the close of the preceding tax year of at least $100,000 per full-time student.
- Some of the proposed Unrelated Business Income Tax (UBIT) provisions appear to be aimed specifically at colleges and universities.
Both Congress and the IRS have been concerned about unrelated business income, especially after the College and University Compliance Project Final Report indicated that underreporting of Unrelated Business Taxable Income (UBTI) resulted in an increase in UBTI for the schools totaling approximately $90 million in the aggregate and disallowance of more than $170 million in losses and net operating losses (NOLs). The Draft Legislation proposes the following:
Unrelated business taxable income of each activity would be computed separately and the loss from one unrelated business activity could not be used to offset the income from another unrelated trade or business activity. Any unused loss would be subject to the general rules for net operating losses—i.e., such losses may be carried back two years and carried forward 20 years. The provision would generally be effective for tax years beginning after 2014. However, NOLs generated prior to 2015 could be carried forward to offset income from any unrelated trade or business, but NOLs generated after 2014 could only be carried back to offset income with respect to the unrelated trade or business from which the net operating loss arose.
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Other UBIT provisions in the Draft Legislation include:
- Royalty income for the use of names and logos would be impacted. Under this provision, any sale or licensing by a tax-exempt organization of its name or logo (including any related trademark or copyright) would be treated as a per se unrelated trade or business, and royalties paid with respect to such licenses would be subject to UBIT. Many institutions that have affinity credit cards or license their name for apparel could be impacted.
- A change in the rules for Qualified Sponsorship Payments whereby mention of a sponsor’s product lines would turn a mere acknowledgement that is not taxed into advertising income that would be taxed.
- A limit of the exclusion for fundamental research unless results are freely available to the general public
- Imposition of a penalty on organization managers such as officers, directors, or responsible employees for the substantial understatement of unrelated business income tax.
Under current law, if a 501(c)(3) public charity or a 501(c)(4) organization pays excessive compensation (more than fair market value) to an individual who can substantially influence the organization—i.e., a Disqualified Person (DP)—the DP is subject to a 25-percent excise tax. If the excess benefit is not corrected, a 200 percent tax is imposed on the individual. If the DP tax is imposed, a manager who knowingly participated in the transaction is subject to a 10-percent excise tax. A manager may avoid the excise tax if the manager relies on advice provided by an appropriate professional. An organization can establish the rebuttable presumption of reasonableness that shifts the burden to the IRS to prove that the compensation is not reasonable.
The Draft Legislation proposes some significant changes to the Intermediate Sanctions rules:
- Intermediate Sanctions would also apply to Internal Revenue Code (IRC) 501(c)(5) unions and 501(c)(6) chambers of commerce and trade associations.
- A 10 percent tax would be imposed on the tax-exempt organization when the excess-benefit excise tax is imposed on a DP.
- Managers could not rely on the professional advice safe harbor.
- The rebuttable presumption would be eliminated.
- The provision would expand the definition of disqualified persons to include athletic coaches and investment advisors.
The Joint Committee on Taxation has “scored” the provisions indicating whether the provision would raise money (and how much) or lose money, or whether it is revenue neutral. There are various provisions that impose greater penalties for not properly reporting and disclosing returns, applications for exemption, transactions, etc., changes to private foundation rules, and the reduction of the excise tax on the net investment income of private foundations to a uniform one percent.
It is very early in the process and we have no way to predict whether any of these provisions will become law, however it would be worthwhile for all tax-exempt organization to take a look at the provisions to see what the impact could be.