Insight

A Taxing New World for Nonprofits

Extensive changes to U.S. tax law will have significant effects on the nonprofit sector. What to expect—and how to cope.

How Trump's Policy Effects Nonprofits
Elizabeth J. Atkinson

Elizabeth J. Atkinson

June 26, 2018 11:10 AM

The Tax Cuts and Jobs Act, signed into law by President Trump at the end of 2017, ushered in sweeping changes that will affect every kind of taxpaying entity in the United States. Its enactment on December 22 prompted heated debate: Does the new law favor the middle class or the wealthy? Small businesses or large corporations? One sector that got hit hard, though, was barely mentioned at all: nonprofits. The law’s overall impact on nonprofit and charitable organizations is nuanced and multilayered. Some effects are indirect; other changes create immediate new taxes for these groups. Here’s a rundown of some key provisions.

New Excise Taxes

The new excise tax on college and university charitable endowments is 1.4 percent of net investment income. This will affect a relatively small number of endowments—those of only 30 to 40 schools nationwide—because it applies solely to schools with more than 500 full-time students and endowments greater than $500,000 per student. This tax is forecast to raise an estimated $1.8 billion over the next 10 years. It seems high-impact given the small number of schools affected—and critics caution that Congress is setting a dangerous precedent: expanding taxes on endowments that offer students access to higher education and make research projects possible.

There’s also a new 21 percent excise tax on nonprofit executive compensation exceeding $1 million. (There’s an exception for income based on the provision of medical services—pay for doctors, nurses, and veterinarians, for example.) The purpose of this tax was to bring nonprofits into closer alignment with corporate tax law, in which executive compensation over $1 million is not tax-deductible. Yet nonprofits are already subject to stringent rules and excise taxes regarding “excessive” compensation. It might be a surprise that anyone in the nonprofit sector earns $1 million and up, but many do—major-college-sports coaches, to cite one prominent example. The new tax also applies to termination payments (“golden parachutes,” even severance) and to salaries of “shared” employees—those who earn wages totaling seven figures from multiple entities.

Certain fringe benefits—including transportation benefits, parking and on-premises athletic facilities—will now be subject to an excise tax. Although these fringe-benefit taxes were designed to create parity between nonprofit and for-profit entities (which also cannot deduct these costs), they’ve spurred great concern at nonprofits about their overall budget impact. Some local governments require employers to provide transportation benefits—New York, San Francisco, and Washington, D.C., for example, all mandate that companies with 20 or more employees must provide them transit benefits. As such, the new excise tax might easily cost a qualifying company north of $500 per employee per year.

Not-So-Standard Deductions

It had long been U.S. tax policy that if you got something in exchange for a charitable deduction, that benefit was not a tax deduction. Let’s say you pay $100 to attend a gala. The cost of the meal is not deductible, but the balance of the donation is. The same was true of preferred seats at sporting events: Colleges relied on guidance that 80 percent of payments made to acquire the right to preferred seating at athletic events was deductible, because the quid pro quo, such as it is, constituted 20 percent of the cost. The cost of the tickets themselves was never tax-deductible. Now, though, no charitable gift that includes preferred sports seating can be deducted. Colleges are therefore scrambling to figure out how to encourage giving in light of this change. The IRS has yet to issue guidance; lawyers are trying to figure out how to get around this restriction.

The most momentous change, though, is the increase in the standard deduction, which will lead fewer Americans to itemize. This may simplify tax preparation for many, but charities worry that donations, especially those made by middle-class taxpayers, will shrink significantly. Wealthier donors might give less, too, because tax rates are lower and estate thresholds are higher, though the law’s five-year carry-forward allowed for charitable deductions, and the concomitant increase in the adjusted-gross-income limit, from 50 to 60 percent, may encourage more giving. Studies by Independent Sector (a sort of membership organization for nonprofits and charitable groups of all stripes) and Indiana University School of Philanthropy, as well as Rice University’s Baker Institute for Public Policy, concluded that the reduction in the number of taxpayers itemizing deductions will reduce charitable giving by 1.7 to 5 percent overall. That might seem trivial, but it constitutes billions of dollars every year, and its effects are greater on smaller charities, especially those that rely on modest grassroots donations.

Competing for Tax Dollars

New limits on deducting state and local taxes have prompted some states to propose charitable-deduction mechanisms in lieu of taxes. If this workaround becomes widespread, it might well put states in competition with private charities for donation dollars. California State Senator Kevin de León (D–Los Angeles) has introduced legislation to create the “California Excellence Fund”—a contentious maneuver that would give taxpayers an 85 percent tax credit for donations made to the fund, which they could then write off on their federal returns. Similar, narrowly tailored state funds—those to fund private-school scholarships, for example—already exist. It remains to be seen, though, whether these new state efforts will be successful. The IRS is expected to challenge them on the basis that there is no overt charitable intent when there is a quid pro quo—in this case a state tax credit—for the donation.

Expect to see a variety of creative solutions to respond to these new tax laws, as well as new fundraising methods. Some in the nonprofit sector believe that these policy changes are ominous precedents, only the start of a broader effort to tax nonprofits more heavily. Other changes—proposed excise taxation of undistributed money in donor-advised funds, for example—were not included in last December’s final legislation but could certainly become part of future efforts, especially if concern about the federal budget deficit returns to the fore.

Regardless of what lies ahead, though, finance executives for nonprofit institutions must pay close attention to how these changes apply to their organizations—and work closely under the guidance of a tax attorney who specializes in nonprofits. Their very viability might depend on it.

Related Articles

Lecher Pays


by Ann E. Evanko and Katherine L. Wood

Can social change be sped up via legislation? A key provision of the recent tax-law overhaul, clearly written with #MeToo in mind, suggests it can.

Social Change Amid #MeToo

For the Greater Good


by Nancy Lippincott

San Francisco nonprofit specialist Rosemary Fei on advice for young careerist women and helping make the world a better place.

2018 Lawyer of the Year Winner Rosemary Fei

Trending Articles

Johnny Depp and Amber Heard: The Best Lawyers Honorees Behind the Litigation


by Gregory Sirico

Best Lawyers takes a look at the recognized legal talent representing Johnny Depp and Amber Heard in their ongoing defamation trial.

Lawyers for Johnny Depp and Amber Heard

The Real Camille: An Interview with Johnny Depp’s Lawyer Camille Vasquez


by Rebecca Blackwell

Camille Vasquez, a young lawyer at Brown Rudnick, sat down with Best Lawyers CEO Phillip Greer to talk about her distinguished career, recently being named partner and what comes next for her.

Camille Vasquez in office

Announcing The Best Lawyers in The United Kingdom™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from the United Kingdom.

The Best Lawyers in The United Kingdom 2023

Announcing The Best Lawyers in France™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from France.

Blue, white and red strips

Education by Trial: Cultivating Legal Expertise in the Courtroom


by Margo Pierce

The intricacies of complex lawsuits require extensive knowledge of the legal precedent. But they also demand a high level of skill in every discipline needed to succeed at trial, such as analyzing technical reports and deposing expert witnesses.

Cultivating Legal Expertise in the Courtroom

Announcing The Best Lawyers in Germany™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from Germany.

Black, red and yellow stripes

Announcing the 2022 Best Lawyers® in the United States


by Best Lawyers

The results include an elite field of top lawyers listed in the 28th Edition of The Best Lawyers in America® and in the 2nd Edition of Best Lawyers: Ones to Watch in America for 2022.

2022 Best Lawyers Listings for United States

Announcing The Best Lawyers in Belgium™ 2023


by Best Lawyers

The results include an elite field of top lawyers and firms from Belgium.

Black, yellow and red stripes

What If Johnny Depp and Amber Heard Had a Premarital Agreement?


by John M. Goralka

Oh, the gritty details we’re learning from the latest court battle between Johnny Depp and Amber Heard. This unfortunate airing of dirty laundry may have been avoided with a prenup. Should you think about getting one yourself?

What If Johnny Depp & Amber Heard Had Prenup?

Announcing the 2022 Best Lawyers™ in France


by Best Lawyers

The results include an elite field of top lawyers and firms, including our inaugural Best Lawyers: Ones to Watch recipients.

Announcing the 2022 Best Lawyers™ in France

Choosing a Title Company: What a Seller Should Expect


by Roy D. Oppenheim

When it comes to choosing a title company, how much power exactly does a seller have?

Choosing the Title Company As Seller

We Are Women, We Are Fearless


by Deborah S. Chang and Justin Smulison

Athea Trial Lawyers is a female owned and operated law firm specializing in civil litigation, catastrophic energy, wrongful death and product liability.

Athea Trial Law Female Leadership and Success

Announcing the 2022 Best Lawyers™ in Germany


by Best Lawyers

The results include an elite field of top lawyers and firms, including our inaugural Best Lawyers: Ones to Watch recipients.

Announcing the 2022 Best Lawyers™ in Germany

What the Courts Say About Recording in the Classroom


by Christina Henagen Peer and Peter Zawadski

Students and parents are increasingly asking to use audio devices to record what's being said in the classroom. But is it legal? A recent ruling offer gives the answer to a question confusing parents and administrators alike.

Is It Legal for Students to Record Teachers?

U.K. Introduces Revisions to Right-to-Work Scheme and Immigration Rules


by Gregory Sirico

Right-to-Work Scheme and Immigration Rules in

Famous Songs Unprotected by Copyright Could Mean Royalties for Some


by Michael B. Fein

A guide to navigating copyright claims on famous songs.

Can I Sing "Happy Birthday" in Public?