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Congress Slaps New Taxes on Nonprofits

CRAINS.COM | SHERRI WELCH

  • Tax reform has brought new taxes to the "tax-exempt" sector
  • They add to fears charitable giving will drop with higher standard deductions
  • Industry experts say nonprofits of all sizes need to step up in advocacy efforts

For charitable nonprofits, tax reform has done the unthinkable: find new ways to tax them.

And that could be a harbinger of things to come, industry experts warn.

Among other things, new taxes in the Tax Cuts and Jobs Act will decrease endowment interest income for some private colleges and tax unrelated business income for even the smallest nonprofits.

The tax changes compound projected declines in charitable donations resulting from fewer people itemizing tax deductions because the standard deduction has grown.

The increased financial pressures tax reform will bring for charitable nonprofits are an issue not just for them but society as a whole, given that the sector has taken on many services government doesn't provide.

Nonprofits need to develop a new muscle for pushing back, industry leaders said, communicating the value of the work they are doing, weighing in on how the U.S. Treasury Department and Internal Revenue Service enact the new regulations to ensure they are not onerous and even advocating to have the new taxes rolled back.

That will be a challenge for a sector seen as meek by the Internal Revenue Service, said Washington, D.C., attorney M. Ruth Madrigal, who served as an attorney and policy adviser in the Office of Tax Policy at the US Treasury Department for six years before becoming a partner at Washington, D.C. law firm Steptoe & Johnson LLP.

During her years at Treasury, it was always clear which people coming to talk tax policy were from nonprofits. They were quieter and more demure, while corporate representatives were loud and demanding, Madrigal said during a recent tax reform presentation hosted at the Detroit Athletic Club by the Community Foundation for Southeast Michigan.

With so much at stake, nonprofits can no longer sit on the sidelines and trust their interests will be protected, "particularly when there are very strong voices from the corporate sector advocating for their own interests," she said.

Without strong advocacy for the sector, charitable nonprofits' ability to meet their missions will erode with their tax exemptions.

"If you can tax the endowment income of a charity, what does tax exemption even mean?" Madrigal said.

Taxing 'exempt' organizations

There are many intricacies to tax reform that nonprofits will need financial experts to help navigate.

But overall, charitable nonprofits — which are responsible for payroll taxes and taxes on businesses they run and for private foundations an excise tax but are otherwise exempt — now face three new taxes and a change in the way a fourth is figured that could see them paying more.

Exempt nonprofits that pay any of their five top-compensated employees more than $1 million in annual compensation will now be required to pay a 21 percent tax on that compensation, in line with the federal corporate tax rate.

Local nonprofit executives with compensation of more than $1 million include the heads of local health systems and University of Michigan spinoffs NSF International — which helps develop standards for food and water safety and tests against them — and health care think tank Altarum. All compete with for-profit companies for talent.

They will also be subject to the tax for "golden parachute" payments of more than three times the annual salary of a departing employee.

Medical professionals and veterinarians providing medical services were excluded from the tax in the days leading up to the speedy passage of tax reform in December. They're often highly paid employees of nonprofit hospitals and salaries over $1 million aren't unheard of.

Nonprofits that employ other highly paid professionals aren't so lucky — for example, investment managers who sometimes oversee nine-figure endowments, Madrigal said. People with those skills are handsomely compensated in the private sector.

Affected organizations will have to compare the added cost of paying someone in-house for specialized skills like managing the investments of an endowment, vs. contracting that out.

The new compensation tax is expected to hit the largest nonprofits but nowhere near the number as the employee benefit taxes, she said.

Even tiny nonprofits that provide employee benefits such as bus passes or pay for carpooling expenses or parking will now be subject to a 21 percent tax on the total amount they spend on those qualified transportation benefits. The tax act also changed the rules for for-profits, taking away their ability to deduct those things, Madrigal said.

The provision of an on-site premise athletic facility is now also taxable for nonprofits if the same benefit would not be deductible by a for-profit employer. But Madrigal said the IRS doesn't believe there will be any cases of that.

Certain private colleges and universities with 500 or more tuition-paying students will now be subject to a 1.4 percent tax on the net investment income from endowments and any other assets not directly used for educational purposes.

Those educational institutions can figure out if they're subject to the tax by deducting their buildings and other educational assets and dividing the remaining asset number by their total number of students. If it's $500,000 or more and the college or university has at least 500 tuition-paying students, they'll pay the tax, Madrigal said.

The net effect of taxing a college or university is to make fewer resources to serve students.

The money paid for the tax will translate to either a cut in services or increases in areas such as tuition, she said.

The endowment tax is coming initially only for those private colleges and universities, but "it's very, very easy for me to think this could expand," Madrigal said.

Tax reform has also changed how the tax on the unrelated businesses nonprofits operate to support their mission is figured.

Goodwill Industries of Greater Detroit is one example of a nonprofit with multiple business lines in manufacturing, industrial materials recovery and upscale thrift shops.

The unrelated business income tax on nonprofits was put in place in the 1950s to level the playing field between them and for-profits operating the same types of business.

Previously, nonprofits subject to the tax could lump their unrelated business income and expenses together in figuring out the tax they owed. And sometimes a money-losing line of business might offset a money-making line, reducing the overall tax load.

With the tax bill, nonprofits will now have to figure out the tax they owe on each individual unrelated business or trade. The upshot is nonprofits will pay tax on all profitable businesses, Madrigal said. And for those with more than one unrelated business, they'll have to figure out how to allocate expenses across those businesses.

Speaking up

On the donor end, the tax incentive for charitable gifts is no longer as big an incentive to give.

"The only way a person can be connected to your mission is based on your relationship and the story you're telling," said Donna Murray-Brown, president of the Michigan Nonprofit Association.

Nonprofits also need to be sharing their stories with legislators.

It's always been important for nonprofits to be a voice for their communities and to stay on top of policy issues that impact the people they serve, she said. Now it's even more important that nonprofits advocate, as they face both federal funding cuts and direct hits to their revenue streams.

"We need to make certain we, both charitable organizations and foundations, are unified and ... loud," Murray-Brown said.

MNA will travel to Washington, D.C., March 12-14 with the Council of Michigan Foundations and other local and national foundation leaders for the annual "Foundations on the Hill" event to take the sector's issues to congressional leaders.

The following week, on March 20, MNA is hosting "Nonprofit Legislative Day at the Capitol" in Lansing to educate nonprofits on lobbying and advocacy and give them the opportunity to meet with their state legislators.

Aside from contacting legislators, nonprofits should stay in the loop on the new rules the IRS and treasury introduce and comment on them to prevent them from becoming an administrative burden, Madrigal said.

Through a partnership with the National Council of Nonprofits, the Michigan Nonprofit Association shares policy alerts with real-time opportunities for commenting on new rules that impact nonprofits, Murray-Brown said.

It may be wishful thinking, Madrigal said, but "I would argue (nonprofits) should be starting to talk to their legislative representatives about rolling these taxes back at the earliest opportunity."

It's not impossible. Senate Majority Leader Mitch McConnell was able to add a caveat that private colleges and universities subject to the new excise tax on their endowments must have at least 500 tuition-paying students, a measure that had the effect of exempting Berea College in his home state of Kentucky, through language in a bipartisan budget agreement in February.

The National Council of Nonprofits is looking at the opportunity to do just that through a new technical bill that's in the works to fix some of the errors/oversights in the tax bill, said Murray-Brown, a director of the Washington, D.C.-based organization.

There's no strategy yet to do that, and it's not clear the bill could be used to roll back the new taxes on nonprofits.

"But we're looking at it," Murray-Brown said