On December 22, 2017, President Trump signed the tax reform bill, commonly known as the “Tax Cuts and Jobs Act” (the “Act”), the most comprehensive tax reform legislation since 1986. It will affect organizations of all forms, including businesses, tax-exempt organizations and individuals. The following summarizes the Act and its impact on tax-exempt organizations.
Effect on Unrelated Business Taxable Income (“UBTI”)
The Act requires that organizations that carry on one or more unrelated trade or businesses separately calculate UBTI for each trade or business. A loss from one trade or business may not be used to offset income from another trade or business. Net operating loss carryovers from one trade or business will only be allowed to offset income from the same trade or business.
The provision is effective for taxable years beginning after December 31, 2017. However, net operating losses arising in a taxable year beginning before January 1, 2018 are not subject to the provision.
Also, organizations subject to UBTI will no longer be able to deduct certain fringe benefits, including parking and transportation benefits, effective for amounts paid or incurred after December 31, 2017.
Excise Tax on Excess Tax-Exempt Organization Executive Compensation
The Act imposes a 21% excise tax on compensation in excess of $1 million. This is applicable to all tax-exempt organizations, including federally and state-chartered credit unions. This tax, paid by the organization, is applicable to compensation in excess of $1 million for any covered employee (the five highest-paid individual employees) for the tax year (or a person who was such an employee in any prior tax year beginning after 2016).
For computing the excise tax, compensation includes certain parachute payments made under change-in-control agreements. It also includes deferred compensation in the first year that it is no longer subject to a substantial risk of forfeiture. Questions have arisen regarding expense recognition for a future excise tax that is deemed both probable of payment at a future date and estimable in amount. When it is probable that a covered employee will continue to be employed by the organization until any vesting requirements are met, accrual of the estimated excise tax over the required service period, beginning on January 1, 2018 and ending on the applicable vesting date, would be appropriate.
The provision is effective for compensation paid, or is no longer subject to a substantial risk of forfeiture (vested), in tax years beginning after December 31, 2017.