Although comprehensive tax reform in 2016 is unlikely in the midst of an election year, so far in 2016, parties on all sides have proposed specific changes to the rules applicable to exempt organizations.
Lawmakers in Congress have introduced bills that would expand IRA rollovers, simplify the net investment income tax, and eliminate reporting of donors. Both President Obama and House Republicans have released their proposals for future tax reform. The IRS has finalized or proposed regulations concerning program-related investments, nonqualified deferred compensation plans, and the PATH Act notice requirement for Section 501(c)(4) social welfare organizations. Finally, the Department of Labor has issued regulations expanding overtime eligibility to millions of additional workers.
- Form 1023-EZ: Reform Recommended, Fee Reduced
- IRS Withdraws Proposed Charitable Donation Substantiation Rule
- Congress Questions Colleges About Endowments
- Obama’s Fiscal Year 2017 Budget Proposals Relating to Tax-Exempt Organizations
- Congressional Proposals Promote Charitable Giving
- IRS Adopts Final Regulations for Program-Related Investments
- Legacy IRA Act Proposes to Expand IRA Rollovers to CGAs and CRTs
- Department of Labor Issues Regulations Expanding Overtime Eligibility
- House Passes Bill to Stop Reporting of Donors by Section 501(c) Organizations
- House Republicans Release “Tax Reform Blueprint”
- IRS Proposes New Regulations for Nonqualified Deferred Compensation Plans
- IRS Proposes Regulations Governing Notice from Section 501(c)(4) Organizations
Form 1023-EZ: Reform Recommended, Fee Reduced
In January, the National Taxpayer Advocate released its 2015 Annual Report to Congress. The report recommended changes to Form 1023-EZ to reduce the risk of noncompliance by new exempt organizations. According to analyses conducted by the IRS and the Taxpayer Advocate Service, a significant percentage of Form 1023-EZ filers in 2015 lacked the necessary purpose and dissolution clauses in their organizing documents and could not be Section 501(c)(3) organizations as a matter of law.
The National Taxpayer Advocate recommended that the IRS revise Form 1023-EZ to require applicants to submit additional information, including their organizing documents, a description of their activities, and a summary of revenues and expenses. The National Taxpayer Advocate also recommended that the IRS make a determination only after reviewing such information and requiring an applicant to correct any deficiencies. The report noted that reviewing such information would take only “about an hour” of employee time.
The IRS has not indicated whether it will implement any of the National Taxpayer Advocate’s recommendations regarding the Form 1023-EZ as set forth in the report. In late May, the IRS announced a reduction in the user fee for filing Form 1023-EZ, from $400 to $275, effective July 1, 2016.
IRS Withdraws Proposed Charitable Donation Substantiation Rule
In January, the IRS withdrew a proposed rule that would have allowed charitable organizations to report donations directly to the IRS. Under current law, donors are required to report their donations to the IRS and obtain a “contemporaneous written acknowledgement” from the charity to substantiate donations of $250 or more. The Internal Revenue Code provides that this substantiation is not required for contributions reported by the charitable donee on such forms and in accordance with such rules as the IRS may prescribe. The proposed rule, released in late 2015, would have permitted charitable organizations to report the donation to the IRS on a form with a donor’s social security number instead of issuing a written acknowledgment to the donor. Many nonprofit organizations filed comments opposing the proposed rule, citing concerns about identity theft and a potential chilling effect on donors reluctant to divulge their social security numbers.
Congress Questions Colleges and Universities About Endowments
Large college and university endowments continue to face congressional scrutiny in the face of rising tuition costs. In February, the Senate Finance Committee and the House Ways and Means Committee jointly sent letters to 56 colleges and universities with large endowments (greater than $1 billion). The letters asked wide-ranging questions about endowment management, endowment spending and use, naming rights, and conflict-of-interest policies. The deadline for response was April 1, 2016. Sixteen of the responding schools have been asked to provide additional information. The House Ways and Means Committee has scheduled a hearing on September 13, 2016, titled “Back to School: Review of Tax-Exempt College and University Endowments.” The hearing will examine how colleges and universities are attempting to reduce tuition costs using endowments.
Also in February, House Representative Tom Reed (R-N.Y.) announced plans to introduce legislation requiring colleges and universities with endowments in excess of $1 billion to pay at least 25 percent of their investment income toward student financial aid. Under his proposal, a college or university would lose its tax-exempt status after three years of noncompliance. To date, Rep. Reed has not released the final text of his bill or filed the bill for consideration by the House.
This year’s scrutiny echoes former Rep. David Camp’s tax reform proposals, released in late 2014, which also included a provision aimed at large endowments of private colleges and universities. Rep. Camp proposed to subject these colleges and universities to the excise tax on net investment income that currently applies to private foundations and certain charitable trusts. He also proposed reducing the tax rate from 2 percent to 1 percent. For more information concerning Rep. Camp’s proposals, see our March 3 legal alert, “The House Ways & Means Committee’s Broad Proposals for Federal Tax Reform.”
President Obama’s Fiscal Year 2017 Budget Proposals Relating to Tax-Exempt Organizations
In February, President Obama released his Fiscal Year 2017 budget proposals. President Obama’s proposals include a limit on itemized deductions, a simplified tax rate on private foundations’ net investment income, an extension of the charitable deduction carryforward period, and new rules for conservation easements.
Changes to Itemized Deduction Limit and the Charitable Deduction
President Obama proposes to limit the value of itemized deductions, including the deduction for charitable contributions, to 28 percent for individuals who are in the top three tax brackets. For example, taxpayers in the 33 percent tax bracket currently get a tax savings of 33 cents for every dollar of their charitable contributions, but under the proposed limitation, taxpayers in the 33 percent tax bracket would gain a tax savings of only 28 cents per dollar of charitable donations. President Obama also proposes simplified rules for determining limits on the charitable deduction. Taxpayers may deduct charitable donations only up to a percentage of their contribution base (i.e., adjusted gross income without regard to net operating loss carrybacks). The limits currently depend on the type of asset donated and the type of organization receiving the asset (e.g., a public charity versus a private foundation). The proposal would keep the contribution base cap at 50 percent of the donor’s contribution base for cash donations to public charities and cap all other charitable donations at 30 percent of the donor’s contribution base.
Simplified Excise Tax on Foundations’ Investment Income
President Obama proposes to simplify the excise tax on private foundations’ net investment income. As others have proposed in the past, the proposal would eliminate the two-tiered tax. While others have suggested a 1 percent tax rate, President Obama proposes a 1.35 percent tax rate, which is intended to mirror the effective tax rate paid by all private foundations.
Changes to the Charitable Deduction for Conservation Easement
President Obama proposes to modify the conservation easement deduction in several ways. The rules for claiming deductions would require that: (1) contributions be made to “qualifying organizations,” a term the Treasury would define through regulations; (2) contributed easements further a federal conservation policy and yield significant public benefit; (3) donors provide detailed descriptions of the easement’s conservation purposes; and (4) donee organizations disclose more information about conservation easements they receive. President Obama also proposes to eliminate deductions for contributions of partial interests in properties that are used for golf courses.
Changes to the Capital Gains Tax and Exceptions for Transfers to Charity
President Obama proposes to increase the maximum long-term capital gains and qualified dividend tax rate from 20 percent to 24.2 percent, but would retain the 3.8 percent net investment income tax for higher-income taxpayers. Thus, the maximum capital gains and dividend tax rate would rise to 28 percent.
The proposals also would alter the rules governing realization of capital gains. Currently, a taxpayer who gives appreciated assets to charity does not realize capital gains as a result of the gift. President Obama proposes generally to treat transfers of appreciated assets as sales, creating taxable income to the donor. Transfers to charities, however, would receive different treatment and would continue to be exempt from capital gains tax.
President Obama’s budget would also change basis rules upon death. Current law provides heirs with a “step up” in basis to the date of death value on inherited property. The proposal would eliminate the basis step up. Instead, the decedent’s basis in the inherited property would carry over to the heirs of appreciated assets.
Extensions on the Carryforward Period for Charitable Deductions
President Obama proposes to change the carryforward rules for charitable deductions to allow longer carryforwards. Charitable deductions are capped at a percentage of the taxpayer’s contribution base, as discussed above. Current law allows a taxpayer to carry forward excess charitable donation deductions made in one tax year for up to five tax years until fully used. The proposal also extends the carryforward period to 15 years.
No Deduction for Donations That Are Prerequisites for Purchasing Sports Tickets
The budget proposal would also eliminate the deduction for a charitable donation that is a prerequisite for purchasing tickets to sporting events. Colleges and universities often require a charitable contribution before an individual may purchase tickets to sporting events. Current law allows taxpayers to deduct 80 percent of donations that entitle the donor to purchase tickets.
Congressional Proposals Promote Charitable Giving
In April, U.S. Senators John Thune (R-S.D.) and Ron Wyden (D-Ore.) introduced the Charities Helping Americans Regularly Throughout the Year Act (the “CHARITY Act”). The CHARITY Act would maintain the current charitable deduction structure, expand the IRA charitable distribution rules, and simplify the excise tax on private foundations’ net investment income.
The CHARITY Act seeks to incentivize charitable giving by preventing changes in the “value or scope” of individuals’ charitable deductions. Under current law and the CHARITY Act, a donor in the 33 percent tax bracket could receive tax savings of 33 cents per dollar of donation to charity, up to certain limits based on adjusted gross income.
The CHARITY Act would also make it easier for senior citizens to donate to charity. Recently enacted tax rules allow senior citizens to direct IRA funds to qualifying charities without realizing taxable income. The CHARITY Act would expand these rules to permit a qualifying charitable distribution to a donor-advised fund.
The CHARITY Act would also simplify taxes paid by private foundations on their net investment income. Currently, a private foundation must pay a 2 percent excise tax on its net investment income each year. The foundation can reduce its tax rate to 1 percent if its qualifying distributions for charitable purposes exceed certain amounts. The CHARITY Act proposes to eliminate the two-tiered structure and reduce the excise tax on net investment income to a flat 1 percent. This is the same proposal included in former Rep. David Camp’s 2014 tax reform proposals.
In the House, lawmakers introduced two bills that include provisions similar to the CHARITY Act’s proposals: the Grow Philanthropy Act and the Private Foundation Excise Tax Simplification Act. The former bill would allow IRA charitable distributions to donor-advised funds, while the latter would mirror the CHARITY Act’s simplification of the excise tax on net investment income.
IRS Adopts Final Regulations for Program-Related Investments
In April, the IRS finalized regulations pertaining to program-related investments made by private foundations. First proposed in 2012, the regulations provide nine additional examples clarifying the types of investments that qualify as program-related investments. Program-related investments are not treated as jeopardizing investments for purposes of the excise tax under Section 4944. For more information concerning nonprofit organizations and program-related investments, as compared with mission investing, see our December 18 legal alert, “Charities and Mission Investing.”
Legacy IRA Act Proposes to Expand IRA Rollovers to Charitable Gift Annuities and Charitable Remainder Trusts
In May, several House Ways and Means Committee members introduced a new bill called “The Legacy IRA Act” to authorize qualifying charitable distributions from IRAs for gifts that benefit charities and provide taxable retirement income for the donors.
Under current law, an individual who is 70 1/2 years old or older may make tax-free gifts of up to $100,000 each year from IRAs to qualifying charities. The Legacy IRA Act would expand the current law and permit certain individuals to make gifts from IRAs in exchange for a charitable gift annuities or to fund charitable remainder trusts. A donor over 70 1/2 years old would have a combined annual ceiling of $400,000 for direct and charitable life-income plan transfers and a cap of $100,000 on direct transfers to charities.
Department of Labor Issues Regulations Expanding Overtime Eligibility
The U.S. Department of Labor published its final rule on May 18, 2016, expanding overtime protections to 4.2 million additional workers. The rule doubles the threshold over which employees are exempt from overtime rules, from $23,660 per year to $47,476 per year. Under the new rule, an employee earning less than $47,476 per year will be subject to overtime rules. The new rules will be effective December 1, 2016. For a more extensive discussion of the new rules, see our May 18 legal alert, “Department of Labor Issues Final Rule Expanding Overtime Eligibility.”
House Passes Bill to Stop Reporting of Donors by Section 501(c) Organizations
In June, the U.S. House of Representatives passed a bill that would prevent the IRS from requiring 501(c) organizations to report each contributor who donates $5,000 or more in a tax year. The bill, titled “The Preventing IRS Abuse and Protecting Free Speech Act” (H.R. 5053), would eliminate Schedule B to the Form 990. Supporters of the bill argue that it will prevent the IRS from using the identities of donors to specifically target exempt organizations. Opponents of the bill argue that the disclosure of donor information is necessary for the IRS to enforce the tax laws. The bill was referred to the Senate Finance Committee and is currently under consideration in the Senate.
House Republicans Release “Tax Reform Blueprint”
In June, Republicans in the U.S. House of Representatives released their “Tax Reform Blueprint.” The proposal would eliminate the estate and gift taxes and lower the top individual income tax rate to 33 percent. The proposal would also raise the standard deduction for individual income taxes. House Republicans estimate that the higher standard deduction would reduce the number of taxpayers itemizing their deductions from 33 percent to 5 percent. The proposal would also eliminate all itemized deductions other than the mortgage interest deduction and the charitable contribution deduction.
IRS Proposes New Regulations for Nonqualified Deferred Compensation Plans
In June, the IRS proposed new regulations under Section 457 of the Internal Revenue Code, which governs nonqualified deferred compensation plans of state and local governments and private tax-exempt entities. At the same time, the IRS proposed clarifications to the regulations under Section 409A of the Code, which applies to certain nonqualified plans of those entities as well as to nonqualified plans of for-profit entities. For a full discussion of these proposed regulations, see our June 29 legal alert, “Nonqualified Deferred Compensation: IRS Proposes New Section 457 Regulations and Section 409A Clarifications.”
IRS Proposes Regulations Governing Notice from Section 501(c)(4) Organizations
In July, the IRS issued temporary regulations regarding new reporting requirements for Section 501(c)(4) organizations. Under the Protecting Americans from Tax Hikes Act of 2015, Section 501(c)(4) organizations are required to notify the IRS within 60 days of organization. Earlier this year, the IRS extended the deadlines for giving notice until temporary regulations had been issued. After the temporary regulations were issued, organizations had until September 6, 2016, to submit the required notification. An organization that may have filed a Form 1024 or a Form 990 (or 990-EZ or 990-N) before July 8, 2016, may be entitled to transitional relief.
McGuireWoods’ Nonprofit and Tax-Exempt Organizations Group
Our nonprofit and tax-exempt organizations group provides advice and guidance that enable charities and other nonprofits to operate more efficiently and effectively in today’s increasingly complicated, regulated and competitive environment.