For the past 18 months, non-profit policy experts have been busier than usual as they continue to digest the 2017 Tax Cuts and Jobs Act (TCJA) and its impacts on the sector. Many changes were aimed at leveling the playing field between the non-profit and business sectors when it comes to tax treatment (whether that’s even appropriate is a different kettle of fish).
Under the TCJA, businesses can no longer deduct parking and transportation benefits provided to employees, so Congress imposed unrelated business income tax (UBIT) on those benefits at non-profit organizations. (Even though UBIT is supposed to be on income, not expenses, but go figure.)
The TCJA also tightened the rules on compensation over $1 million for top executives at public companies (private companies are exempt from the $1 million cap). Consequently, nonprofits now have to pay a 21% excise tax on salaries they pay employees and officers over $1 million.
To date, the UBIT issue has been garnering far more attention because it affected most nonprofits, and many of those nonprofits thought the salary their top executives earned was well below $1 million, even when adding in deferred compensation.
But, the excise tax issue is quickly becoming a hair-on-fire problem for many corporate and private foundations (PFs) across the country.
Treasury Guidance is Unexpectedly Sweeping
This new 21% excise tax on compensation over $1 million is on the PF, so it’s akin to a for-profit organization that can’t deduct certain salaries over $1 million. But, here’s where it goes off the rails. In Notice 2019-09, Treasury requires that included in that $1 million is compensation received from “related organizations.”
Many PFs assumed, wrongly, that compensation received from “related organizations” meant an operationally connected organization, like a sister non-profit organization, and PFs generally don’t have those, so most ignored this piece.
However, Treasury decided to take a very expansive view of “related organizations” and include compensation earned from for-profit organizations under the control of PF’s employees and officers.
Here’s a simple example: Lucy Loo is the President of the Loo Family Foundation and takes no compensation for the few hours a month she devotes to the PF. She’s also the founder and CEO of Loo, LLC, a successful private company that funds the PF. Loo’s compensation is $5.1 million. Treasury guidance would require the private company and PF to each pay a portion of a 21% tax on Lisa’s combined amount over $1 million (so, a 21% tax on $5.1 million).
Keep in mind, private companies aren’t subject to the same rules that public companies have on compensation over $1 million. They are now, but only if their leaders are philanthropic.
Corporate foundations, likewise, are in this mess. Substitute Loo Family Foundation with Loo Corporate Foundation and Loo, LLC with Loo, Inc. and you get the picture.
The remedy? Foundations are considering at least two options. The first is to cleanse their leadership of all ties to the business enterprises that sustain them. The second is to transfer foundation assets into a donor-advised fund (DAF)—which has no employees or officers—and conduct charitable giving using that vehicle. Neither option is ideal.
In the case of a PF, the first option potentially strips the donor—and their intent—from the PF, which for most donors, we must believe, is a non-starter.
The second option, transferring foundation assets to a DAF, allows the donor to recommend charitable giving, but because those charitable assets are the property of the DAF sponsoring organization, this may be less than ideal for some foundations. We would be remiss in not mentioning the ongoing criticism of DAFs (no requirement to make distributions to a charity, for one thing), which could prompt Congress and/or the regulators to force some changes. Again, not ideal but perhaps better than the steep tax liability.
Blunting Philanthropic Participation
What’s as concerning to us is the chilling effect this could have on business leaders serving as foundation executives or officers. Engagement in civil society from all Americans is critical to our communities.
In a time when charitable participation is declining, we shouldn’t be putting up even more roadblocks.
So, What’s Next?
Treasury Notice 2019-09 is the first step. They’re accepting comments on that Notice, and given the gnashing of teeth at a recent convening of tax lawyers and Treasury officials, there will be plenty to chew on. Proposed regulations will come out next, hopefully taking into consideration those comments and several in-person meetings we know about. But we don’t expect those regulations for months. So, in the interim, taxes must be paid and remedies must be thought through.
Because no good deed goes unpunished.