On Feb. 26, 2014, the Chairman of the House Committee on Ways and Means, Dave Camp, R-Mich., unveiled a tax-reform plan that would overhaul many provisions of the Internal Revenue Code. Camp’s proposal would impact all taxpayers, including corporations, individuals and even tax-exempt organizations. We have highlighted some of those provisions that specifically impact tax-exempt entities:
Unrelated business income
- Subject royalty income from licensing of name and logo rights to unrelated business income (UBI).
- Segregate unrelated business activities so that the gain or loss from one activity cannot offset the gain or loss of another activity. (e.g.,. losses from rental activities could not offset gains from limited partnership activities).
- Losses from a particular activity could be carried back to the prior two tax years or carried forward to the subsequent 20 tax years, but only to offset UBI from that same activity.
- Built up net operating losses prior to the effective date would still be allowed.
- Research income for institutions operated primarily for purposes of carrying out fundamental research would only be excluded from UBI if the results of such research are freely available to the general public.
- The specific deduction to offset UBI would be increased from $1,000 to $10,000.
- The definition of “qualified sponsorship payments” (QSP) would exclude from the permitted substantial return benefit the use or acknowledgment of the sponsor’s products.
- Would also exclude from the definition of QSP an event sponsor that receives acknowledgment substantially greater than other donors in respect to such event. (e.g., corporate sponsorship of a bowl game would likely constitute advertising).
- Doubling of penalties on failure to timely file returns or failure to allow public inspection.
- Institute a 5% tax on organizational managers (officers, directors, trustees, employees or other responsible person) for any substantial understatement of tax attributable to UBI.
- If more than one manager was involved, the penalty is shared jointly and severally and is capped at $20,000 per instance.
- Penalty is doubled if the UBI is attributable to activities considered “reportable transactions” by the IRS.
- Institute an organizational level tax equal to 10% of any transaction found to be an excess benefit.
- Eliminate the “rebuttable presumption of reasonableness.” Procedures that presently provide that presumption of reasonableness will be the minimum due diligence standards and create no presumption.
- Treat investment advisors (person/organization primarily responsible for investments) and athletic coaches as “disqualified persons”
- Subject organizations exempt from income tax under sections 501(c)(5) and 501(c)(6) to the Intermediate Sanctions rules
Private foundations, donor-advised funds and supporting organizations
- Institute an organizational level tax equal to 2.5% on any self-dealing transaction (10% if the transaction is one of compensation).
- Institute a 20% tax on a donor advised fund that fails to distribute, in an eligible distribution, the required amount of a contribution within the required five year distribution period.
- Change the current two rate tax structure on net investment income (2% with the ability to qualify for 1%) to a flat 1% rate for all foundations.
- Repeal the exemption from tax on net investment income eligible for exempt operating foundations.
- Repeal of the exception available for private operating foundations from the excise tax on failure to distribute income.
- Repeal of type II and III supporting organizations causing all supporting organizations to be operated, supervised or controlled by one or more publicly supported organizations or be treated as a private foundation.
- Compensation under deferred compensation arrangements would be taxable unless there is a requirement for future performance of substantial services.
- Impose a 25% excise tax on an organization for annual compensation paid in excess of $1 million to any of the five highest paid employees. Compensation paid by related parties is included and the tax is shared pro-rata by the parties based on the portion of the excess that each paid.
- Create a tax of 1% on endowments of private colleges and universities to the extent the endowment exceeds $100,000 per student.
- Repeal of tax-exempt status of professional sports leagues.
- Elimination of section 501(c)(15) and 501(c)(29) from the Internal Revenue Code.
- Effective date of most proposals is for years beginning after Dec. 31, 2014.
- Limit the charitable contribution deduction allowed by individuals to only the excess over 2% of their income given to charity.
Grant Thornton commentary
Representative Camp’s tax reform plan is merely a proposal; the likelihood of its passing both houses of Congress in a divisive election year is remote. Nevertheless, in an economic climate where the government is looking to raise revenue and close tax loopholes, tax-exempt organizations should be aware of these reforms’ potential impact if implemented. Major tax changes may occur in the very near future and these changes may hit a heavily scrutinized tax-exempt sector. The proposals pertaining to Intermediate Sanctions, unrelated business income and the reduction in the private foundation tax rate have been circulating for a few years and stand a better chance of being passed in some form. Recent IRS scrutiny of UBI and executive compensation in the College and Universities Report and in recent audit activity signifies that these issues are at the forefront of their agenda. Among other compliance needs, organizations should be placing on top of their to-do-lists the need to review operations for UBI and to ensure compensation practices are fully supported by documentation for reasonableness.
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