News and analysis
February 27, 2014

House Tax Plan Would Penalize Nonprofits That Pay High Salaries

The House is taking aim at nonprofit financial practices with an eye toward putting more gifts directly to work for charities. It would slap a tax on nonprofits that pay employees $1-million or more and would require gifts to donor-advised funds to be deployed to charities within five years.

The plan, announced Wednesday by the head of the House Ways and Means Committee, would levy a 25-percent surtax on nonprofits that paid $1-million or more to employees. Large private-college endowments would face an excise tax as part of an effort to put pressure on colleges to lower tuition.

While passage of the draft bill, released Wednesday by Rep. Dave Camp, the Michigan Republican who chairs the House Ways and Means Committee, is a tough sell during a midterm election year, many tax experts say his proposal will pave the way for future debates, when a comprehensive bill stands a better chance of passage.

Mr. Camp’s bill would:

  • Subject nonprofits to a 25-percent surtax on executive compensation for each of its five highest paid employees when their individual compensation exceeds $1-million. It’s estimated the provision would produce $4-billion in tax revenues over the next 10 years.
  • Require money deposited in donor-advised funds to be paid out to a charity within five years. An organization that sponsors a donor-advised fund and maintains legal control over fund deposits would be subject to a 20-percent excise tax on money remaining in an account after five years. According to the Joint Committee on Taxation, the proposal would yield less than $50-million in additional tax revenue from 2014 through 2023.
  • Levy a 1-percent excise tax on private colleges and universities’ investment income. It would be applied only to institutions with assets greater than $100,000 per enrolled student. It is expected that would raise $1.7-billion in tax revenues over the next 10 year.
  • Require all nonprofits, even small ones, to file their Form 990 informational tax returns electronically.

Proponents of the proposed payout rule for donor-advised funds argue that it would unleash money that is currently parked in investment funds and send more of it to charities. Opponents maintain that charitable organizations that run the funds receive crucial operating revenues from fund fees and that using donor-advised funds as an investment tool results in more charitable giving over the long term because market returns can boost the assets in accounts.

Currently, contributors to donor-advised funds are under no time constraint to empty their accounts and make charitable gifts.

Preserving Flexibility

Ray Madoff, a Boston College law professor and an early proponent of a mandatory payout requirement, said the current rules allow money to “leak out” of the charitable world.

She said Mr. Camp’s proposal would preserve one of donor-advised funds’ most popular attributes: their ability to allow donors to receive an immediate tax benefit, while giving contributors flexibility on when to make gifts.

“Five years will give them a sufficient amount of time to make thoughtful decisions,” she said.

Ms. Madoff praised the plan because it would encourage the transfer of gifts from funds to actual charities. She said donor-advised funds receive more favorable tax treatment than gifts to foundations, so “it makes sense that they should be subject to more rigorous payout requirements.”

Following the passage of the 2006 Pension Protection Act, which introduced new rules for a wide range of tax-exempt activities, Congress directed the U.S. Treasury to craft regulations on how donor-advised funds are administered.

Regulators have yet to set those rules. The reason, Ms. Madoff says, is because they have felt pressure from financial managers who benefit from fees they earn for overseeing the funds. More than $45-billion is currently held in donor-advised funds, according to an estimate by the National Philanthropic Trust.

Against a Payout Rule

Community foundations, which often administer the funds, were caught off guard by Mr. Camp’s proposal.

“I was really surprised,” said Jeff Hamond, a vice president at Van Scoyoc, a Washington lobbying firm, who represents community foundations. “No one had ever mentioned this was under consideration, and I’m not aware of any member [of Congress] who is pushing it.”

Setting limits on donor-advised funds will increase gifts to private foundations, which are “more rife with abuse,” Mr. Hamond said.

A spokesman for the Council on Foundations, whose membership includes private foundations and community foundations, declined to comment, saying the organization’s legal staff was still going over the proposal.

Although there is no payout requirement for the funds, Mr. Hamond and others have said they actually inject more money into charities than the 5 percent required of private foundations. The National Philanthropic Trust estimated that in 2012, donor-advised funds paid out 16 percent of their assets, on average.

He said community foundations rely on fund fees to keep their operations running and that ultimately money invested in a fund can benefit from market returns.

“The power of the donor-advised fund is that it leads to increased giving over time,” he said.

Ken Berger, chief executive officer of Charity Navigator, an organization that rates charities, said the House proposal was well-meaning in attempting to steer money out of investment accounts and executive salaries, putting it directly in the hands of charities. But he defended the use of donor-advised funds.

As for the effort to rein in salaries, he said nonprofits will be able to find ways to highly compensate their leaders even with a rule change.

Mr. Berger suggested the bill’s progress would be ground to a halt once it faces the “juggernaut” of the higher-education and nonprofit health-care lobbies.

“The likelihood of passage is slim to nil,” he said.

Send an email to Alex Daniels.