Many nonprofits thought discussions of tax policy were behind them after the federal overhaul passed at the end of 2017. But the year ahead will be a big one for deciding whether their organizations’ missions will be constrained for decades by extra financial burdens imposed on tax-exempt organizations by federal, state, and local governments.
By the end of 2019, we’ll probably have answers to numerous questions still flowing from the 2017 federal tax law. For example, will donations plummet for certain types of charitable organizations? Will nonprofits owe tens of thousands of dollars to governments because of new taxes levied in the Tax Cuts and Jobs Act and similar laws in the states? What will it cost to overhaul accounting systems and other processes to accommodate the record keeping required by the federal tax law and resulting state tax changes?
The answers to these and many other questions will come through the push and pull of imperfect processes at the federal, state, and local levels involving:
- Hundreds of members of Congress as they revise the 2017 law to fix mistakes and dial back some of the harshest provisions. Meanwhile, thousands of state legislators are seeking to adapt their state laws to recent changes at the federal level or reject those policies as they apply to state taxpayers.
- Thousands of bureaucrats struggling to adjust regulations and forms to what lawmakers intended.
- Tens of thousands of paid lobbyists for both for-profit enterprises and governmental entities trying to tilt the playing field in their favor.
The maneuvers by these competing players may mean that nonprofits receive fewer donations and must pay new tax bills — changes that could force them to make cuts in services and programs. Alternatively, if nonprofits engage, there could be enhanced charitable-giving incentives, repeal of the new levies on tax-exempt organizations, and additional positive results. That’s why the million-plus leaders of nonprofits and foundations; the tens of millions of nonprofit and foundation employees, board members, and other volunteers; and the hundreds of millions of Americans who benefit from nonprofit missions have a major stake and supreme opportunity to influence how these tax-policy debates turn out.
Here are some key issues for nonprofits.
Charitable-Giving Incentives
The 2017 federal tax law doubled the standard deduction for individuals and imposed a $10,000 cap on the amount that individuals can deduct for state and local taxes they’ve paid. As a result, 28.5 million fewer Americans will itemize their deductions, according to projections by the congressional Joint Committee on Taxation. Experts from across the political spectrum agree: The law significantly reduced tax incentives for Americans to give to the important work of charitable organizations across the country.
Early reports showed fewer small to midsize donations, which are even more troubling in light of the steady decline in the number of donors. That’s why we and nonprofits across America have called for immediate tax-law changes at the federal and state levels to provide stronger incentives that encourage donors to support important work in their communities.
Legislators in several states, with one notable exception, are listening. Colorado and Minnesota currently provide a charitable deduction for taxpayers who don’t itemize, and last year legislators in both states tried to enhance the incentive by removing thresholds and limits. Neither bill passed then, but they have a chance in 2019. New Jersey, which currently doesn’t have a state tax incentive to promote charitable giving, recently saw two bipartisan bills get serious consideration. These and other states can be expected to heed the call to help their charitable communities overcome the hit to charitable giving suffered under the federal tax law.
With every rule, there is the inevitable exception. In 2018, that exception was Vermont. It quickly recognized that it needed to change its law, or else the new federal tax law would effectively force its residents to pay significantly higher state taxes. The governor saw that the federal law likely would reduce charitable giving. Yet the “fix” the state enacted eliminated the deduction for charitable giving and replaced it with a much less beneficial 5-percent tax credit that’s capped at $1,000 — thus removing any true incentive to give more because gifts of $10,000 or $100,000 would still give the taxpayer the same $1,000 credit.
Taxing Tax-Exempt Nonprofits
Perhaps the biggest surprises in the federal tax law were two new levies on tax-exempt entities, subjecting them to tortured applications of unrelated business income taxes (also known as UBIT). One provision imposes a 21-percent income tax on nonprofits for the expenses they pay providing their employees with transportation benefits, such as parking and transit passes. Another provision forces nonprofits to reallocate all their income and costs in unrelated business activities into “separate” “trades or businesses,” whatever those undefined terms mean.
Accountants, lawyers, nonprofits, foundations, and many others were baffled by the terms and demanded delay and clarification. The Treasury Department and the Internal Revenue Service proposed regulations, but not until mid-December. The federal advocacy efforts in which we and others participated proved the point that the transportation tax was abysmal policy — even Kevin Brady, the chair of the House tax committee who put the tax into the 2017 law, eventually called for its repeal, albeit too late in the year to get it enacted.
There is legitimate optimism that the transportation tax will be repealed this year as part of a technical corrections tax bill. But only if nonprofits make sure every member of the new Congress knows how badly the tax affects their constituents. Likewise, the regulations that come out of the review process could narrow or minimize some of the more egregious effects of the law.
The very good news at the state level is that governors and legislators see no sense in taxing nonprofits for parking and transit passes. New York and North Carolina have laws that automatically impose state unrelated business income taxes on top of any federal UBIT, meaning that nonprofits would pay additional state taxes. The legislatures in those states acted in 2018 to prevent this injustice, passing measures that “decouple” the otherwise automatic state tax from the federal UBIT on nonprofit transportation benefits. The reaction in these states bodes well for nonprofit advocacy efforts in 2019 on targeted issues that just make no sense.
State and Local Tax Deductions
What will states do now that the most their residents can deduct from their federal taxes for what they paid in state and local taxes (often called SALT) is capped at $10,000? The outcome of a major federal versus state tax fight could significantly erode state giving incentives, so close attention is needed.
Estimates are that taxpayers in at least 19 states have average state and local deductions totaling more than the $10,000 cap. These include traditionally blue states like California and New York, as well as more conservative states such as Nebraska and Ohio. The breadth of affected states could encourage Congress to reconsider the cap, but the revenue it generates — hundreds of billions of dollars over 10 years — is probably too much to raise reasonable expectations that repeal is likely anytime soon.
Three states (Connecticut, New Jersey, and New York) countered last year by enacting state and local tax workaround laws that enable their residents to treat some tax payments as donations that can be claimed as charitable itemized deductions on their federal taxes.
The Treasury Department and the IRS responded by proposing regulations that effectively take the tax benefit out of the proposed workarounds.
But the proposed regulations, as initially drafted, go beyond SALT and would apply as well to more than 100 programs in 32 states and the District of Columbia that provide a state or local tax credit to individuals who donate to certain nonprofits, such as school-choice scholarship funds. If formally adopted in the coming months, the regulations could deny donors the federal tax benefit they get for supporting charter schools, endowment funds, conservation programs, and many more organizations.
States Have More Tax Revenue for New Giving Incentives
Since the 43 states that levy their own income taxes rely on at least portions of federal tax law, the 2017 changes to the Internal Revenue Code are not the end but the beginning of the story.
Many states have already seen increased tax revenues because of the way federal and state laws interrelate. In states with laws coupled to the federal tax code, personal exemptions were repealed (thus raising a taxpayer’s taxable income), but state tax rates remained the same, causing individuals to pay more to the states. Now, when most states are enjoying unexpected revenues, this may be the ideal time to propose enhancements of charitable-giving incentives.
Last year Delaware actually increased tax rates to bring in more revenue, and Oklahoma’s revenue law capped itemized deductions but excluded charitable donations from being under the cap. This last victory was not by accident; charitable organizations there mobilized in support of the state’s charitable deduction and prevailed because nonprofits did not sit on the sidelines but engaged in aggressive advocacy.
Sales Taxes and Nonprofits
It’s not just the federal tax code that changed tax matters for nonprofits. The U.S. Supreme Court last summer ruled that states may impose sales taxes on entities outside their borders that sell things online to the state’s residents. The decision in South Dakota v. Wayfair, Inc. could have significant implications for charitable organizations because states currently are not consistent in whether some or all nonprofits are exempt from sales taxes. As a result, it is hard for nonprofits to know if they should be paying sales taxes when buying or charging sales taxes when selling.
Adding to the challenge is that nonprofits could be hurt as states seek ways to tap into the estimated $13 billion to $26 billion in new revenues, also known as the Wayfair windfall. Legislatures can — whether intentionally or inadvertently — impose levies on previously tax-exempt nonprofits. That was the case earlier this year in Kentucky, where, much to the surprise of nonprofits and even lawmakers, the legislature imposed sales taxes on such things as nonprofit membership dues and sales items at charity auctions.
Picking Winners and Losers
In a letter to the incoming chairs of the congressional tax committees, we recently wrote: “Tax policy does far more than just define the nonprofit sector as tax exempt; whether intentionally or not, it also can promote fairness or its opposite, pick winners and losers, and support or ruin well-managed operations trying their best to improve the lives of others.”
The stakes in the upcoming tax-policy debates could not be more clear or more stark. Nonprofit leaders, board members, and others must not back away from this challenge to encourage tax policies to advance, rather than hinder, the common good.
Tim Delaney is chief executive and David L. Thompson vice president for public policy at the National Council of Nonprofits.
