The GOP tax legislation signed into law in December drastically alters the landscape for nonprofits—and not for the better. Even so, the sector should breathe a sigh of relief. Early provisions in the original House bill would have created more disruption, such as eliminating the use of tax-exempt bonds and repealing rules that keep nonprofits nonpartisan.
Although the Senate helped to soften the blow, the new tax law is going to cause some hardship. It’s time to start planning for 2018. We have identified four areas that deserve immediate attention.
1 ) Financing is More Expensive
One of the most immediate and unwelcome effects of the new law is that tax-exempt financing will be more expensive. Here’s why: the discounted interest rate that nonprofits pay on tax-exempt financing is tied to the bond holder’s (e.g., the bank’s) tax rate. Because the corporate tax rate for banks under the new law dropped from as much as 35% to 21%, the discount rate for bonds went from approximately 65-68% of the taxable rate to 79% of the taxable rate as of January 1, 2018.
Not only does this mean that future bonds will have higher interest rates, but in most cases, the new corporate tax rate has triggered bond language that re-sets interest rates higher on existing bonds. Not surprisingly, many nonprofits have not had time to plan and budget for these increased borrowing costs. Nonprofits are often concerned and frustrated that rates are increasing, but the bottom line is that the new tax rate means outstanding bonds have interest rates that are discounted too steeply, which makes them unprofitable for the bank.
Although most banks are increasing rates, anecdotal evidence suggests that in some cases, they are willing to work with nonprofits to find solutions to lessen the impact. While both sides must avoid running afoul of rules against tying certain services to a lending arrangement, there are plenty of legal options worth considering and discussing with your banker.
2 ) Charitable Giving Expected to Decrease
Another big change that nonprofits must prepare for is an almost certain decrease in charitable giving. The new tax law doubles the standard deduction for individuals to $12,000 and for couples to $24,000. While the new standard deduction will provide a higher overall deduction for many taxpayers, it will most likely depress charitable giving because only those who itemize deductions, instead of taking the standard deduction, get the benefit of a charitable contribution.
Experts estimate that the provision will radically decrease the number of taxpayers who itemize their deductions – from about 30% of taxpayers in 2017 to 6% in 2018. The National Council of Nonprofits predicts that the change will shrink giving to charitable nonprofits by $13 billion or more each year, and the Massachusetts Nonprofit Network predicts the impact in Massachusetts will be as high as $500 million.
This change may also encourage more so-called “bunched” giving. Instead of making annual gifts to charities, donors might wait and make several years’ worth of donations in one year. The idea would be to raise the value of itemized deductions (including charitable contributions) above the standard deduction.
This change will demand creativity and new planning strategies on the part of nonprofit development officers. Indeed, there are already signs that nonprofits are ramping up other forms of fundraising. For example, many charities have begun to aggressively hire grant writers; and in the first quarter, the People’s United Community Foundation has seen a dramatic increase in grant applications.
In addition to changes to the standard deduction, the tax law also doubles the exemption for the estate tax to almost $11 million for individuals and to approximately $22 million for couples. The National Council of Nonprofits predicts this could depress charitable giving by another $4 billion per year.
3 ) Demand for Services Likely to Increase
Ironically, as the tax law depresses charitable giving, it’s also likely to increase the demand for services—particularly those offered by human and social service charities. Why? If the tax law reduces federal and state income, governments may cut back on local programs that serve the needy, increasing the burden on charitable nonprofits. For example, the law limits the amount of state and local taxes that people can deduct from federal taxes to just $10,000. That rule is likely to pressure state and local governments to enact tax and spending cuts.
In response, nonprofit representative organizations such as the Massachusetts Nonprofit Network, the Providers’ Council, the Association of Developmental Disabilities Providers (and others) will continue to play a key role in working with local governments to keep these programs adequately funded.
4 ) Federal Tax Levies Introduced
The law imposes a new 1.4% excise tax on the net investment income of private colleges and universities with assets of at least $500,000 per full-time student and more than 500 full-time students. A new 21% excise tax has also been created for any nonprofit that pays any of its five highest-paid employees $1 million or more.
According to The National Council of Nonprofits “the provision should be of concern to all charitable nonprofits because it represents an invasion of nonprofit independence, replacing the fiduciary judgment of organizational trustees with the political will of elected officials.” Moreover, there is serious concern among nonprofit leaders that these new tax levies are a breach that will expose the sector to future tax increases.
While the new tax law was not actually about nonprofits, it has radically reshaped the nonprofit environment. Donations are likely to dip, while demand for charitable services is likely to climb. Moreover, other proposed changes that did not make it into the final law could emerge once again in future tax proposals. The nonprofit community will need to be vigilant and united in their efforts to work through these and future challenges.