Nonprofits Face Challenges Due to the Tax Cuts in 2018

Happy New Year to all! After two weeks off for the holiday, we here at Capacity Building and Policy Experts, LLC are back. In 2018, it seems the nonprofit sector and its donors will face several challenges due to the new tax cuts. This is the first part of my two-part series that will examine the impact of the recent tax cuts signed into law by President Trump in December of last year, which is known as the Tax Reform and Jobs Act of 2017.

What does this tax bill do?

It is an overhaul of the Internal Revenue Tax Code of 1986. The bill aims to simplify the tax code. It increases the standard amount that families and businesses can deduct from their taxes. It also reduces the personal itemizations and business-related expenses that can be deducted.  Some of these itemizations include but are not limited to, the deductions for mortgage interest, and state and local taxes (SALT). The Act also does away with business deduction expenses for entertainment, amusement, recreational activities, and membership dues with respect to any club organized for business, pleasure, recreation, or any other social purpose.

It also repeals the Affordable Care Act’s (ACA’s) individual mandate and associated penalties. In addition, some fringe benefits provided to employees will now be considered taxable wages. Some nonprofits will also have to pay taxes on a specific set of income-generating strategies, and on executive compensation above $1 million dollars. There is also an increase in the cash donation threshold, which will result in fewer individuals that will be able to deduct charitable donations.

Notwithstanding, nonprofit leaders, board members, employees, and donors should consult with their accountants and nonprofit auditors to see how the Tax Reform and Jobs Act of 2017 will impact their nonprofit organization’s operations and compliance requirements. To view the bill that was signed into law, click here. For more guidance, you can also click here to look at the analysis put forth by the Joint Committee on Taxation on the tax cuts.

Impact on Donations

Nonprofits will have to rethink how they go about targeting individual donors by appealing to them with their organization’s mission and impact since fewer private donors will be able to deduct their charitable donations due to the tax cuts. In addition, they should target larger-scale donors who can offer more robust gifts. This shift in thinking is attributable to the increase in the cash donation threshold, for those who choose to itemize, from 50% to 60% of Gross Adjusted Income (GAI). The standard itemization is simultaneously increasing for individuals, married couples, and heads of household. This means that in order for charitable contributions to count when you are doing your taxes, the combined value of all of your deductions must exceed the standard deductions.

The long-term impact of the tax cuts on the third sector as a whole is potentially devastating. According to the Joint Committee on Taxation, out of the individuals who itemized under the old tax code, a total of 40.7 million taxpayers were estimated to make charitable contributions for a total of $241.1 billion in charitable deductions. However, under the 2017 Tax Cuts and Jobs Act, the Tax Committee estimates that only 9.4 million taxpayers will claim a total of $146.3 billion. This decrease in revenue will have a destructive effect on nonprofits that could potentially trigger cutbacks in or the elimination of many vital services and programs. The Council on Nonprofits estimates that this drop in funding will result in a loss of 220,000 to 264,000 in nonprofit jobs. Shrinking the nonprofit workforce will further endanger the ability of organizations to provide vital services to the most vulnerable.

Threat to Tax-Exempt Status

Some nonprofits are now going to have to pay taxes due to the tax cuts. Nonprofits will now be penalized for identifying fiscal strategies that generate unrestricted funding streams through the imposition of taxes on unrelated business income, executive compensation, and some endowment returns. Some of these for-profit fundraising strategies have been developed by the nonprofit sector in order to overcome contradictory funding obstacles that result in deficits, and are imposed by various funders. They also aim to protect organizations by serving as a backup during economic downturns, such as recessions. The imposition of taxes essentially translates into an additional funding cut by diminishing the ability of nonprofits to generate revenues.

The following are some of the taxes being imposed by the Act:

• Nonprofits with unrelated business income taxes (UBIT) will be required to calculate their taxes on each trade or business they run that is not closely aligned with their mission;

• An excises tax will be imposed on nonprofits that pay compensation of $1 million or more to any of the five highest-paid employees;

• A 1.4 percent excise tax on larger university endowment returns will be imposed; and

• Certain employee benefits that nonprofit employers provide will be taxed (e.g., commuter assistance and other employee incentives).

Impact on Nonprofit /Operations

Nonprofit board members, fiscal departments, and the HR staff must review their fiscal policy and procedures and HR manuals to ensure that they are up-to-date. In some cases, benefits and incentives for employees will have to be modified. Nonetheless, irrespective of whether the tax cuts result in any changes in an organization’s policies, there should be informational sessions and/or training that are organized by senior staff to answer questions that employees may have.

The Act makes the following changes in the tax code:

• New Tax Tables and Rates. All staff members and board members involved in the organization’s finances will have to familiarize themselves with the new federal income tax tables and rates that became effective on January 1, 2018. The Internal Revenue Service (IRS) anticipates issuing the initial withholding guidance in January, which should be reflected in employees’ paychecks by February. Until then, employers should continue to use the existing (2017) withholding tax tables and guidance.

• W-4 Forms are Expected to Be Revised: The number of personal exemptions that employees indicate they expect to report on their personal taxes is currently one of the key factors in determining the withholding calculations. The Act repeals the deduction for personal exemptions, which for 2017 is $4,050 per individual (e.g., employee, spouse, and dependents). It is likely that the W-4 State Forms will also be revised by states since, for the most part, they are based on federal law. Currently, the existing Forms W-4 that employees have already filed will likely not require any further action by employees. Click here for more information.

• Guidance for the Supplemental Wage Withholding Rate is Pending. The Treasury Department will be issuing the withholding rate for bonuses and commissions for 2018 in the near future.

• Benefits and Incentive packages for some nonprofits will be impacted. Your HR Department, HR Board Committee (if you have one), or staff assigned to HR matters will have to review the HR manual to ensure it is up to date with current standards. The following will have to be updated for organizations that offer these benefits:

  • Qualified Transportation Fringe Benefits. The Act repeals the employer deduction for expenses related to qualified transportation fringe benefits, with some exceptions. Qualified transportation fringe benefits will remain tax-exempt to employees.

  • Several Fringe Benefits Will Now Be Reported as Employee Wages. The Act will now require employers to report the following fringe benefits and incentives as taxable employee income:

    • Qualified bicycle commuting reimbursements of up to $20 per month for employees, and

    • Qualified moving expense reimbursements, with an exemption for members of the Armed Forces who are on active duty and required to move due to a military order.

  • The Affordable Care Act (ACA)’s Individual Mandate Penalties Are Eliminated. The individual mandate that requires individuals to be covered by health insurance with at least a Minimum Essential Coverage (MEC) remains in effect through 2018. However, the Act eliminates the penalty to the individual altogether, effective in 2019. The ACA employer mandate, though, for coverage and reporting (Section 4980H of the Internal Revenue Code) will continue for employers with 50 or more full-time employees.

What Nonprofits Should Do

During this challenging period that is fraught with uncertainty, it is essential that nonprofit leaders engage in strategic management and leadership. This is the moment in which the board, the executive director, and senior leadership should focus on making their nonprofit organization’s services stand out as unique. Organizations should also institute any necessary changes that will allow the organization to adapt to changing circumstances while remaining aligned with the mission. Below are a couple of strategies for creating a sense of security for employees who perceive a looming crisis or for organizations that are experiencing a crisis as a direct result of tax cuts, budget cuts, or a reduction in donations.

Strategic Management

Board members on the Development, HR, and Finance Committees; the executive director; senior management; development staff; fiscal staff; and program staff must:

• Come up with strategies to continue to engage old and new donors in the event they are unable to meet the 60% of the GAI cash donation threshold through strengthening personal relationships and highlighting the organization’s unique niche;

• Take time to strategize on what the funding priorities are for the organization (e.g., infrastructure, existing or new programs, staff development, etc.);

• Strategize on how to engage larger-scale donors;

• Determine what partnerships or realignment strategies (e.g., collaborations, administrative consolidation, joint programming, program transfer, parent-subsidiary, joint venture, merger/acquisition, etc.) are essential to enhance existing programs, and to continue services, in the event the organization has to implement staff layoffs or program cuts;

• Monitor the policy environment to try to prepare for any anticipated budget cuts or changes in the distribution of government funds that may impact your nonprofit;

• Engage in advocacy efforts with key policy brokers to protect services;

• Examine the environmental carrying capacity in your field by candidly assessing the number of similar organizations that can be supported by current political, social, and economic conditions and resources; and

• Focus on your organization’s niche and what makes it unique above other nonprofits that provide similar services.

Transparency

This will also be a time of uncertainty for employees. Informational sessions and/or training that are conducted by senior staff must be organized to answer questions that employees may have. Questions that should be answered include:

• How W-4 forms will change and the implications for personal exemptions?

• When will the changes go into effect?

• How will existing policies and procedures be impacted?

• How are fringe benefits impacted?

• What is now considered taxable income?

• What impact will the upcoming FY ’19 budget combined with the tax cuts have on the organization’s budget? Questions that you should be prepared to address in this discussion include, what happens if there is a decrease in funding? Will there be frozen or reduced salaries? Will programs be curtailed? Will there be a reduction in staff? Will there be a reduction in employee benefits? Will there be an increase in fees-for-service for clients? Are people’s jobs safe?

• What is the fundraising plan for the organization to prepare for a reduction in revenue from government and private donors?

Senior administrators and the Executive Director should brainstorm to identify other important questions that may come up and must be answered.

Strategic Leadership

If it turns out that the organization will be facing program or staff cuts (whether large or small), it is important to maintain transparency at every level of the organization. In addition, for those in leadership positions, particularly for the Executive Director, it is important to remain focused and strategic. Everyone is looking to you to know how to behave. If you panic, everyone else panics and quits. If you are strategic, your staff will be more likely to try to stick it out with you.

The following are a couple of tips for navigating this process:

• Help board members, senior leadership, and employees understand what is happening;

• Keep yourself centered and act strategically as things begin to evolve;

• Do not panic and understand that crisis is normal in organizations as they evolve; and

• Continue to keep your finger on the pulse of the organization and external trends.

Broader Implications

The Congressional Budget Office (CBO) has estimated that the tax cuts will add an estimated $1.4467 trillion to the national debt in the next decade. Governments at the local, state, and federal levels will inevitably have to strategize on how to balance their budgets with less revenue. Unsurprisingly, when governments have less income, this means that they have to cut spending to balance their budgets. This usually translates into cutting funding for critical services provided by nonprofit organizations. According to various economists, including Paul Krugman, tax cuts that result in deficits could also trigger cuts in safety net programs such as Medicare, disability insurance, and other social programs. In my next post, I will expand further on the impact these cuts will have on nonprofits and our social safety net. For the full CBO report, click here.

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By: Paulina Alvarado-Goldman, Founder & CEO