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Nonprofits could be squeezed in tax reform if Republicans decide to expand the instances in which the organizations must pay taxes—a move that would carry political consequences but would help bring in some revenue for rate cuts.
Nonprofit advocates have long feared that their sector could be a pay-for in a tax reform bill. Those negotiations are ongoing and will likely become more contentious in the coming weeks as lawmakers dig into specific policy areas while hearing from lobbyists and constituents with concerns. But even without legislative text, the outcome of making the sector a revenue-raiser is clear: Organizations that are generally exempt from tax would end up paying more.
While tax reform may touch nonprofits—from churches to major universities—in myriad ways, requiring organizations to pay more tax on certain types of income is a possibility that Republicans have considered in the past. While nonprofits don’t pay tax on income from activities that are substantially related to their exempt purpose, they do pay tax on income that stems from a business that is regularly conducted but isn’t substantially related to their mission—a levy known as unrelated business income tax.
The use of unrelated business income tax was expanded in former Ways and Means Committee Chairman Dave Camp’s (R-Mich.) 2014 tax reform draft, which has been among the proposals tax-writing committee staffers are considering for an overhaul now. Rep. Peter Roskam (R-Ill.), a top member of the Ways and Means Committee, said Oct. 11 that members will become increasingly “forward-leaning” on what can pay for tax cuts as they come closer to releasing a bill in response to being asked whether lawmakers would turn to unrelated business income.
“Anything that changes how it’s done and increases the tax liability of nonprofits is going to be of concern to them,” James P. Joseph, a partner and co-chair of the tax group at Arnold & Porter Kaye Scholer LLP, told Bloomberg Tax.
Examples of unrelated business income could include a museum selling candy or trinkets (activity unrelated to its mission) and a charity selling holiday cards (irregularly carried on).
Roskam’s Oct. 11 comments were the first indication that Republicans may be looking at unrelated business income. The development is particularly troubling because nonprofits have increasingly been using it to “fill the gap” as government funding has declined, said Allison Grayson, director of policy development and analysis at Independent Sector.
“It’s disappointing to hear Congress may start looking at this area as a potential source of revenue to pay for tax cuts in other parts of the tax code,” she said.
House Ways and Means Chairman Kevin Brady (R-Texas) has repeatedly said members of the tax-writing committees are still working on legislation. He hasn’t publicly discussed unrelated business income, and has previously said he wants to encourage charitable giving in tax reform.
Rep. Mark Walker (R-N.C.), chairman of the Republican Study Committee, dipped his toe into charitable issues with an Oct. 6 bill that would allow taxpayers who take the standard deduction to deduct charitable contributions up to an amount equal to one-third of the deduction.
“I think that’s a little bit of a reach,” he said of the idea that the nonprofit sector could become a revenue-raiser.
The Camp draft included many changes regarding the treatment of nonprofits. Unrelated business income-related provisions included taxing nonprofits for royalties from the sale or license of an organization’s name or logo, income from research that isn’t public, certain sponsorship payments over $25,000, and gain or loss from the sale of distressed property.
Camp’s proposal also would have changed how the tax was calculated, requiring nonprofits to determine it separately for each trade or business. It also would have prohibited using a loss from one business to offset income from another, a strategy that corporations regularly use. This “bucketing rule” could significantly increase the amount of tax paid by colleges and universities, which are complex organizations with many income streams.
“It treats nonprofit corporations fundamentally differently than for-profit corporations. I think it’s fair to say the purpose is to collect more tax from not-for-profits,” Matthew Hamill, a senior vice president at the National Association of College and University Business Officers, told Bloomberg Tax.
NACUBO represents more than 2,100 colleges and universities. Its members have been trying to remind lawmakers about the potential negative effects of a tax reform bill and have zeroed in on the Camp draft because it is “the only known quantity out there,” Hamill said.
“If you make these kinds of changes that increase tax liability, you’re going to just see them passed on to students and taxpayers,” he said.
But Republicans may also conclude that some pay-fors don’t bring in enough revenue and are too politically unpopular to include in a final bill. The nonprofit portion of Camp’s 2014 proposal would have raised $8 billion over a decade, according to analysis by the Joint Committee on Taxation. In comparison, the business tax changes would have raised $562.4 billion over a decade.
Treating name and logo royalties as unrelated business income would have raised $1.8 billion over a decade and requiring unrelated business income to be calculated separately for each activity would have raised $3.2 billion over a decade. Those estimates would be a drop in the bucket for the current Republican framework, which is estimated to cost several trillion dollars.
“I just question whether it’s going to raise enough to make a difference. There might be enough of a backlash,” Joseph said. In particular a few major universities in key congressional districts pressuring lawmakers could sway them, he said.
Republicans may then decide “I like my season basketball tickets and I don’t want to irritate the basketball coach at my university, so I’m not going to go in for this since it doesn’t raise that much anyway,” he joked.
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