The destructive tsunami the new federal tax law unleashes is about to pound the nation’s nonprofits and foundations. The law that Congress passed and the president signed in the waning days of 2017 has created the most dangerous policy environment across the state, local, and federal levels that we’ve ever seen in the decades we’ve spent focusing on how governments and nonprofits interact.
That may sound like hyperbole. It is not.
Consider state policy making. In the next few months, states — operating without lead time or complete information — must react immediately to the complex federal tax law changes enacted just a couple weeks ago. States must now instantly assess the potential damage from the new law in time to make any required, yet disruptive, midyear changes to their budgets. At the same time, states must reopen their own tax codes to conform with the federal changes. Local governments will follow.
Every time tax laws are rewritten, it creates winners and losers. We anticipate attempts will be made to reconfigure state and local tax laws in ways that lead to new levies on tax-exempt entities, such as additional fees, payments in lieu of taxes on nonprofit-owned real estate, penalties on nonprofit salaries seen as overly high, and excise taxes on some endowments. What’s more, as governments at all levels are forced to cut spending, more work will fall on nonprofits to help people hurt by the spending reductions. Expect nonprofits to have to seek more money from foundations to cover those costs — think of it as a new tax on philanthropy to subsidize decisions of politicians.
With the challenges of 2018 so clear, it’s imperative that nonprofit and foundation professionals move quickly to advocate aggressively for smarter public policies at all governmental levels. Here are some of the key changes at stake.
Nonprofit Nonpartisanship vs. Politicking
Charitable, religious, and philanthropic organizations (with an assist from state charity regulators) have so far successfully blocked passage of five bills attempting to politicize their operations. Radical language in early versions of the tax bill and other proposed legislation would have weakened or eliminated the longstanding measure known as the Johnson Amendment (because it was proposed by then-Senator Lyndon Johnson) that protects charitable organizations, houses of worship, and foundations from political operatives pressuring those organizations to endorse or oppose candidates. It also insulates nonprofits from powerful donors exerting even more pressure by giving or threatening to withhold charitable contributions to organizations that endorse or oppose candidates the donors prefer.
But the threat remains very active — and likely will erupt again within the coming two weeks as Congress and the White House try to cobble together a spending bill for fiscal year 2018 before January 19 to avert a government shutdown.
President Trump, Vice President Pence, House leaders, Ralph Reed, Jerry Falwell Jr., televangelists, and the National Religious Broadcasters are among those vowing to "destroy" the Johnson Amendment — even though it has proven successful for more than 60 years. Why? We suspect it’s lust for profit and power, because the language in the House-passed tax bill, according to Congress’s nonpartisan Joint Committee on Taxation, would have encouraged partisans to divert billions of dollars of political campaign contributions to houses of worship and charitable organizations — where it would be both anonymous and (for the first time) tax-deductible.
Particularly offensive about the well-funded advocacy campaign to corrupt charitable and philanthropic organizations by dragging them down into toxic partisan politicking is: It falsely disguises a campaign-financing proposal as a "religious speech" issue. Yet not a single religious denomination has stepped forward to endorse it — compared with more than 100 denominations and major religious institutions, 4,300 religious leaders, 5,600 charitable, religious, and philanthropic organizations, and many state law-enforcement officials who strongly oppose any changes in the prohibition on partisan politics.
The fight to shield charitable and philanthropic organizations from divisive partisan involvement isn’t over, and it isn’t just a federal issue; it’s also a live threat in the states. This past year, legislators in Texas (enacted) and Michigan (pending) pushed to modify their laws to encourage or at least hinder enforcement of limits on partisan activities.
Tax Cuts = Revenue Cuts = Spending Cuts
The tax bill’s deepening of the deficit by $1.5 trillion already has been used as shallow "justification" for not fully funding the Children Health Insurance Program and cutting Medicare, Medicaid, and Social Security.
Expect things to get worse, as Bishop Frank Dewane of Florida, speaking for the U.S. Conference of Catholic Bishops about the federal tax bill, points out: "The final bill creates a large deficit that, as early as next year , will be used as a basis to cut programs that help the poor and vulnerable toward stability."
States currently receive, on average, almost a third of their total revenues from the federal government. The reductions in revenue that will prompt the federal government to slash its spending will wreak havoc on many state and local budgets, further injuring the work of charitable organizations and increasing demands on foundations to fill the void.
What’s the connection between nonprofits and the fiscal health of governments?
Several, but two stand out.
First, when federal, state, and local governments cut spending, they never cut human needs; in fact, human needs increase as individuals lose services on which they depend, generating increased demands on nonprofits (and foundations). Second, America’s nonprofits earn almost a third of their entire revenue through government contracts and grants that pay for services in communities.
When governments cut spending, they reduce the resources needed to pay nonprofit contracts and grants; in turn, those nonprofits then must compete in the narrowing pool of contributions, thereby affecting all nonprofits, not just those with direct government agreements.
The states are in no condition to absorb revenue losses.
In 2017, 22 states suffered revenue shortfalls, making them unable to maintain services at existing levels, let alone with less federal funding. Here’s a partial sampling of states now in fiscal duress: The ongoing Illinois budget crisis is legendary, while New Mexico and North Dakota are mired in at least their third straight year of spending cuts. Kentucky has a $1 billion budget hole and is already cutting human services, and Iowa expects to make cuts of $45 million to $90 million by June 30. Oklahoma doesn’t even have a budget for the fiscal year that started July 2017.
Any one change to federal tax law can knock state budgets out of alignment.
Montana, for instance, a state already in financial stress, calculates it will lose $29 million in revenue this year because of federal tax changes that favor "pass-through" entities like small businesses, partnerships, and others that pass tax responsibilities onto owners, partners, and others.
How will the state raise replacement dollars? By taxing individuals, for-profit corporations, charitable organizations, or philanthropic assets? If you were a foundation or nonprofit, would you ignore this threat, go it alone, or join with other nonprofits in Montana to have more eyes and ears to learn what’s happening — and a louder collective voice?
The new federal tax law will affect every state differently. While many states expect resulting revenue shortfalls, some may be spared. But as The New York Times reported this week, leaders in California, Connecticut, New Jersey, New York, and elsewhere are considering promptly redesigning their tax codes with changes like shifting responsibility for all payroll taxes onto employers and allowing "residents to replace their state income tax payments with tax-deductible charitable contributions to their state governments."
Shrinking Charitable Gifts
As the American public just witnessed, neither facts nor logic mattered when the tax bill was before Congress.
State and local governments lost their objections to capping deductibility of state and local taxes, mortgage lenders lost their arguments about limiting the deductibility of mortgage interest, and homebuilders lost on both of those major changes. Similarly, Congress did not listen to charitable organizations and foundations about the dangerous consequences of tampering with incentives for giving.
Members of Congress may assert that they did not directly change the charitable-deduction provision in the tax code. That may be technically accurate, but it’s certainly not the whole truth. By doubling the standard deduction and lowering tax rates, Congress will be depressing charitable giving by $13 billion to $20 billion annually and eliminating 220,000 to 264,000 nonprofit jobs, according to economists. When and where those shortfalls will hit are uncertain; it might take a full year or two to grasp the consequences.
Meanwhile, expect increased threats to state charitable-giving laws. In 2011, Hawaii capped its itemized deductions to fill a budget hole, and Michigan repealed charitable tax credits to provide big tax cuts for businesses. Charitable giving declined in each state by more than $50 million annually. (Hawaii restored it in 2013 after seeing the fallout.) Since that time, at least seven additional states have tried (some more than once) to restrict charitable giving but have been defeated by strong nonprofit advocacy campaigns: Delaware, Kansas, Minnesota, North Carolina, Oklahoma, Oregon, and Vermont.
The new tax law repeals the Affordable Care Act’s requirement that every American must have health insurance or pay a penalty. The repeal will increase health-insurance premiums in some areas by 10 percent annually, according to the Congressional Budget Office. These changes matter to nonprofits of all kinds, not just health-care groups.
After all, nonprofits are employers that may incur significant new costs to provide health insurance for their workers. And the repeal will lead to new demands for services: Of the 13 million more people projected to have no health insurance, many may be forced to choose between paying for mandatory life-saving medication and paying other bills. Yet, for example, loss of car payments in an area with no public transit may mean that some people are no longer able to get to work, leading to loss of income, then loss of housing, food, and so on. Someone losing health insurance may suddenly have lots of nonmedical needs — and turn to more and more nonprofits for assistance.
An additional major concern is the ramifications to state budgets. As the federal government shifts more burdens for health-care costs onto the states, the resulting strains will create even more havoc.
Taxing Tax-Exempt Organizations
It sounds like an oxymoron: Congress decided to tax tax-exempt organizations to pay for additional tax cuts for for-profit corporations and others. In the tax bill, Congress:
• Imposes a 1.4 percent excise tax on larger university endowment returns. That means that elected officials are ignoring the fiduciary decisions of nonprofit trustees to impose their own political will.
• Increases unrelated business income taxes, often known as UBIT, by requiring that nonprofits calculate their taxes on each trade or business they run that is not closely allied to their mission. For example, a nonprofit hospital that earns revenue by running a laundry business now may have to pay UBIT. Under current law, nonprofits aggregate profits and losses of all entities.
• Imposes a new 21 percent excise tax on nonprofits that pay compensation of $1 million or more to any of their five highest-paid employees.
• Taxes certain employee benefits that nonprofit employers provide, including gym memberships and commuter assistance.
Some of these approaches have been attempted before by some states.
For years, legislators in Massachusetts and Connecticut have sought to tax the investment returns or even the assets of college and university endowments. This past year, bills in Connecticut and Massachusetts would have denied tax-exempt status to nonprofit hospitals paying salaries that politicians regard as "high."
Legislation proposed in Montana would have deprived nonprofit hospitals of their property tax exemption for paying salaries of $250,000 or more per year. A new bill just introduced in Vermont would cap salaries at nonprofits that do $1 million or more in business with the state.
That’s not all. For years nonprofits have been battling local governments searching for any new revenue sources. The efforts to impose new taxes, fees, and payments in lieu of taxes — (known as Pilot payments) — can pop up in normal or creative forms, such as redefining what qualifies as "tax-exempt" and assessing a "bed tax" on patients of nonprofit hospitals and students at nonprofit colleges.
Time for Action
The cascading spending cuts from the federal, state, and local levels, the pending frenzied rewriting of state and local tax laws, and other threatened policy changes demand our collective action.
Every nonprofit and foundation should hold a special board meeting immediately with senior staff members to review:
Operational matters. What does your organization need to do to comply with the new federal tax law (and upcoming state and local changes), such as adjusting employee withholding?
Policy. Identify the greatest risks your organization would face if particular state and local policies are changed, as well as any new opportunities. Figure out where to get timely, trustworthy policy information in your state and to lift your organization’s voice collectively with others.
Advocacy. Because the markedly heightened threat level to missions makes it inescapable that organizations must engage in advocacy (directly or through other groups), make sure your organization understands its legal rights — and fiduciary obligation — to speak out in self-defense through legislative lobbying and engaging in other forms of advocacy.
There’s no question big change is on the way, and it has the power to do tremendous damage to nonprofits and the people they serve. Indeed, a policy tsunami is racing toward us all. If we learn nothing else from 2017, it should be the urgent need for nonprofits and foundations to take active steps to advocate for smarter public policies.
Tim Delaney is chief executive and David L. Thompson vice president for public policy at the National Council of Nonprofits.