The past 18 months have been full of challenges for nonprofits. Adding on to the scope are several significant tax changes for nonprofits and updated guidance that has been released. Some changes can be traced back to the Tax Cuts and Jobs Act (TCJA) of 2017 and are just now receiving guidance or enforcement. Here are the important tax changes for nonprofits you should be aware of.
Updates to charitable giving
The events of 2020 that carried into 2021 have spurred changes in tax deductions related to charitable giving for your donors, both individual and corporate. Here are the key tax changes for nonprofits:
- Nonitemizers can deduct up to $300 in charitable donations for 2020 and 2021.
- 2020’s donation is per tax return and reduces adjusted gross income.
- 2021’s is per taxpayer (up to $600 for a joint return) and does not reduce adjusted gross income.
- Cash donations are not subject to any reduction in gross income, but certain donations don’t qualify including:
- Supporting organizations and donor-advised funds.
- Prior year carry-forwards.
- Non-cash donations.
- Non-corporate businesses can deduct up to 25% of aggregate net income for contributions of “apparently wholesome food inventory.”
- Corporations’ contributions get a raise from the 10% net income limitation to 25%.
Changes made to compensation
Several changes have been made and clarifications issued related to nonprofit compensation. Most notably:
- Executive compensation: Applicable tax-exempt organizations are subject to an excise tax of 21% on executive compensation of $1 million for the top five covered employees. Final regulations were published in January 2021 and are effective beginning in 2022. This could affect your nonprofit if you:
- Are tax exempt under 501(a).
- Are a farmer cooperative.
- Have connected to a public utility or essential state or municipal government function.
- Are a political organization.
- Independent contractor compensation: All contractor compensation must be reported on Form 1099-NEC (not 1099-MISC). This applies to any vendor where the payments made:
- Total $600 or more over the calendar year.
- Were not used for product purchases only.
- Were not paid by credit or debit card.
- Were not paid to vendors who are taxed as corporations (generally does not include LLCs), government agencies, tax-exempt organizations, or non-resident aliens.
- Note that LLCs may make an election for exemption from Forms 1099-NEC but payors have the responsibility of asking for a Form W9 or equivalent written statement.
- Penalties are enforced for failing to provide 1099-NECs to vendors or the IRS of up to $560 per vendor, but you can also be held responsible for 24% of the amount paid to the vendor in addition to the penalty. It is necessary to require all vendors to complete a Form W9 in order to secure their correct information for reporting. If they refuse, the IRS requires you to withhold 24% of all payments as backup and pay that to the government.
- Employee compensation: W2 wages for nonprofits are eligible for the employee retention credit for periods between March 13, 2020, and June 30, 2021. We can help you claim this credit.
Updates to unrelated business taxable income
Nonprofits with unrelated business taxable income (UBTI) must compute UBTI separately for each unrelated trade or business. This means you cannot use an operating loss from one unrelated trade to offset your income of another. These regulations and guidance were finalized in Dec. 2020 and apply to taxable years beginning after Dec. 2, 2020. Your two-digit NAICS code is used to identify the separate trades or businesses. Separate businesses that sell donated items or operate with volunteer workers are generally exempt.
If you change the identification of a separate business, you must report it in the taxable year of the change. You must provide:
- Identification for the previous tax year.
- Identification for the current tax year (the change).
- Reason for the change.
Additionally, when calculating UBTI, tax-exempt organizations may make charitable contributions of up to 10% of UBTI. However, expenses related to tax-exempt income do not qualify for deduction.
Electronic filing required for certain forms
All Form 1024-As for Recognition of Exemption must be submitted electronically at www.pay.gov effective Jan. 5, 2021. Paper applications will cease being accepted after April 5, 2021. The Form user fee is $600 and can be paid through the application portal. Here are the steps to submit your 1024-A electronically:
- Register for an account on pay.gov.
- Search for 1024-A and select the form.
- Complete the form and pay the user fee.
Additionally, all Forms 990 must be filed electronically.