15 February 2016 Proposals in President's 2017 Budget would affect exempt organizations A number of provisions in the Obama Administration's FY 2017 Budget proposals could affect tax-exempt organizations. General provisions affecting exempt organizations Under current law, tax-exempt private foundations are generally subject to a 2% excise tax on investment income. This tax is reduced to 1% in any year that the foundation makes charitable distributions exceeding its average charitable distributions for the preceding five years. Based on the concern that using a five-year average to qualify for the lower rate under the current system might discourage foundations from making higher levels of charitable distributions in a particular year for fear of increasing their five-year average, the Administration proposes replacing the two-tier rate system with one rate equal to 1.35%. Deny deduction for charitable contributions that give donors the right to purchase tickets to a sporting event The law currently allows college and university donors receiving the right to purchase tickets for seating at an athletic event in exchange for their contributions to deduct 80% of the contribution. For colleges and universities, the Budget would disallow the deduction for charitable contributions that are a prerequisite for purchasing tickets to college sporting events. The Administration proposes simplifying the complicated set of rules limiting deductions for charitable contributions to allow a single deduction limit of 30% of a taxpayer's contribution base for noncash contributions (other than conservation easements), irrespective of the type of property being donated or whether the contribution is to or for the use of the organization. Additionally, the Budget would extend the carryforward period for contributions exceeding limitations from five to 15 years. — Strengthen the requirements for entities to e-File and require returns electronically filed by tax-exempt organizations to be in a machine-readable format. — Increase the standard mileage rate for the charitable contribution deduction for automobile use by volunteers, harmonizing the rate with the one applicable for medical and moving expense deductions. Proposals related to tax-exempt bonds Section 501(c)(3) organizations can use exempt bonds to finance either capital expenditures or working capital expenditures. In 1986, Congress enacted a $150 million limit on outstanding, non-hospital tax-exempt 501(c)(3) bonds, but repealed the limit in 1997 for bonds issued after August 5, 1997, if at least 95% of the net proceeds were used to finance capital expenditures incurred after that date. To reduce complexity and remove disparities in the availability of exempt-bond financing, the Administration proposes repealing in its entirety the $150 million limit on the volume of outstanding, non-hospital tax-exempt bonds for the benefit of any one Section 501(c)(3) organization. State and local governments can issue tax-exempt private activity bonds with permitted private business use and other private involvement to finance certain specified types of projects, including "qualified public educational facilities" under Section 142(k). A private corporation must own the public school facilities under a public-private partnership agreement with a public state or local educational agency, and the private corporation must transfer the ownership of the school facilities to the public agency at the end of the term of the bonds for no additional consideration. In addition, a special separate annual volume cap applies to these bonds. To simplify exempt bond financing for qualified public educational facilities, the Administration proposes to eliminate the private corporation ownership requirement, thereby allowing any private person, not just corporations, to either own the public school facilities or operate those school facilities through lease, concession or other operating arrangements. In addition, the proposal would remove the requirement to transfer the school facilities to a public agency at the end of the term of the bonds for no additional consideration and would remove the separate volume cap for qualified public educational facilities. Although professional sports facilities, such as stadiums, are not a permitted category for financing with qualified private activity bonds, stadiums can be financed with tax-exempt government bonds, even if use by a professional sports team exceeds 10% of the total use of the facility, provided the debt service is paid from sources other than sports facility revenues or other private payments, such as generally applicable taxes. To prevent the benefits of tax-exempt financing from flowing to private professional sports teams, the Administration proposes to eliminate the private payments test for professional sports facilities. As a result, bonds used to finance professional sports facilities could be considered taxable private activity bonds when more than 10% of the facility is used for private business use. The removal of the private payment test would disallow sports facilities with significant private business use by professional sports teams to obtain tax-exempt governmental bond financing. Two types of complex arbitrage investment restrictions apply under Section 148 to certain investments of tax-exempt bond proceeds. "Yield restriction" limits returns on investment and arbitrage "rebate" requires issuers to pay back any arbitrage benefit at prescribed intervals. These restrictions have various exceptions and apply in different ways simultaneously. Describing the arbitrage investment restrictions as creating "unnecessary complexity and compliance burdens," the Administration proposes to unify the yield restriction and rebate requirements by making the arbitrage rebate the principal arbitrage restriction for exempt bonds, resulting in the effective repeal of yield restrictions except in limited situations, such as the investment of escrows in an advanced refunding issue. In addition, the spending exception for most tax-exempt bond proceeds would be expanded from two years to three years, as long the bonds had a fixed yield and a minimum weighted average maturity of at least five years. The proposal would also increase the small-issuer exception to the arbitrage rebate requirement from $5 million of tax-exempt bonds to $10 million and index this size limit for inflation. It would also eliminate the qualification requirement of a general taxing power, thus expanding those issuers eligible for this exception. Tax-exempt bonds issued by state and local governments are generally treated as governmental bonds if they do not constitute private activity bonds — that is, more than 10% of the bond proceeds are both used for private business use and payable from property or payments derived from private business use. Under some circumstances, this threshold is lower. For example, a 5% unrelated or disproportionate private business use limit is imposed under Section 141(b)(3). In addition, a $15 million cap on private business involvement applies for governmental output facilities (e.g., electric and gas facilities). In an effort to simplify the private business limits on exempt government bonds, the Administration proposes repeal of the 5% unrelated or disproportionate private business use test and the $15 million private business cap on output facilities. Build America Bonds, established under the American Recovery and Reinvestment Act of 2009, were an alternative to traditional tax-exempt bonds in 2009 and 2010, but have since expired. State and local governments issued these taxable bonds and Treasury subsidized part of the issuers' borrowing costs by paying refundable tax credits equal to 35% of the coupon interest on the bonds. Build America Bonds could only be issued for the original financing of public capital projects that would otherwise be funded by tax-exempt bonds. Based on the success of the Build America Bond program, the Administration proposes the creation of a new, permanent "America Fast Forward Bond" program that would be an optional alternative to traditional tax-exempt bonds for a number of eligible uses. Like Build America Bonds, America Fast Forward Bonds would be taxable bonds issued by state and local governments and would be subsidized by Treasury. The subsidy would equal 28% of the coupon interest on the bonds. In addition to including financing for Section 501(c)(3) organizations, eligible uses would also include financing for the types of projects and programs that can be financed with qualified private activity bonds, subject to the applicable state bond volume caps for the qualified private activity bond category. The Administration proposes creating a new category of tax-exempt private activity bonds to be called "qualified public infrastructure bonds" (QPIBs). QPIBs would be available for the financing of newly constructed or substantially rehabilitated infrastructure facilities owned by governmental entities and available for general public use, such as airports and other transportation facilities, water and sewage facilities, and certain telecommunications assets. A volume cap would not apply to QPIBs and the interest would not be a preference that is subject to tax under the alternative minimum tax (AMT). The Administration proposes changes to the treatment of banks investing in tax-exempt bonds. Specifically, it would increase the size limit for the qualified small issuer bond exception from $10 million to $30 million. It would also allow financial institutions to deduct up to 80% of interest expense allocable to any tax-exempt obligations (whether or not a qualified small issuer bond) subject to a cap that would limit the benefit of this rule to interest expense allocable to bonds representing no more than 2% of the basis of the institution's assets. In addition, the proposal would equalize treatment for subchapter S and qualified subchapter S subsidiary banks, removing their exemption from the 20% disallowance of interest expense allocable to qualified small issuer bonds. — Provide more flexibility for purposes of the private business use limits in the case of bona fide arm's-length research arrangements, allowing setting the terms of use of resulting products in advance of when the products become available for use. — Allow current refundings of state and local bonds if: (1) the principal amount of the current refunding bonds is no greater than the outstanding principal amount of the refunded bonds, and (2) the weighted average maturity of the current refunding bonds is no longer than the remaining weighted average maturity of the refunded bonds. — Simplify the single-family housing mortgage tax-exempt bond targeting requirements by repealing the purchase price limitation and the refinancing limitation. — Modify the standards for Indian tribal government tax-exempt bond financing, including adopting the state or local government standard for tax-exempt governmental bonds without a bond volume cap on such governmental bonds for purposes of Indian tribal government eligibility to issue tax-exempt governmental bonds. The Obama Administration's Budget proposals include a number of provisions applicable to specific types of tax-exempt organizations, including private foundations, colleges and universities, and organizations that issue tax-exempt bonds, as well as taxpayers claiming charitable contribution deductions. The Budget also contains provisions that may broadly apply to tax-exempt organizations, including changes to electronic filing requirements and charitable contribution deductions for automobile use by volunteers. While passage of the proposed provisions is uncertain, tax-exempt organizations would be well-advised to review these proposed provisions and be prepared to take steps to make necessary modifications to the areas affected by the proposals if any of them are enacted. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg
Document ID: 2016-0326 | ||||||||||||||||||||||||||||
