22 May 2025 House reconciliation bill would modify provisions affecting tax-exempt entities The US House of Representatives (House) on May 22, 2025, approved a nearly 1,100-page budget reconciliation bill and managers amendment containing tax provisions and revenue offsets meant to accompany extensions of Tax Cuts & Jobs Act (TCJA) provisions expiring at the end of 2025 (the Bill). Several proposals in the Bill specifically apply to tax-exempt organizations. The Bill now heads to the Senate for consideration. Before becoming law, the Bill will need to be passed in identical form by both the House and Senate, then signed by the president. The following Alert is a snapshot of the Bill's provisions affecting exempt organizations. These provisions are subject to change as the Bill moves through the remainder of the legislative process. IRC Section 4960 imposes a 21% excise tax on employers that pay over $1 million in compensation or pay an excess parachute payment to covered employees of tax-exempt organizations. Covered employees are defined as one of the five highest compensated current or former employees for the applicable tax year. The Bill would amend IRC Section 4960(c)(2) to modify the definition of covered employee to include any current or former employee. This provision would remove the five-employee limit on the number of new employees that are added to the list of a tax-exempt organization's covered employees each year. For tax-exempt entities with more than five employees with compensation over $1 million, this would expand the number of covered employees whose compensation is subject to the excise tax. For organizations whose five highest compensated employees have compensation under $1 million, it would eliminate the need to track their covered employee status. Under current law, a tax-exempt organization with all of its employees in a single legal entity could have fewer covered employees than it would have if its employees were employed by separate legal entities, a disparity that would be eliminated by this provision. The Bill would not change the definition of "remuneration" for determining what portion of compensation is taxable, nor would it eliminate the exclusion from remuneration of compensation paid to a licensed medical professional for the performance of medical or veterinary services. Tax-exempt organizations should consider reviewing their compensation policies and procedures to determine the Bill's potential impact on their excise tax liability under IRC Section 4960 and prepare to accrue for potential tax impacts. Exempt organizations would need to update their procedures to account for all employees as "covered employees" — not just their five most highly compensated employees in a given tax year — and prepare to pay excise tax on the annual compensation above $1 million of all such employees. IRC Section 4968 imposes a 1.4% excise tax on the net investment income of an "applicable educational institution." Net investment income is determined using rules like those in IRC Section 4940(c), on the net investment income of a private foundation. An "applicable educational institution" is an eligible education institution described in IRC Section 25A(f)(2) (relating to the Hope and Lifetime Learning credits) that (1) has at least 500 tuition-paying students during the preceding tax year, more than 50% of whom are located in the US; (2) is not described in the first section of IRC Section 511(a)(2)(B) (i.e., generally describing state colleges and universities); and (3) has assets with an aggregate fair market value of at least $500,000 per student at the end of the preceding tax year (other than those assets that are used directly in carrying out the institution's exempt purpose). The number of students at an institution is based on the daily average number of full-time students attending the institution, with part-time students being taken into account on a full-time student-equivalent basis. For purposes of determining whether an institution meets the asset-per-student threshold and determining net investment income, assets and net investment income include those of an organization that is related to the institution. An organization is treated as related to the institution for this purpose if the organization: (1) controls, or is controlled by, the institution; (2) is controlled by one or more persons that control the institution; or (3) is a supported organization (as described in IRC Section 509(f)) or a supporting organization (as described in IRC Section 509(a)(3)) during the tax year with respect to the institution. The 1.4% excise tax on applicable educational institutions under IRC Section 4968 would remain the same if an applicable college or university's investment assets were greater than $500,000 and not more than $750,000 per student. For applicable colleges or universities whose investment assets exceeded $750,000 per student, the excise tax would increase to:
The Bill would limit the definition of "eligible student" used in the denominator of the assets-per-student fraction to students of the institution meeting the eligibility requirements under Section 484(a)(5) of the Higher Education Act of 1965, which includes US citizens and nationals, and permanent residents of the United States. This change would result in foreign students being removed from the denominator of the assets-per-student fraction. The Bill would expand the definition of "net investment income" of an applicable educational institution to include (1) interest from student loans and (2) royalties from patents, copyrights, and other intellectual property and intangible property to the extent those assets resulted from federally subsidized work of students or faculty members in their capacity as such with the applicable educational institution. Other than those changes, the Bill would not modify the definition of "net investment income," which is determined under rules similar to those of IRC Section 4940(c). The Bill would exempt "qualified religious institutions" from IRC Section 4968. "Qualified religious institutions" are defined as religious institutions that (1) were established after July 4, 1776, (2) were established by, or in association with, and that have continuously maintained an affiliation with, a church described in IRC Section 170(b)(1)(A)(i), and (3) maintain a public institutional mission approved by the institution's governing body that includes or is predicated upon religious tenets, beliefs or teachings. Colleges and universities subject to the excise tax would be required to report on their Forms 990 the number of eligible students considered in determining whether the organization had more than 500 tuition-paying students during the tax year, and the number of eligible students used to calculate assets per student. The Bill would significantly complicate the excise tax calculation. Under the proposed rules, the excise tax rate is graduated from 1.4% to 21%, the application of which is dependent upon the institution's asset-per-eligible-student calculation. Defining an eligible student under Section 484(a)(5) of the Higher Education Act of 1965 would generally exclude foreign students from the denominator of the investment assets-per-student fraction, thereby increasing institutions' investment assets per student and making more of them subject to the excise tax. Many colleges and universities that would become subject to the tax have never paid it, as their asset levels are not high enough under current law for the tax to apply. For these schools, determining how to calculate the tax and budgeting for its payment could be an additional challenge. For institutions subject to (or potentially subject to) the increased rates, the increased tax liability could significantly affect financial planning and budgeting. The proposed changes to IRC Section 4968 would require colleges and universities to implement or modify systems to track and monitor the size of their investment assets per student so they can determine the applicability of the tax and, if it applies, determine the amount of the tax and report student numbers on their annual Forms 900. The exemption for qualified religious institutions would be a change from current law, as no such exemption currently exists. Faith-based colleges and universities that are affiliated with a church may want to examine the proposed requirements to determine if they would qualify for the exemption. Educational institutions that are or may be subject to the excise tax may want to consider restructuring or reducing their investment assets to minimize application of the tax, particularly those institutions that would be subject to one of the higher tax rates. Because the Bill would not apply until tax years beginning after December 31, 2025, educational institutions have time to consider accelerating gains on investments, using investment assets to pay off debt, restructuring foreign investments to defer income realization, or taking other actions to minimize future excise tax liabilities. Tax-extenders legislation signed into law in December 2019 retroactively repealed IRC Section 512(a)(7), which was added to the code by the Tax Cuts and Jobs Act to require tax-exempt organizations to treat as unrelated business taxable income (UBTI) amounts paid or incurred to provide certain transportation fringe benefits to their employees. As a result, tax-exempt organizations are not currently required to treat such amounts as UBTI. The Bill would reinstate IRC Section 512(a)(7), requiring tax-exempt organizations to increase their UBTI by the amount paid or incurred for providing employees with qualified transportation or parking fringe benefits, as defined by IRC Sections 132(f) and 132(f)(5)(C), respectively. The Bill, unlike the former IRC Section 512(a)(7), would not apply to churches, conventions of churches, or associations of churches. Under the Bill, affected organizations would need to account for transportation fringe benefits as UBTI, potentially increasing their taxable income. The UBTI for transportation fringe benefits would be siloed from other sources of UBTI and thus, not subject to any offsetting losses. Organizations that previously filed a Form 990-T for transportation fringe benefits (and retroactively received a refund for any prior UBTI paid pursuant to IRC Section 512(a)(7)) would be required to again recognize taxable income to reflect these employee benefits, and report and pay the tax using Form 990-T. All organizations should consider reviewing their employee benefit polices to determine if changes or additions to transportation fringe benefits would fall within the proposal's purview. If this proposal were enacted, organizations would need to update their accounting systems and processes to ensure compliance with the transportation fringe benefit rules. Organizations that were never previously required to track or report transportation fringe benefits before the repeal would need to develop new procedures to comply with the Bill. Certain types of income, such as dividends, interest, royalties and certain rents, are generally excluded from the UBTI of tax-exempt organizations under IRC Sections 512(b)(1)-(3). IRC Section 512(b)(9) permits tax-exempt organizations that operate primarily for the purpose of carrying on fundamental research that is freely available to the public to exclude from UBTI income from all research, not just research made available to the general public. The Bill would narrow the research exclusion provided by IRC Section 512(b)(9) for organizations operated primarily to carry out fundamental research made available to the public, so that such exclusion would only apply to income derived from research that is, in fact, made available to the public, not to all research carried on by such organizations. The original draft of the Bill introduced by the House Ways and Means Committee would have included in UBTI any royalties from selling or licensing an exempt organization's name or logo. However, this provision was removed by the House Budget Committee and is not included in the final Bill passed by the full House, The UBTI research income exclusion would be effective for tax years beginning after December 31, 2025. The UBTI research income exclusion would not apply to most schools, hospitals, or other exempt organizations whose research activities are incidental to their primary activities. Organizations to which the Bill does apply — that is, organizations operated primarily to carry out fundamental research made available to the public — would need to revisit whether income from activities previously excluded as research no longer qualifies for the exclusion and is now taxable. Private foundations recognized as exempt from income tax under IRC Section 501(a) are subject to a 1.39% excise tax on their annual net investment income under IRC Section 4940(a). The flat 1.39% excise tax would be replaced with a tiered rate structure based on the total assets held by a private foundation at the close of each tax year, as follows:
Private foundations would be required to aggregate assets of related organizations to determine the excise tax rate on their net investment income. Assets would not, however, be taken into account for more than one private foundation. Unless a related organization is controlled by the private foundation, assets not intended or available for the use or benefit of the private foundation would not be aggregated for purposes of the aggregate fair market value of all the private foundation's assets. Assets of related organizations controlled by the private foundation would need to be aggregated with the private foundation's assets if the related organization were controlled by the private foundation. The proposal defines a related organization as any organization that controls, or is controlled by, the private foundation or is controlled by one or more persons that also control the private foundation. "Control" is not defined in the Bill. Under the Bill, private foundations with significant assets would face substantially higher excise tax rates. In another paradigm shift from existing law, private foundations might need to aggregate the assets of their related organizations to determine their excise tax rate and tax liability under IRC Section 4940. Additionally, private foundations paying a higher excise tax under IRC Section 4940 on their net investment income in any particular tax year would have a lower distributable amount for that year under IRC Section 4942, as the distributable amount for a given tax year would be reduced by the foundation's unrelated business income tax and IRC Section 4940 excise tax paid. A private foundation may generally hold up to 20% of a corporation's voting stock, reduced by the percentage of voting stock held by all disqualified persons, as defined by IRC Section 4946. That 20% limitation can increase to 35% if certain requirements are met. Private foundations are subject to a 10% excise tax on their excess business holdings, unless an exception applies. A private foundation that acquires an excess business holding, other than as a result of a purchase by the private foundation, has 90 days from the date it knows, or has reason to know, of the event that caused it to have an excess business holding. When a corporation repurchases voting stock from an employee, the reduction in outstanding shares may cause a private foundation's ownership, along with other disqualified persons' ownership, to increase the foundation's business-holding percentage, potentially causing an excess business holding. The Bill would amend the excess business holdings rules so that certain voting stock repurchased by a business would be treated as outstanding stock when calculating a private foundation's holdings in the business enterprise.
Under the proposal, repurchased stock would only be treated as outstanding if it did not result in permitted holdings exceeding 49%. However, this threshold would not apply to purchases of stock made during the 10-year period beginning on the date the plan is established. The proposal would be effective for tax years ending after the date of enactment, and to purchases by a business of voting stock in tax years beginning after December 31, 2019. Under the Bill, certain company repurchases of employee-held stock could be treated as outstanding for purposes of determining the ownership of a business enterprise by a private foundation and its disqualified persons under IRC Section 4943. Certain stock repurchases would not result in an increased ownership percentage held by the private foundation, thereby limiting the excess business holdings impact of certain stock repurchases. The IRS may suspend the tax-exempt status of an organization exempt from tax under IRC Section 501(a) under IRC Section 501(p) for any period for which the organization is designated or identified as a terrorist organization or supporter of terrorism under the Immigration and Nationality Act, the International Emergency Economic Powers Act, and the United Nations Participation Act of 1945. A terrorist organization is one that has been designated or identified as a terrorist organization or foreign terrorist organization under:
Or
No organization or person may challenge the suspension of tax-exempt status under IRC Section 501(p) in any administrative or judicial proceeding. In the original draft of the Bill introduced by the House Ways and Means Committee, IRC Section 501(p) would have been expanded to apply not only to terrorist organizations, as under current law, but also to "terrorist supporting organizations," which would be treated as terrorist organizations under IRC Section 501(p)(2). A "terrorist supporting organization" would have included any organization designated by the Secretary of Treasury as having provided material support or resources to a terrorist organization or terrorist supporting organization during the three-year period ending on the date of designation. Organizations designated as a terrorist supporting organization could have, but would not have been required to, dispute that designation with the IRS Independent Office of Appeals. A final determination on designation as a terrorist supporting organization could have been appealed in the United States District Court, regardless of whether the organization sought review by IRS Appeals. This provision was removed from the Bill by the House Budget Committee and is not included in the final version of the Bill passed by the full House.
Document ID: 2025-1126 | ||||
