Effects of the RRA on exempt organizations.

With the passage of the Revenue Reconciliation Act of 1993 (RRA) came a number of tax law changes that will have an impact, both favorable and unfavorable, on tax-exempt organizations.

Higher income tax rates

The RRA created two new income tax brackets for high-income individuals. These 36% and 39.6% brackets, which are retroactive to Jan. 1, 1993, apply to married taxpayers with taxable incomes in excess of $140,000, and all individuals with taxable income in excess of $250,000, respectively. Charitable organizations are hoping that these rate increases (which have the effect of reducing the after-tax cost of making charitable contributions) will result in a substantial increase in contributions in the near future.

Repeal of the AMT tax

preference on contributions of

appreciated property

Under prior law, taxpayers were allowed to deduct the fair market value of donations of appreciated capital gain property for regular tax purposes, but would only receive a deduction equal to the property's tax basis for alternative minimum tax (AMT) purposes. For donations of tangible personal property after June 30, 1992, and for other donations after Dec. 31, 1992, this AMT preference item has been repealed. Taxpayers who in the past could not fully use these contribution deductions may now be more likely to make such contributions, as their after-tax cost may be substantially reduced.

Substantiation of

charitable contributions

Beginning Jan. 1, 1994, taxpayers will be required to obtain a written acknowledgment from a charity to support deductions for contributions of $250 or more; canceled checks will no longer be sufficient documentation. The failure to obtain the required information will result in the disallowance of the taxpayer's charitable deduction. Although no particular form is required, the acknowledgment must include the amount of cash and a description (but not the value) of any property contributed, whether the organization provided any goods or services in exchange for the contribution, and, if applicable, a description and good faith estimate of the value of the goods or services provided. It is the donor's responsibility to request (rather than the charity's duty to provide) this information and to obtain it before the due date of the return (including extensions) on which the deduction will be claimed. Charitable organizations may, nevertheless, want to provide the acknowledgment as a matter of courtesy to their donors by, for example, sending a letter containing the necessary information to donors at the end of each calendar year.

In addition, charitable organizations will be required to supply donors with a written statement for any quid pro quo contributions (i.e., contributions that are, in part, payment for goods and services) received in excess of $75. This statement (1) must indicate that the deductible portion of the payment received from the donor is limited to the excess of the amount contributed over the value of the goods or services received by the donor and (2) must provide the donor with a good faith estimate of the goods or services provided. Although the IRS previously encouraged organizations to provide such guidance, no statutory requirement existed and no specific penalties were assessed for noncompliance. The new law, which takes effect for contributions made after Dec. 31, 1993, provides for penalties of $10 per contribution, up to $5,000 per fundraising event or mailing, for failure to properly disclose this information.

Lobbying limitations

The RRA repeals the deduction for direct lobbying expenses, effective for amounts paid or incurred after Dec. 31, 1993. In addition, no deduction is allowed for the allocable portion of dues or contributions paid to tax-exempt organizations that relate to lobbying expenses, unless the organization pays a proxy tax. (Note: The repeal of the deduction for lobbying expenses is addressed in detail in the Tax Clinic item, "Impact of New Antilobbying Rules on Trade Associations," on page 783.)

On their annual information returns, exempt organizations will be required to report the total amount of lobbying expenses and the amount of dues or contributions allocated to such expenses. Organizations must also provide written notice at the time of assessment or payment of dues or similar amounts, of a reasonable estimate of the portion of such amounts allocable to the lobbying expenses and therefore not deductible. These reporting requirements apply to all exempt organizations other than Sec. 501(c)(3) organizations.

Unrelated business income

provisions

Under pre-RRA law, income from certain real estate investments was subject to the unrelated business income tax (UBIT) provisions if the investment was acquired with "acquisition indebtedness." UBIT provisions in the new law will now make it easier for certain exempt organizations to invest in debt-financed real estate and in other real estate activities. The new rules apply to "qualified organizations" for transactions that occur after Dec. 31, 1993. Qualified organizations include qualified retirement trusts, educational organizations and their affiliates, and Sec. 501(c)(25) title holding companies.

The new rules exempt these organizations from UBIT on leasebacks of real estate if up to 25% of the leasable floor space in the building (or complex of buildings) is leased back to the seller on commercially reasonable terms. Similarly, qualified organizations may now use seller financing to acquire real estate if the financing is on commercially reasonable terms. For property purchased from a financial institution that acquired the property by foreclosure or that was held by the financial institution at the time it entered into receivership, mortgage payments may, in certain situations, now be based on the revenue, income or profits derived from the real estate activity without being treated as unrelated business taxable income (UBTI).

Under prior law, gains from the sale of real estate held by tax-exempt organizations that was considered "inventory type" real property were treated as UBTI. The new rules allow these gains to be excluded from UBTI if the property was acquired from financial institutions in receivership or conservatorship. In addition, income from publicly traded partnerships will no longer be statutorily classified as UBTI; instead, the nature of the partnership's income will determine whether the tax-exempt organization's share of the income is classified as UBTI.

Conclusion

Tax-exempt organizations, despite their name, are not exempt from the effects of the RRA. These organizations need to be aware of the newly enacted requirements, both in terms of the reporting requirements the organization must satisfy, as well as for the benefit of their contributors who seek to maximize deductions.