The new administration has made mention of repealing the so-called Johnson Amendment. What would a repeal mean? In 1954, Lyndon Johnson (later the 36th President of the United States) was the Democratic Senate Minority Leader running for reelection. On the road to reelection, Johnson faced a conservative nonprofit group calling for the election of his opponent.
Johnson, known as a Senate legislator without equal, responded to his opposition by introducing an amendment to Section 501(c)(3) of the Internal Revenue Code, which applies to organizations organized and operated exclusively for religious, charitable, and scientific purposes. In the amendment, tax-exempt status organizations cannot participate or intervene in, which includes the publishing or distributing of statements, any political campaign on behalf of or in opposition to any candidate for public office. In effect, to be exempt from paying taxes one cannot participate in partisan elective politics.
Today, religious groups and charities alike believe the amendment restricts free speech from the pulpit and that the amendment should be repealed. The Alliance Defending Freedom is a major force behind repealing the amendment. The group argues that from the founding of the Country until 1954, Pastors were free to speak boldly from the pulpit about the most crucial social and political issues of the day. Without fear of the IRS restricting or revoking their tax exemption. A commission to study the topic convened by the Evangelical Council of Financial Accountability (ECFA) recommended amending the Johnson Amendment to allow the following.
Defenders of the current law believe partisan politics should not be part of their mission – that they should exist to feed the homeless, provide education, do scientific research, or carryout their mission without political influence or thought. Currently, churches and charities can receive tax-deductible contributions whereas contributions to candidates or political parties are not tax deductible. If tax-deductible contributions were made to churches who promoted or opposed specific candidates, how would such contributions be treated? Furthermore, the equivalent of a Federal Election Commission (FEC) does not exist, which could create pockets of dark money. Are Political Action Committees (PACs) subject to FEC reporting the answer to oversight?
As with healthcare reform, travel restrictions, and Supreme Court nominations, if the Johnson Amendment comes up for legislative change it will no doubt be hotly contested from all sides. Additional information can be found here.
According to a recent Wall Street Journal article by Andrea Fuller, nonprofits are becoming increasingly generous in their executive compensation. A searchable IRS database containing 2014 data, showed more than 2,700 executives received over $1 million in total compensation for that year.
The highest total compensation shown was over $17 million. Most of the top earners were a combination of doctors in various nonprofit hospital systems, and collegiate athletic coaches at private universities such as Duke and Baylor; or, coaches at public universities paid out of a separate auxiliary nonprofit such as Florida. The amounts included both base compensation and total compensation. It’s important to note, that the data could be misleading in a year where an executive retired or took a large deferred compensation payment during that one-year period.
In any regard, pay for executives at both nonprofit charities such as 501(c)(3)s, which was the subject of the article and associations largely 501(c)(6) organizations, is clearly trending upward for top level employees. Many of these organizations are large complex entities and pay must be competitive to attract the talent necessary to operate them. Whether the IRS or contributing public would regard the amounts as excessive is an open question. Any organization would be wise to establish safeguards around CEO pay such as using compensation consultants, comparing their packages against peer organizations, CEO review by independent Board members, and specific performance evaluation criteria for CEOs.
For more information or questions, please contact Craig Stevens at 301.231.6200.
This article was co-authored by Richard Lee.
Many donors make multi-year commitments to a charity of their choosing. For example, an agreement to contribute $50,000 per year for 5 years to a new building campaign. Some donors are happy to make the pledge payment each year from their annual income, which makes them eligible to take an income tax charitable deduction annually. However, what about the donor that wants to fund their pledge payment out of existing wealth and garner a large upfront income tax deduction? There may be a way to accommodate this type of donor with a Charitable Lead Trust (CLT).
Conventional wisdom is that CLTs are actually estate-planning tools for the very wealthy. While this is true, there are estate and gift planners, such as Lani Starkey of Fifty Rock Consulting, who believe there are income tax planning uses for CLTs as well, particularly to generate an upfront income tax charitable deduction, in a year in which the donor has unusually high income.
A CLT involves making a charitable gift to an irrevocable trust. A CLT in some respects is the mirror-image of its trust cousin Charitable Remainder Trust (CRT). A CRT is tax-exempt and provides a regular income stream to the donor or named beneficiary for the donor’s lifetime(s) or term of years, with the remainder thereafter going to the charity. Conversely, a CLT is not tax-exempt, with periodic payments going to charity for a specified term, and the remainder either reverting to the donor or passing to some other person chosen by the donor.
Please note there are two different types of lead trusts: grantor trusts and non-grantor trusts. The income tax benefits discussed here stem from using a grantor charitable lead trust.
With a grantor trust, the trust will annually file a fiduciary income tax return for income tax purposes, the trust’s income, gain or loss, will flow through the trust and be reportable on the donor’s personal income tax return (Form 1040).
The upfront income tax charitable deduction is equal to the present value of the charitable income stream, which is determined by using an IRS-prescribed interest rate known as the “Section 7520” rate. The lower the Section 7520 rate, the higher the discounted present value of the charitable income stream, and the higher the upfront income tax charitable deduction. Currently the Section 7520 rate is very low, thus producing higher income tax charitable deductions for gifts to CLTs.
As an example, assume a donor makes a pledge to a charity for $25,000 per year for 10 years and has accumulated assets of $500,000. The donor could donate to a charitable lead annuity trust and they could use a large charitable deduction in the current year to offset a large bonus they received. If you assume a 5% payout rate and a 6% investment rate of return on trust assets over the 10 years, the transaction would yield the following:
This might be a very attractive result for a prospective donor. The catch is that they would have to have sufficient wealth to completely fund the trust in the first year. A donor that pays their yearly contribution out of their annual income could not do that.
A CLT can be structured to fit a donor’s objectives and financial situation. The donor can select the trust’s start date, the trustee (e.g., a bank, individual, or the charity), the trust term, the lead interest charitable recipient, the payout percentage and formula (annuity or unitrust), the payout frequency (e.g., quarterly or annually), the contributed assets, and the remainder beneficiaries (e.g., the donor themself, or their children).
As mentioned before, a CLT is taxable, unlike its tax-exempt CRT cousin. Therefore, contributing low basis assets and selling them once inside the trust would result in the grantor having to recognize capital gain on the sale, thus offsetting the income tax benefit of the upfront charitable deduction. Thus, higher basis assets would generally be better assets to contribute to a CLT.
Note: Although the initial contribution of assets to the trust will generate an immediate income tax charitable deduction, over the trust’s term the initial income tax benefit is at least partially offset by the donor’s reporting of the trust’s income. And, if the donor dies during the trust term, the donor is required to report as income a portion of the up-front charitable deduction.
Keep in mind too that any income tax charitable deduction allowed is limited to 20% of a donor’s adjusted gross income, or 30% of adjusted gross income in the case of contributions of cash rather than capital gain assets, even if the lead interest goes to an otherwise 50% public charity.
These arrangements might work very well in the right situation for the right donor. If you would like additional information, please contact our office at 301.231.6200. .
The value of reciprocal relationships between entrepreneurs and nonprofits or associations may not be obvious, but they can bring myriad benefits. And the divide between the nonprofit and for-profit communities is smaller than you might think. As a managing director at 1776, a startup incubator in Washington, DC, I work each day with companies that sincerely want to drive change and have a positive impact on the world. Sound familiar?
Many nonprofit leaders I speak to don’t realize how aligned their interests are with entrepreneurs who are addressing global problems. Last year, 1776 hosted its first Challenge Cup, a global startup competition taking place in 16 cities across 11 countries to identify the most promising startups solving the biggest challenges in education, energy, health, and cities. Winners included:
Each of these startups could provide partnership opportunities for particular associations and nonprofits. For associations, there is an opportunity to play matchmaker—connecting entrepreneurs to members who would value their innovative product, but would not otherwise know about it. Think about a teacher association that could publicize eduCanon to members as a free tool they can use to improve their lessons. Meanwhile, nonprofits can serve as “early adopters” of new tools that can improve your services. For example, a nonprofit that serves the homeless could work with HandUp to provide clients with services like dental work or interview clothes that they could not otherwise offer.
DC Metro Area Opportunities
The Washington metropolitan region has a particularly active startup scene that provides ample opportunity for nonprofit and association leaders to connect with it. The area is home to a growing number of startups due to its favorable economic outlook, well-educated and young labor pool, and vibrant neighborhoods. Pair that with one of the strongest nonprofit communities in the country and you have a recipe for success. You can engage with for-profit innovators in a number of ways:
In addition to 1776, there are many established organizations throughout the region that are working to connect nonprofits and associations with relevant startups. The Alexandria Chamber of Commerce invited me to speak at their recent Nonprofit & Association Leadership Academy event, and they have some great programs scheduled this fall to address the changing exempt landscape. Aronson LLC, a metro area-based accounting and consulting firm, is partnering with both 1776 and local chambers to connect organizations with the resources, products and services provided by local innovators.
Perhaps the most important takeaway is to embrace innovation and be open to forging new relationships with the startup community. Great ideas deserve to be shared!