1. Impact of Tax Law Changes on Tax-Exempt Entities1
March 6, 2018
Impact of Tax Law Changes on Tax-Exempt Entities
Charles Purcell, Won-Han Cheng

2. TAX REFORM HAPPENED QUICKLY2
TAX REFORM HAPPENED QUICKLY
Tax Cuts and Jobs Act signed December 22, 2017
Comprehensive tax reform affecting virtually all taxpayers
7 weeks from start to finish
Fast pace/process led to drafting errors, lack of clarity, gaps, overlaps and unintended consequences
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3. CLEANING UP THE AFTERMATH3
CLEANING UP THE AFTERMATH
Congress will spend 2018 fixing these problems
Technical corrections
Legislative changes
Treasury/IRS regulatory and guidance projects to interpret and implement
This means risk and opportunity for you
Planning around the new law
Chances to clarify/shape
Think outside the box!
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4. 4
MAJOR THEMES
Most significant spread between corporate and individual rates since 1982
Different tax treatment for taxpayers receiving the same or similar types of income
Increased complexity in the Code for business taxpayers
Significant variations in treatment of similar transactions from year to year built into the Act
Major changes for foreign-related transactions
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5. AGENDA Tax-Exempt Entity Provisions Taxation of Pass-Through Income5
AGENDA
Tax-Exempt Entity Provisions
Taxation of Pass-Through Income
Compensation and Related Issues
Interest, Depreciation and NOLs
Foreign-Related Provisions
Examples
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6. 6
Tax-Exempt Entities

7. 7
WHAT WAS NOT ENACTED
UBIT not applied to income of public pension funds
Exclusion from income for tuition reductions for employees and graduate students retained
Lower tax rate under Section 4940 (tax on investment income of private foundations) for distributed income retained
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8. 8
WHAT WAS NOT ENACTED (2)
UBIT not expanded to include royalties on names and logos
501(c)(3) organizations are still permitted to issue tax-exempt bonds
Deduction for student loan interest retained
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9. EXCISE TAX ON EXCESS COMPENSATION OF EMPLOYEES OF TAX-EXEMPT ENTITIES9
EXCISE TAX ON EXCESS COMPENSATION OF EMPLOYEES OF TAX-EXEMPT ENTITIES
A new 21% excise tax is imposed on “applicable tax-exempt organizations” that pay compensation to any “covered employee” in excess of $1 million
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10. APPLICABLE TAX-EXEMPT ORGANIZATIONS
1010
APPLICABLE TAX-EXEMPT ORGANIZATIONS
Applicable tax-exempt organizations include:
Organizations exempt from tax under Section 501(a)
Farmer’s co-ops
Organizations exempt from tax under Section 115(1)
Section 115 exempts income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof
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11. TAX-EXEMPT STATUS OF STATES AND PUBLIC UNIVERSITIES
1111
TAX-EXEMPT STATUS OF STATES AND PUBLIC UNIVERSITIES
Application to organizations exempt under Section 115(1) is not clear
Public universities may be treated as both a part of the State and a 501(c)(3) entity
The IRS has ruled that states themselves are generally exempt from tax under an “intergovernmental tax immunity” doctrine
To the extent an organization has received a determination from the IRS of exempt status under Section 501(c)(3), it may raise questions as to whether the excise tax applies
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12. 1212
COVERED EMPLOYEES
A covered employee is one of the 5 highest compensated employees of an organization
Compensation paid to medical personnel and veterinarians for medical or veterinary services not subject to this rule
Compensation from related organizations is aggregated for this purpose
If State U pays its president $600,000 and the State U Foundation also pays her $600,000, the aggregate compensation from both organizations is subject to this rule
Once a covered employee, always a covered employee
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13. EXCISE TAX ON EXCESS COMPENSATION: PARACHUTE PAYMENTS
1313
EXCISE TAX ON EXCESS COMPENSATION: PARACHUTE PAYMENTS
The excise tax also applies to “parachute payments”, i.e., separation payments to a covered employee whose total amount payable exceeds 3 times such person’s average annual compensation for the prior 5 years
Payments to qualified plans are not subject to this rule
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14. THE COMPENSATION EXCISE TAX IS BASED ON OTHER PROVISIONS
1414
THE COMPENSATION EXCISE TAX IS BASED ON OTHER PROVISIONS
The excise tax on excess compensation for the 5 highest compensated employees is based on Section 162(m) which denies a deduction for executive compensation in excess of $1 million
Section 162(m) applies only to public companies
The excise tax on parachute payments is based on Section 280G which applies to payments to employees of corporations that undergo a change in control. Such payments are not deductible and subject employees to an additional tax.
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15. NEW EXCISE TAX ON INVESTMENT INCOME OF LARGE EDUCATIONAL INSTITUTIONS
1515
NEW EXCISE TAX ON INVESTMENT INCOME OF LARGE EDUCATIONAL INSTITUTIONS
1.4% excise tax is imposed on the investment income of certain large private colleges and universities
A university must have (i) over 500 tuition paying students, (ii) more than 50% of their students in the U.S., and (iii) at least $500,000 in investment assets per student, to be subject to the tax
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16. EXCISE TAX ON INVESTMENT INCOME OF LARGE EDUCATIONAL INSTITUTIONS
1616
EXCISE TAX ON INVESTMENT INCOME OF LARGE EDUCATIONAL INSTITUTIONS
Assets of related institutions are taken into account
Non-educational operating foundations are not subject to this rule
State universities are specifically exempted
Applies to tax years beginning after 12/31/2017
Tax is based on Section 4940 which applies to grant-making private non-operating foundations
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17. CHANGES TO THE UBIT RULES
1717
CHANGES TO THE UBIT RULES
Income from each separate trade or business subject to the unrelated business income tax is computed separately
Losses from one business may not shelter income from another
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18. UBTI INCREASED FOR DISALLOWED FRINGE BENEFITS
1818
UBTI INCREASED FOR DISALLOWED FRINGE BENEFITS
Section 274 was amended to provide that qualified transportation fringe benefits (including transit passes and certain parking) are no longer deductible. In addition, expenses in connection with certain on premise athletic facilities provided to employees are not deductible
Section 512 was amended to include in UBIT any expenses of a 501(c)(3) entity relating to these benefits
Extent of UBIT inclusion not clear
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19. Changes for Pass-Throughs
1919
Changes for Pass-Throughs

20. SECTION 199A: A NEW DEDUCTION FOR NON-SALARY INCOME
2020
SECTION 199A: A NEW DEDUCTION FOR NON-SALARY INCOME
A deduction of up to 20% of the income from businesses conducted as partnerships, S corporations, or sole proprietorships is now available.
EXTREMELY COMPLEX
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21. SECTION 199A IN A NUTSHELL Bad Income: Good Income:
2121
SECTION 199A IN A NUTSHELL
Bad Income:
Income from performance of services in fields of law, consulting, investment management, and other certain service businesses
Deduction only available up to $315,000 of income
Good Income:
Real estate
Deduction based on W-2 wages or capital interest
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22. SECTION 199A – FIRST CALCULATION
2222
SECTION 199A – FIRST CALCULATION
Is taxable income more than threshold amount?
Is income from a “specified service”? No
Yes
Yes No
Is taxable income more than threshold amount?*
Is taxable income more than threshold amount + phase–in?
Result (B)
Initial amount =
QBI x 20% No
Yes
Result (C)
Initial amount equal to result (B) reduced to account for difference between amounts (i) and (ii) in Result (D)
Is taxable income more than threshold amount + phase-in?** No
Yes No
Result (D)
Initial amount equal to lesser of:
QBI x 20% or
The greater of:
W-2 wages x 50% and
W-2 wages x 25% + 2.5% of unadjusted basis of depreciable property
Yes
Result (A) Initial amount = 0
* Threshold Amount is $315,000 of taxable income if filing jointly and $157,00 in all other cases
** Phase-In is $100,000 of taxable income if filing jointly and $50,000 in all other cases
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23. WITHHOLDING ON DISPOSITION
2323
WITHHOLDING ON DISPOSITION
Prior Law: Non-U.S. persons subject to tax on “effectively connected income” earned by a partnership
Gain on disposition may be caught by this rule
New Law: Gain on disposition of partnership interest subject to U.S. tax to the extent attributable to the partnership’s assets used in a U.S. trade or business
Why does this matter for you? Withholding
Transferee required to withhold 10% of amount realized if any portion of gain is attributable to a U.S. trade or business unless transferor certifies that it is U.S. person
If transferee fails to withhold, partnership must withhold from distributions to transferee
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24. Compensation and Related Issues
2424
Compensation and Related Issues

25. 2525
CARRIED INTEREST
3-year Holding Period for Certain Profits Interests (watered down “carried interest” provision)
Gain from allocations in respect of, or on sale of, certain partnership profits interests held for less than 3 years is taxed as short-term capital gain
Only applies to “applicable partnership interests”, i.e., “profits interests” issued for services in the business of:
Raising or returning capital
Investing in or developing “specified assets” (securities, rental or investment real estate, cash or cash equivalents, options or derivatives)
Under regulations to be issued, 3-year holding period requirement would be limited to assets held for portfolio investment on behalf of third-party investors
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26. EXAMPLES ON CARRIED INTEREST
2626
EXAMPLES ON CARRIED INTEREST
(Applicable Partnership Interest)
Manager A.
Securities and portfolio investments
(Not an Applicable Partnership Interest)
Employee
Operating
Partnership
Manager B.
(Not an Applicable Partnership Interest)
Employee
(Applicable Partnership Interest)
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27. WHY THIS IS IMPORTANT TO INVESTORS
2727
WHY THIS IS IMPORTANT TO INVESTORS
Less alignment of interest with managers
Managers are incentivized for longer term holding
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28. 162(M) DEDUCTION LIMITATION
2828
162(M) DEDUCTION LIMITATION
Expansion of Section 162(m) deduction limitation
Under prior law, publicly traded corporations could not deduct compensation in excess of $1 million to the CEO and other 4 highest-compensated officers, subject to various exceptions
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29. DEDUCTION FOR EXECUTIVE COMPENSATION
2929
DEDUCTION FOR EXECUTIVE COMPENSATION
Tax Cuts and Jobs Act expands this limitation:
No exception for options and other performance-based compensation
“Covered employee” = principal executive officer, principal financial officer and other 3 highest-compensated officers required to be reported on company’s proxy statement
Once a covered employee (post-2016), always a covered employee
Applies to all domestic publicly traded corporations, all foreign companies publicly traded through ADRs, and companies with publicly-traded debt
Exception for payments pursuant to binding contracts in place as of 11/2/2017
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30. PATENTS AND INVENTIONS
3030
PATENTS AND INVENTIONS
Patents and inventions
A patent, invention, model, design, secret formula or process held by the taxpayer who created the property or acquired the property in a “substituted basis” transaction is excluded from the definition of “capital asset”
However, the special rule under Section 1235 is retained, which treats gain from the sale of a patent by an individual whose efforts created the property as long-term capital gain
Interaction between these two provisions is somewhat unclear
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31. Taxation of Operating Companies
3131
Taxation of Operating Companies

32. INTEREST DEDUCTION LIMITED TO 30% OF EBITDA (AFTER 2022, EBIT)
3232
INTEREST DEDUCTION LIMITED TO 30% OF EBITDA (AFTER 2022, EBIT)
Interest deductions of taxpayers are limited to 30% of “adjusted taxable income”
Adjusted taxable income for any year is taxable income determined without regard to interest (received or paid), the NOL deduction, and the Section 199A deduction
In years before 2022, adjusted taxable income is calculated without regard to depreciation or amortization deductions
No grandfathering of previous transactions
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33. EXCEPTIONS TO INTEREST DEDUCTION LIMITS
3333
EXCEPTIONS TO INTEREST DEDUCTION LIMITS
Real estate businesses
Small businesses (average gross receipts in the prior 3 years of $25,000,000 or less)
Farming businesses
Motor vehicle, boat and farm equipment dealers (for floor plan indebtedness)
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34. CARRYOVER OF UNUSED INTEREST DEDUCTIONS
3434
CARRYOVER OF UNUSED INTEREST DEDUCTIONS
Disallowed interest may be carried over indefinitely
Treated as incurred in the next year
Not part of NOL deduction
Subject to limitation after sale of the business
Limitation applies at partnership level
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35. 3535
WHY THIS IS IMPORTANT
This provision will potentially impact private equity portfolio companies
Investors should inquire about this
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36. NOL DEDUCTION FOR POST-2017 NOLS LIMITED TO 80% OF TAXABLE INCOME
3636
NOL DEDUCTION FOR POST-2017 NOLS LIMITED TO 80% OF TAXABLE INCOME
NOLs may be used to shelter only 80% of taxable income in years after 2017
NOLs may not be carried back beginning in 2018
NOLs may be carried forward indefinitely
Changes are effective for losses arising in taxable years after 12/31/2017
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37. EXPENSING OF CAPITAL ASSETS
3737
EXPENSING OF CAPITAL ASSETS
Section 179 has been amended to allow the expensing of up to $1,000,000 per year of otherwise depreciable assets ($500,000 under prior law)
This is a permanent change
Section 168(k), which provides for bonus depreciation on tangible personal property where 179 does not apply, has also been modified to allow for increased depreciation deductions
This benefit varies by year in which the property is placed in service.
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38. EXPENSING OF CAPITAL ASSETS (2)
3838
EXPENSING OF CAPITAL ASSETS (2)
Through 2022, 100% of the cost of tangible personal property may be deducted as bonus depreciation in the year such property is placed in service
This percentage is reduced by 20% every 2 years until 2027, when the benefit terminates
Any cost not recovered by bonus depreciation is written off under the regular MACRS system
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39. EXPENSING OF CAPITAL ASSETS (3)
3939
EXPENSING OF CAPITAL ASSETS (3)
Bonus depreciation applies to used property under the Act
Taxpayers may elect out of bonus depreciation
Consider the interaction of the NOL rules, the interest deduction limits and the new expensing rules
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40. International Provisions
4040
International Provisions

41. 4141
CHANGES TO RULES RELATED TO CONTROLLED FOREIGN CORPORATIONS AND SUBPART F INCOME
A “controlled foreign corporation” is
Any foreign corporation owned more than 50% (by vote or value) by “United States shareholders” on any day during the taxable year of the foreign corporation
What’s new:
Expansion of the definition of “U.S. shareholder”
Testing date for Subpart F income inclusion
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42. DEEMED REPATRIATION PROVISION
4242
DEEMED REPATRIATION PROVISION
Prior Law: U.S. persons were permitted to defer the U.S. taxation of non-Subpart F income from foreign corporations until the earnings were repatriated to the United States
Current Law: One-time deemed repatriation of net post-1986 undistributed E&P
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43. DEEMED REPATRIATION PROVISION
4343
DEEMED REPATRIATION PROVISION
Who: “U.S. shareholders”
What: Income inclusion of shareholder’s pro rata share of the accumulated post-1986 deferred foreign income of the foreign corporation
When: Income inclusion in the year of the foreign corporation’s last taxable year beginning before 2018; payment can be spread out over 8 annual installments
Income added to Subpart F income from the foreign corporation
Taxed at reduced rates after corresponding deduction: 15.5% on portion attributable to cash and cash equivalents; 8% on the remainder
Effective Date: Last taxable year of the foreign corporation which began before January 1, 2018
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44. ACCUMULATED POST-1986 DEFERRED FOREIGN INCOME
4444
ACCUMULATED POST-1986 DEFERRED FOREIGN INCOME
Means the post-1986 E&P of the foreign corporation, other than ECI, to the extent not previously taxed as of 11/2/2017 and 12/31/2017, whichever is higher
An E&P deficit from one CFC may be used by a U.S. shareholder to offset E&P from another CFC
E&P deficits are also shared within an affiliated group
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45. NEW PARTICIPATION EXEMPTION FOR DIVIDENDS
4545
NEW PARTICIPATION EXEMPTION FOR DIVIDENDS
Who: U.S. corporate shareholders who have held their shares in the foreign corporation for more than 365 days during a 2-year testing window
What: 100% deduction for foreign-source portion of dividends from a “specified 10% owned foreign corporation”
Effective Date: Distributions made after 12/31/2017
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46. “SPECIFIED 10% OWNED FOREIGN CORPORATION”
4646
“SPECIFIED 10% OWNED FOREIGN CORPORATION”
A “specified 10% owned foreign corporation” is
Any foreign corporation if a domestic corporation is a U.S. shareholder of that foreign corporation
Status must be maintained during the 2-year testing window for the holding period requirement
A foreign corporation that is a PFIC is not treated as a specified 10% owned foreign corporation unless it is also a CFC
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47. 4747
DEDUCTION AMOUNT
The “foreign-source portion” of a dividend is determined based on the following percentage:
undistributed foreign earnings of the foreign corporation
total undistributed earnings of the foreign corporation
Limited application - deduction is not available for
Hybrid dividends
Dividends from a PFIC (unless also a CFC)
Not available for GILTI
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48. GLOBAL INTANGIBLE LOW-TAXED INCOME
4848
GLOBAL INTANGIBLE LOW-TAXED INCOME
Who: U.S. shareholders of CFCs
What: New foreign income category taxed on a current basis, like Subpart F income
Includes all untaxed net operating income over a 10% return on the adjusted tax basis of the foreign corporation’s tangible assets used to produce such income
Effective Rate: Tax years beginning after 12/31/2017
Key Issue: Deferral is minimized or eliminated for most taxpayers
GILTI is not eligible for the participation exemption
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49. 4949
GILTI (2)
GILTI rates
Corporations - taxed at reduced rate after special deduction: 10.5% (rising to 13.25% after 12/31/2025)
Individuals - taxed at regular rates (max rate 40.8% when 3.8% Medicare tax is taken into account)
Tax-exempt organizations - do not appear to be subject to tax on GILTI unless such income is also UBTI
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50. GILTI EXAMPLE 5050 U.S. Corporation Foreign Corporation U.S.
50%
U.S.
Individual
Income of Foreign Corporation (per U.S. shareholder)
Passive Income
(capital gains, dividends, interest) 40
Income on Sales (non-Subpart F) 50
Active Royalties
Services Income
190
Federal Taxation of U.S. Shareholders
Individual
Corporation
Prior Law Tax
$15.84
$14.00
With GILTI Tax
$70.30
$24.15
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51. DEDUCTION FOR FOREIGN DERIVED INTANGIBLE INCOME
5151
DEDUCTION FOR FOREIGN DERIVED INTANGIBLE INCOME
Who: U.S. corporations
What: New deduction for FDII
Includes income derived from sales of property to be used outside the United States, licenses of intangible property to foreign persons and services performed for foreign persons
Deduction equals 37.5% (21.875% after 2025)
Effective Date: Tax years beginning after 12/31/2017
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52. OTHER NEW BASE EROSION RULES
5252
OTHER NEW BASE EROSION RULES
Most concern post-acquisition structuring or considerations for internal restructuring
Include:
Denial of deduction for interest and royalties paid to related party (i) that is a “hybrid” or is allowed a deduction for the payment or (ii) that is taxed on the amounts paid, but amounts not treated as interest or royalties
Dividends from expatriated corporations will not qualify for long-term capital gain rate
No foreign tax credit for non-U.S. taxes paid by non-U.S. corporate subsidiary except when subsidiary is a CFC and domestic corporate shareholder includes income of subsidiary under CFC rules
New foreign tax credit limitations for non-U.S. branches
Base Erosion and Anti-Abuse Tax
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53. BASE EROSION AND ANTI-ABUSE TAX
5353
BASE EROSION AND ANTI-ABUSE TAX
Think of it as an international AMT, i.e., minimum tax that generally cannot be avoided by using U.S. tax credits
5% rate in 2018
10% rate through 2025
12.5% thereafter
Applies to a U.S. corporation that is a member of a large ($500 million or more of annual gross receipts on average over last 3 years) multinational group with significant payments to non-U.S. affiliates for certain kinds of services
Calculations are complicated, but deductions for payments made to non-U.S. affiliates generally increase the tax base unless payment was subject to withholding (which often does not apply to interest payments)
Increased reporting and $25,000 penalty for failure to report
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54. OTHER INTERNATIONAL CONSIDERATIONS
5454
OTHER INTERNATIONAL CONSIDERATIONS
U.S. to non-U.S. asset transfers
Gain may now be recognized on otherwise tax-deferred transfers of assets by a U.S. corporation to a non-U.S. corporation even if the assets will be used in the non-U.S. corporation’s trade or business
New sourcing rule
Income from the sale of inventory now sourced between U.S. and other countries based on where production occurs
But consider that non-U.S. source income may be subject to GILTI tax
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55. THANK YOU! Charles Purcell charles.purcell@klgates.com Won-Han Cheng
5555
THANK YOU!
Charles Purcell
Won-Han Cheng
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56. 5656