The recently passed tax reform law, the Tax Cuts and Jobs Act (TCJA) of 2017, will have a significant impact on the healthcare industry, including taxation of employee compensation and benefits, fundraising, and for-profit joint ventures. Notable provisions include the following.
Repeal of the Individual Mandate
Beginning in 2019, the TCJA repeals the individual mandate for health insurance. The Affordable Care Act (ACA) relied on the mandate to give individuals, especially young Americans, an incentive to purchase health insurance. The Congressional Budget Office (CBO) estimates the repeal will cause enrollment to drop by 13 million.
As a result, it can be expected that hospitals’ and health systems’ uncompensated care will rise as these organizations continue to treat uninsured patients, often in acute settings, without timely payment.
Younger, healthier individuals represent a majority of those expected to drop coverage. And a decline in their enrollment would leave remaining insurance pools with a sicker and older population, putting pressure on health insurers to make up for lost revenue. The CBO estimates premiums could increase by as much as 10 percent as a result.
One notable ACA provision that remains in place is the employer mandate, which requires applicable large employers to file informational returns (Form 1095-C) documenting offers of health coverage for full-time employees. This provision also continues to subject employers to potential employer-shared responsibility payment penalties for failures to offer affordable qualifying coverage.
Tax Incentives for Charitable Giving
The TCJA reduces certain itemized deductions while significantly increasing the standard deduction. As a result, it is expected that fewer taxpayers will claim itemized deductions, such as charitable contributions. Tax-motivated donors may opt to give larger donations once every two or three years, when the total donation is large enough to receive a tax deduction, instead of giving smaller donations every year.
Research hospitals, pediatric hospitals, and other healthcare organizations that engage in significant fundraising could benefit from adapting their strategies to account for this change.
Excise Tax on Excessive Compensation
The tax reform legislation requires that high executive compensation in tax-exempt organizations be treated similarly to executive compensation paid by publicly traded corporations. Under pre-TCJA law, publicly traded corporations generally were not permitted to deduct executive compensation of more than $1 million, whereas tax-exempt entities were not subject to this restriction. Under the TCJA, compensation of more than $1 million for the five highest compensated individuals in a tax-exempt organization is subject to a 21 percent excise tax.
There’s an exception for physicians paid for performing clinical duties, but this exception does not apply to compensation a physician receives for administrative responsibilities.
Once an individual is designated among the five highest compensated employees within an organization, he or she will remain potentially subject to the 21 percent excise tax on excessive compensation for all future years. It’s possible that impacted organizations will have more than five individuals subject to the tax over time.
Because the tax is on compensation, some organizations may consider revisiting their nonvested, nonqualified, deferred compensation programs to defer the excise tax.
Moving Expenses
Moving expenses are no longer excludable from an employee’s compensation, and a recipient of a moving expense benefit can no longer receive a deduction for it.
Service Awards
Prior to the TCJA, employee service awards of tangible personal property were exempted from an employee’s taxable compensation. Under the new law, gifts can’t be excluded from compensation. Nonexempt gifts include cash, gift cards, vacations, tickets to concerts or sporting events, and stock.
Unrelated Business Income
A number provisions of the TCJA address considerations regarding reporting of unrelated business income (UBI), including the following.
Fringe benefits. The legislation also changes the tax treatment of several common fringe benefits. Organizations not accustomed to reporting UBI may be surprised to discover the need to report certain fringe benefits as UBI and pay the new corporate tax rate of 21 percent on this amount.
Transit. Payments for qualified transportation costs, such as parking allowances and transit passes, continue to be excluded from employee wages. For tax-exempt organizations, these payments are regarded as UBI subject to the new 21 percent corporate tax rate.
Gyms. Tax-exempt organizations with onsite gyms for employees must now treat associated facility costs as UBI.
Gains and losses from UBI. Under prior law, losses from UBI activities could offset profit from other unrelated business income activities before the corporate tax rate would be applied.
The TCJA requires tax-exempt organizations to calculate gains and losses separately for each trade or business activity without any offsets. The corporate tax rate of 21 percent will be assessed, and loss activities will create net operating losses carrying over indefinitely, which will be subject to the new corporate loss limitation rules.
The new rules allow net operating losses generated for tax years beginning after Dec. 31, 2017, to offset up to 80 percent of taxable income in the carry-forward year. Any unused net operating losses generated for tax years ending after 2017 will carry forward indefinitely.
The TCJA doesn’t specify what constitutes a separate trade or business activity, but additional guidance from the IRS is expected.
For-Profit Provisions
Most tax-exempt hospitals and health systems have investments in for-profit joint ventures that are affected by the new law. The following are some key changes for these entities:
- The corporate alternative minimum tax is repealed.
- Organizations with less than $25 million in average annual revenue may qualify for simplified accounting methods.
- Business interest deductions are limited to the extent they exceed 30 percent of an organization’s adjusted taxable income, assuming the organization has more than $25 million in average annual revenue.
- Bonus depreciation is expanded to include used property, allowing for a 100 percent write-off of qualifying property through 2022 and phasing out between 2023 and 2026.
- The expensing limits for deducting depreciable property under Section 179 have been increased for amounts up to $1 million, with phase-outs beginning once qualifying additions exceed $2.5 million.
- Like-kind exchanges are restricted solely to the exchange of real property.
- Entertainment expenses are now nondeductible.
- Meals provided through an on-premises cafeteria or on an employer’s premises for an employer’s convenience are subject to a 50 percent deduction limitation for costs paid or incurred after Dec. 31, 2017, and after 2025, these costs will be nondeductible.
- Research and development expenses paid or incurred in tax years beginning after Dec. 31, 2021, will be capitalized and amortized over a five-year period.
Recommendations
The TCJA is the largest tax reform legislation enacted in 30 years, and it will have a significant impact on revenues, uncompensated care, fundraising, executive compensation, employee benefits, and the UBI taxes not-for-profit entities pay. By preparing early, finance leaders of tax-exempt hospitals and health systems can minimize their organizations’ tax exposure and more effectively navigate the disruptions these large-scale changes will create for their organizations.
Chris Bell, CPA, is a partner, Moss Adams LLP, Sacramento, Calif.
