Special to Philanthropy Journal
Last week, Governor Pat McCrory signed into law legislation (H.B. 998) that makes major changes to North Carolina’s tax system. The tax plan, which reduces individual and corporate income tax rates and eliminates many tax “loopholes,” was the culmination of months of tax reform debate among policymakers in Raleigh.
Nonprofits were at the heart of these discussions, as nonprofit tax exemption and incentives for charitable giving were two of the most contentious issues among legislators.
What the tax plan means for nonprofits
Not much has changed on nonprofit sales tax exemption – at least for now. North Carolina currently nonprofits pay sales tax on their purchases, but can apply for semi-annual refunds from the Department of Revenue. The tax plan caps these refunds at $45 million per year, which is more than any nonprofit currently pays.
Nonprofits remain concerned, however, that the introduction of a cap on sales tax refunds will be an invitation for future legislators to force more and more nonprofits to pay sales tax without reimbursement. The Senate’s original plan capped nonprofit sales tax refunds at $100,000 per year. This would have affected about 250 nonprofits, including hospitals, private colleges and universities, churches, retirement communities, and hospices. Nonprofit leaders advocated with a unified voice that any limitation on tax exemption for charitable organizations is bad policy.
Perhaps the biggest victory for the nonprofit sector was legislators’ decision to maintain the charitable deduction on state taxes. The Senate’s original plan called for the elimination of all itemized deductions, including the charitable deduction. The first House tax reform bill included a $25,000 cap on the total of deductions for charitable contributions and mortgage interest paid. A bipartisan group of representatives amended the House bill to remove the limit on the charitable deduction, and the protection of incentives for charitable giving ultimately became a priority for House tax negotiators.
The General Assembly’s decision to make the charitable deduction the only state tax deduction that isn’t eliminated or capped may have broader significance. Congress is about to consider federal tax reform, and policymakers in Washington will be looking closely at North Carolina’s deliberate decision not to harm the charitable deduction. As Tim Delaney, president and CEO of the National Council of Nonprofits recently noted, “If the states serve as our policy laboratories, then the lab results are demonstrating conclusively” that “charitable giving incentives deserve a permanent place in every reformed tax code.”
The final tax package had mixed news for nonprofits on other incentives for charitable giving. Despite initial resistance from the Senate, H.B. 998 maintains the corporate tax deduction for charitable contributions. However, it eliminates tax credit for charitable contributions by individuals who don’t itemize their taxes.
One of the largest philosophical differences between the House and Senate was the expansion of the sales tax to services. The Senate’s initial tax proposal would have imposed sales tax on more than 100 services that are currently untaxed, including child care, health care, community care retirement homes, hospice care, community housing, admission to arts and some educational programs.
This could have hurt nonprofits in two ways. First, it would have forced many nonprofits to become tax collectors, adding new red tape to their operations. Second, it would force nonprofits to choose between charging higher prices to those who use their services or reducing their program service revenue by internalizing the additional cost of sales taxes.
Ultimately, legislators followed the House’s more limited approach to broadening the sales tax to services. Mostly, the tax plan won’t require nonprofits to charge sales tax on services if they don’t already collect sales tax on goods they sell. One significant exception is that nonprofit arts and cultural organizations will be required to charge sales tax on admission fees. Arts nonprofits fear that this will cost mean administrative headaches and lost revenue, even though it won’t bring in much additional tax money for the state.
The tax plan also repeals several other tax provisions that affect some nonprofits. For example, environmental organizations may find it harder to get land donations without tax credits for contributions of real property for conservation purposes, and private colleges will need to deal with a new tax on food served by dining halls.
In the future, the tax changes may mean further cuts to state grants and contracts with nonprofits. Nonpartisan legislative staff anticipates that the tax plan will reduce state revenue by about $2.4 billion over the next five years. In recent years, shortfalls in state finances have led to disproportionate reductions in funding for nonprofits, regardless of which political party is in power.
What comes next?
The Revenue Laws Study Committee will begin meeting this fall to discuss further changes to tax laws. The committee can’t make new laws, but its recommendations will carry significant weight when the General Assembly reconvenes next May. The study committee will consider three issues that are important to nonprofits:
- Whether to make further changes to nonprofit sales tax refunds. The committee could recommend lowering the $45 million cap to a level that affects some or all nonprofits. On the other hand, it could recommend doing away with the burdensome pay-now-and-get-your-refund-later system and allow nonprofits to be truly exempt from paying sales tax on their purchases.
- Whether nonprofit arts organizations should be exempt from the new sales tax on admission to entertainment. This new tax will unquestionably hurt arts nonprofits with little benefit to the state. With more chance to hear from these organizations, legislators may reconsider.
- Whether to require more nonprofits to charge sales tax on their services.
While nonprofits fared well overall in this round of state tax changes, the sector must remain unified and vigilant to protect nonprofit tax exemption in the coming years.
David Heinen is policy director for the N.C. Center for Nonprofits in Raleigh. Along with Beth Messersmith of Momsrising.com North Carolina, he will present Philanthropy Journal’s “Advocacy Boot Camp” Webinar on Oct. 16. Details will follow soon.