Alert 05.12.25
Alert
Alert
By
05.20.25
This Pillsbury alert provides an overview of the “Big Beautiful Bill” (BBB) as passed by the House Ways & Means Committee on Sunday, May 18, 2025. The overview breaks the bill into three main sections: Changes Affecting Individuals, Changes Affecting Businesses and Changes Affecting Tax-Exempts and Universities. Please note that the legislative process is fluid, and the provisions as described herein may be changed as the legislation advances toward passage.
Getting the “Big Beautiful Bill” out of the House Ways & Means Committee has been anything but beautiful. Despite a Republican majority, the Bill has faced friction from within the party—particularly from members representing high-tax states, who have pushed for relief from the state and local tax (SALT) deduction cap, and from fiscal hawks concerned about deficit increases. A late-night Sunday vote of the House Budget Committee allowed the Bill to advance to the House Rules Committee, which will now determine whether and how the BBB will be brought to the House floor for debate.
The BBB maintains and extends many of the changes under the Tax Cuts and Jobs Act of 2017 (TCJA). The bill steers clear of further complications to the international tax framework implemented by the TCJA and the Organization for Economic Co-operation and Development’s (OECD) global minimum tax efforts, aside from some saber-rattling in new Internal Revenue Code (the “Code”) § 899. Notably, there is no attempt to reverse corporate rate reductions or revisit carried interest. In short, it is not a tax demolition; it is more of a targeted renovation—with certain doors left politely closed.
Select provisions of the BBB affecting individuals, businesses and tax-exempt organizations are discussed below, along with a brief discussion of lingering procedural questions relating to the Byrd Rule—a Senate rule that limits the contents of reconciliation bills to those provisions that directly impact the federal budget. While the Bill’s title may be grandiose, its details reveal a more calculated—and sometimes contentious—effort to advance longstanding Republican tax priorities.
Procedural Questions
Congress continues to rely on the budget reconciliation process to enact tax reform. The appeal lies in its procedural advantage: It bypasses the Senate filibuster process, requiring only a simple majority (51 votes) rather than the 60 votes typically needed for cloture to end debate and take a vote. This is particularly important in a sharply divided Senate where bipartisan consensus is rare.
Although reconciliation generally offers an expedited process, it is constrained by the Byrd Rule (Section 313 of the Congressional Budget Act), which is intended to impose major restrictions on the process. The Byrd Rule prohibits extraneous provisions that do not directly affect federal spending or revenues. In addition, the Byrd Rule bars provisions that increase the federal deficit beyond the 10-year budget reconciliation window. The restriction on creating long-term deficits is the reason that past tax cuts—such as those under the TCJA—were scheduled to sunset after 10 years. Under the Byrd Rule, provisions impacting Social Security are explicitly prohibited.
The Byrd Rule is not self-enforcing: A point of order must be raised at the appropriate point in the process. As a matter of tradition, the Byrd Rule is only considered violated if the Senate Parliamentarian—a procedural advisor to the Senate—agrees.
The Senate’s budget resolution this year introduces a controversial approach to scoring: excluding the current policy baseline. Under this approach, the cost of permanently extending the TCJA provisions otherwise slated to sunset is excluded from the budget (thus treating an estimated $3.8 trillion in tax cuts as budget-neutral). The move has drawn criticism from budget hawks and transparency advocates alike.
I. Changes Affecting Individuals
Estate and Gift Taxation. The Bill would permanently increase the Lifetime Estate and Gift Tax Exemption to $15 million, indexed for inflation, beginning in 2026.
The TCJA temporarily increased the lifetime estate and gift tax exemption from $5 million per person to $10 million per person. The lifetime estate/gift tax exemption is the maximum cumulative amount that a person can give their beneficiaries without triggering a federal estate or gift tax—whether those transfers are made during the person’s lifetime, at death or both.
The TCJA’s increased $10 million lifetime exemption (as indexed for inflation) was scheduled to remain in place until the end of 2025, at which point the exemption was set to revert to the lower $5 million amount (also indexed for inflation). To put this into context: In 2025, the exemption amount rose to $13.99 million, while the projected exemption for 2026—post-reversion—would fall to approximately $7 million.
The BBB would permanently increase the exemption to $15 million starting in 2026, with the amount indexed for inflation in subsequent years. This permanent increase would provide individuals with a longer planning horizon to use their exemption amounts effectively and, in the case of married couples, would allow for $30 million in combined lifetime gifts and bequests without triggering federal transfer taxes.
State and Local Tax (SALT) Deduction. The Bill proposes to increase the deduction for state and local taxes from $10,000 to $30,000 for families with modified adjusted gross incomes (MAGIs) of $400,000 or less and to end the ability of states to impose creditable pass-through entity taxes (PTETs).
The SALT deduction limit has shown itself to be a significant point of contention in getting the BBB through the House of Representatives. Republicans from high-tax states have been holding out for a higher cap of up to $80,000, while their counterparts from low-tax states perceive the deduction as “subsidizing bad decisions in New York, California and New Jersey.”
The BBB would make four significant changes to the landscape for obtaining federal income tax benefits with respect to SALT. First, the deductible amount of SALT paid by a taxpayer (married filing a joint return) would increase from $10,000 to $30,000 beginning in 2026. The deduction would be reduced (but not below $10,000) by 20% of the excess of MAGI over $400,000. Thus, taxpayers with incomes up to $500,000 would be entitled to claim a deduction in excess of the current $10,000 limit.
Second, beginning in 2026, the BBB would end the ability of service partnerships to use PTET regimes to create deductible SALT payments. Under current PTET regimes, service partnerships (and other pass-through entities) pay an entity-level tax. When the partnership income is passed through to the partners, the partners may claim a SALT credit for the PTET paid by the partnership. For federal income tax purposes, the PTET payment is claimed as a deduction or offset to the partnership income, with only the net amount passing through to the partners. This effectively creates a deductible SALT payment for the partners. PTET tax benefits, however, are generally preserved for qualified trades or businesses (which do not include law or accounting firms).
Alarmingly, the revised PTET rules would treat sales tax paid by partnerships in the same manner as creditable income taxes. Specifically, sales tax paid by partnerships would not be deductible. Instead, such taxes would be passed through the partnership as non-deductible expense to the partners.
Third, the proposed legislation specifically shuts down charitable contributions in lieu of SALT payments. Certain states have enacted legislation that permits taxpayers to reduce their SALT burden by the amount of certain specified charitable donations. These taxing schemes have been the subject of litigation between the states and the federal government. The BBB would end the ability of taxpayers taking advantage of these programs from deducting the charitable contributions as such.
Last, the Bill would deny taxpayers the ability to capitalize SALT payments and thereby obtain additional depreciation or amortization deductions (or experience less gain on the disposition of the property into which the SALT payment had been capitalized).
Deduction for Qualified Business Income (QBI). The Bill makes the Code § 199A qualified business income deduction permanent, increases the deduction from 20% to 23%, and replaces the complex phase-in rules for higher-income taxpayers, including professionals, with a more streamlined two-step limitation that may allow partial deductions even where none were previously available.
For taxable years beginning after December 31, 2017, and before January 1, 2026, certain individuals, trusts and estates may deduct 20% of QBI from a partnership, S corporation or sole proprietorship, as well as 20% of aggregate qualified real estate investment trust dividends and qualified publicly traded partnership income. Under current law, the QBI deduction is subject to several limitations. The deduction may not exceed 20% of taxable income (reduced by net capital gain). Limitations based on W-2 wages and capital investment phase in over a range of income above threshold amount of taxable income. A disallowance of the deduction for income of specified service trades or businesses also phases in over a range of income above the threshold amount of taxable income.
The Bill makes several modifications to current law that will benefit a wide range or small and medium-sized business. The Bill would make the QBI deduction permanent, increase the deduction from 20% to 23%, and index the threshold amounts for inflation after 2025. In addition, the prior threshold amounts involving complex calculations based on W-2 wages, capital investment, and specified service trades or business are replaced with a two-step process for taxpayers whose income exceeds the threshold amounts. Under the proposed formula, taxpayers first calculate their deduction using a calculation based on wages and capital investment similar to current law. Under the second step, taxpayers then calculate 23% of their QBI without applying any limits, and subtract a phase-in amount equal to 75% of the excess of taxable income over the threshold. The greater of the two amounts is allowed as the deduction. This formula is more favorable to taxpayers compared with existing law.
Professionals in specified trades or businesses, such as attorneys, accountants, consultants and health care professionals, stand to benefit modestly under the proposed formula. Currently, professionals in specified service trades or businesses are not permitted to claim the deduction once their income exceeds the phase-out range. Under the proposed law, some high-income professionals will qualify for a partial deduction under the new threshold formula where no deduction was permitted under current law. This may be particularly helpful for professionals with income just above the current phase-out levels. The proposed law would begin for taxable years beginning after December 31, 2025.
II. Changes Affecting Businesses
Bonus Depreciation. The BBB would reinstate 100% bonus depreciation for corporate aircraft and other qualified property placed in service after January 19, 2025.
Code § 168(k) permits taxpayers to claim bonus depreciation, which allows for an immediate deduction on the cost of qualifying corporate aircraft and other property used in a trade or business during the first year that the asset is placed in service. From 2018 through 2022, the applicable bonus depreciation rate was 100%, enabling taxpayers to deduct the entire cost of eligible property in the year of acquisition and use.
Beginning in 2023, however, the bonus depreciation rate began to phase down incrementally, reaching 0% for property placed in service in 2027 (2028 for certain longer production period property and certain aircraft).
The BBB would extend bonus depreciation for qualifying corporate aircraft and other property. Under the proposal, 100% bonus depreciation would be reinstated for qualified property acquired and placed in service after January 19, 2025, and before January 1, 2030 (January 1, 2031, for longer production period property and certain aircraft).
Deduction of Research and Development Expenditures. Proposed amendments to Code § 174 would provide optionality to taxpayers for domestic research and experimental (R&D) expenditures paid or incurred in tax years beginning after December 31, 2024, including by restoring expensing for R&D expenditures. Foreign R&D would not benefit from the proposed amendments and would be required to continue to be capitalized over a 15-year period.
Under current law, taxpayers are required to amortize domestic R&D expenditures over five years and foreign R&D over 15 years.
Under proposed Code § 174, for R&D paid or incurred in tax years beginning after December 31, 2024, and before January 1, 2030, taxpayers, at their option, would be able to: (1) deduct domestic R&D expenditures, (2) capitalize and recover domestic R&D expenditures ratably over the useful life of the research (no less than 60 months) beginning with the midpoint of the tax year in which the expenditures were paid or incurred, or (3) capitalize and recover domestic R&D expenditures over 10 years.
Taxpayers would be required to reduce domestic R&D expenditures by the amount of their Section 41 research credits for tax years beginning after December 31, 2024, and before January 1, 2030, or, alternatively, elect to claim a reduced Section 41 research credit.
GILTI and FDII. The Big Beautiful Bill would make permanent the current GILTI and FDII deduction rates that were scheduled to decrease beginning in 2026.
The TCJA enacted two provisions that provide for a lower rate of corporate tax on overseas earnings: Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI), with GILTI accelerating the imposition of tax on such earnings. The FDII and GILTI deductions were scheduled to decrease beginning in 2026, but the BBB proposes to make the current level of deductions permanent.
FDII provides a tax incentive to U.S. corporations by applying a reduced effective tax rate to income derived from the sale of goods and services to foreign persons. It is intended to encourage U.S. taxpayers to retain intellectual property and related activities, such as manufacturing, within the United States. This is achieved through a 37.5% deduction for qualifying FDII, resulting in a current effective tax rate of 13.125%. Although the rate was scheduled to increase to 16.406% starting in tax year 2026, the Bill proposes to maintain the existing 37.5% deduction and thereby preserve the 13.125% rate.
Similarly, the Bill retains the current effective tax treatment of GILTI. Introduced to deter profit shifting of intangible income to low- or no-tax jurisdictions, GILTI requires U.S. 10% or greater shareholders of controlled foreign corporations (CFCs) to include certain foreign earnings in their U.S. taxable income, regardless of whether those earnings have been repatriated. Under the TCJA, a 50% deduction reduces the effective U.S. tax rate on GILTI to 10.5%. This rate was also set to rise to 13.125% in 2026, but the Bill would halt that increase by permanently preserving the current deduction level.
Base Erosion Anti-Abuse Tax. The BBB would retain the current BEAT rate and preserve access to general business credits.
The base erosion anti-abuse tax (BEAT) affects a narrow group of taxpayers, as it applies only to U.S. corporations with average annual gross receipts of at least $500 million (over a three-year period, subject to aggregation rules) and whose deductible related party payments exceed 3% of all deductible payments. IRS data indicates that approximately 1,000 taxpayers meet these thresholds.
The BEAT applies to the extent that the BEAT liability exceeds an affected taxpayer’s regular tax liability reduced by foreign tax credits. If the current regime is not changed, an affected taxpayer would be subject to BEAT to the extent that its BEAT liability exceeds its regular tax liability reduced by all tax credits, including general business credits. The Bill would retain the current scheme in which the BEAT applies only to the extent that it exceeds regular tax liability reduced by FTCs.
Beginning in 2026, the BEAT rate is scheduled to increase to 12.5% (13.5% for financial institutions) from the current 10% (11% for financial institutions). The Bill proposes to retain the current BEAT rate of 10% (11% for financial institutions).
Energy Credits. The BBB would accelerate the phase-out of many Inflation Reduction Act of 2022 (IRA) energy credits, limit credit eligibility based on foreign involvement, and restrict credit transferability.
As expected, the BBB significantly affects the benefits of tax credits for renewable energy projects enacted or extended under the IRA.
Under the BBB, several credits would terminate after December 31, 2025, including those for clean vehicles, energy-efficient homes and clean hydrogen production. Several other credits—most notably the new Clean Electricity Production and Investment Credits (Code §§ 45Y and 48E, respectively), the Zero-Emission Nuclear Credit (Code § 45U), and the Advanced Manufacturing Production Credit (Code § 45X)—would begin phasing out earlier than provided by the IRA. The Clean Fuel Production Credit (Code § 45Z), which is currently scheduled to expire at the end of 2027, would be extended through December 31, 2031. However, the BBB would add a requirement that feedstocks be produced or sourced from the United States, Mexico or Canada. These changes could create major challenges for taxpayers who have planned projects and construction timelines around the availability of the tax credits.
In addition, the BBB would impose prohibitions that effectively deny the ability to claim renewable energy tax credits if taxpayers are owned by or receive material assistance from “prohibited foreign entities.” In general, prohibited foreign entities include those with ties to Russia, China, Iran and North Korea. For this purpose, “material assistance” would include the extraction, recycling, processing, manufacturing or assembly of a component, subcomponent or critical mineral in one of the designated foreign countries, or reliance on intellectual property, know-how or trade secrets originating from such countries.
Finally, the IRA enacted Code § 6418, which allows taxpayers to sell certain tax credits to other taxpayers for cash consideration. This provision enables flexibility for the monetization of tax credits that potentially cannot be fully utilized by the developers of renewable energy projects, generating capital to support the financing of such projects. The Bill, however, would end transferability for various renewable energy tax credits, with the result that taxpayers considering monetization of such credits may need to restructure their projects to address more limited financing options.
Business Interest Deduction Limitation. The proposed bill reinstates the more favorable EBITDA standard that was used prior to 2022 for calculating the business interest limit under Code § 163(j), increasing the amount of deductible interest and expanding relief for capital-intensive businesses for tax years after 2025 through 2029.
Under current law, interest paid or accrued by a business generally is deductible in the computation of taxable income, subject to certain limitations. The deduction for interest expense is generally limited to the sum of business interest income of the taxpayer and 30% of the adjusted taxable income of the taxpayer. For tax years beginning before 2022, adjusted taxable income was calculated based on EBITDA (i.e., earnings before interest, taxes, depreciation, and amortization). Under current law, for tax years beginning after 2021, adjusted taxable income is calculated based on EBIT (i.e., without depreciation and amortization). The bill temporarily reverts back to the more generous EBITDA standard excluding depreciation and amortization deductions in the calculation for tax years after 2025 through 2029. This change increases the interest deduction cap for many businesses and particularly benefits capital-intensive businesses in industries such as manufacturing, energy and transportation.
Unfair Foreign Tax Practices. Proposed Code § 899 would impose increased U.S. tax rates on entities and individuals connected to “discriminatory foreign countries” that enact certain international tax rules.
The Bill introduces a new income tax regime under new Code § 899 aimed at countering what the U.S. government views as discriminatory foreign tax practices against U.S. taxpayers. Specifically, it increases various income tax rates, including FDAP and FIRPTA withholding and branch profits taxes, on “applicable persons.” An applicable person includes any government of a “discriminatory foreign country,” individual residents (other than U.S. citizens or U.S. tax residents) of a discriminatory foreign country, foreign corporations that are tax resident in a discriminatory foreign country or that are 50% or more owned (by vote or value) by applicable persons, trusts where the majority of beneficial interests are owned by applicable persons, private foundations created or organized within a discriminatory foreign country, and certain foreign partnerships, branches and other entities connected to a discriminatory jurisdiction as identified by the Treasury Secretary.
The proposal is widely seen as a response to the OECD’s Pillar Two global minimum tax framework, which has been criticized by some in the U.S., particularly among GOP lawmakers, as unfairly targeting U.S.-based multinationals. Pillar Two seeks to impose a 15% minimum global tax through a “top-up tax” mechanism in jurisdictions where a multinational enterprise’s effective tax rate falls below that threshold.
Under proposed Code § 899, “discriminatory foreign countries” are those that impose one or more “unfair foreign taxes,” which may include an undertaxed profits rule, and, to the extent identified by the Treasury Secretary, an “extraterritorial tax,” a “discriminatory tax,” or any other tax enacted with a public or stated purpose that it will be disproportionately economically borne by United States persons. These applicable persons would be subject to increased U.S. federal income tax rates, including branch profits tax and FDAP and FIRPTA withholding. The tax rate would increase by five percentage points annually, up to a maximum of 20 percentage points above the statutory rate.
In addition, any corporation that is more than 50% owned (by vote or value) by applicable persons would become subject to BEAT under Code § 59A regardless of whether it meets the average annual gross receipts test or base erosion percentage threshold, and by treating certain capitalized amounts as if they had been deducted, among other changes. Such corporations could also face an increased BEAT rate of 12.5%, compared to the standard 10% rate.
The Bill directs the Secretary of the Treasury to publish and update quarterly a list of jurisdictions deemed discriminatory. This list would be instructive for both taxpayers and withholding agents, as the increased withholding tax applies if the country is on the published list. In any event, the proposed legislation provides relief for withholding agents, as they would be shielded from interest and penalties for failure to apply the increased rate prior to January 1, 2027, provided they make best efforts to comply.
The potential reach of this legislation is quite broad. Any country implementing the undertaxed profits rule (UTPR) under the Pillar Two regime, a diverted profit tax, or digital services tax could be considered a discriminatory foreign country. Since the current U.S. effective tax rate on “global low intangible income” is 10.5%, it falls below the 15% minimum, allowing Pillar Two jurisdictions to impose a top-up tax. As a result, EU member states and other countries that have adopted UTPR and whose taxpayers derive U.S.-source income could be exposed to the provisions of Code § 899, unless an exception were to apply. For example, the transitional UTPR safe harbor, which temporarily exempts jurisdictions with corporate tax rates of at least 20% from being subject to a top-up tax.
The increased taxes under proposed Code § 899 would apply to tax years beginning on or after the latest of (1) 90 days after the date of enactment of Code § 899, (2) 180 days after the date of enactment of the unfair foreign tax that causes a country to be treated as a discriminatory foreign country, and (3) the first date that the unfair foreign tax of such country begins to apply.
Qualified Opportunity Zones. The Bill modifies and extends the Opportunity Zone program by tightening eligibility, emphasizing rural investment, expanding reporting, and reintroducing gain exclusion incentives.
The proposed legislation significantly revises the Opportunity Zone (OZ) program by permitting new OZ designations from 2027 to 2033 under a stricter definition of low-income communities. These changes lower income thresholds and eliminate eligibility for contiguous tracts that are not themselves low-income, narrowing the focus to genuinely distressed areas. The proposal also requires that a minimum share of new OZs be located entirely in rural areas, aiming to direct more investment to underserved communities.
Additionally, to enhance transparency, fund managers and OZ businesses will face stricter reporting requirements. Qualified Opportunity Funds (QOFs) must report annually on assets, investments, business activity, and job creation, while OZ businesses must provide supporting data to ensure fund compliance. Noncompliance will result in steep penalties, especially for large funds, reflecting a shift toward a more accountable, data-driven development approach.
In addition to retaining the exclusion of post-investment gains for assets held at least 10 years, the proposal reinstates the ability to permanently exclude 10% of reinvested gains—through a corresponding 10% basis increase—if the investment is held for five years. For those investing in newly defined “Qualified Rural Opportunity Funds” (QROFs), the benefit is more generous, offering a 30% gain exclusion and basis increase after five years. The proposal also introduces a new provision allowing taxpayers to invest up to $10,000 of ordinary income into QOFs, with future gains on that amount excluded if held for at least 10 years, broadening the program’s accessibility to smaller investors.
The proposed changes would significantly impact future OZ investors and fund managers, with a clear goal of directing investment into genuinely distressed and rural communities. As a result, certain regions and industries may disproportionately benefit from these reforms. For example, the proposals could increase the flow of capital to clean energy, data center and agricultural projects across the U.S., potentially advancing energy and agricultural independence—key priorities of the current Republican administration.
REIT Changes. The BBB would increase the amount of stock of taxable REIT subsidiaries that REITs can hold to 25% from 20%.
Real estate investment trusts (REITs) can hold up to 20% of the gross fair market value of their assets in the stocks of taxable REIT subsidiaries. Taxable REIT subsidiaries can engage in businesses and hold assets which, if directly conducted or held by a REIT would generate income that would count against satisfaction of the REIT income and assets tests, respectively. This change would increase the amount of non-qualifying business that could be conducted through taxable REIT subsidiaries.
Third-Party Network Transaction Reporting. The proposed change to Code § 6050W would restore the $20,000 and 200 transaction reporting thresholds for payments made to users by third-party settlement organizations.
Prior to changes enacted by the American Rescue Plan Act, “third-party settlement organizations” (such as Venmo, PayPal and eBay) were required to report transactions on Form 1099-K only if a user had more than 200 transactions and received over $20,000 in payments annually. This threshold was drastically lowered for tax years beginning after December 31, 2021, which set the reporting requirement at a single transaction over $600, increasing tax reporting burdens and confusion, although the IRS ultimately delayed the implementation of the change for 2022 and 2023 and provided transition relief for tax years 2024 and 2025. It is unclear how this tax would apply to blockchain remittances, including transactions in unhosted crypto wallets.
The BBB proposes to undo the stricter reporting rules and revert to the $20,000 and 200 transaction thresholds. The Bill aims to reduce unnecessary paperwork associated with lower-volume users while maintaining tax compliance for higher-earning individuals.
Increase in Reporting Threshold for Certain Payees. The Bill proposes changes to the dollar threshold for reporting payments on Forms 1099-MISC and 1099-NEC.
Currently, taxpayers engaged in a trade or business are required to report payments of non-employee compensation (Form 1099-NEC) and other fixed or determinable income (Form 1099-MISC), if such amounts exceed $600 for a single payee in a calendar year. The BBB proposes to increase the reporting threshold for these payments, beginning with payments made after December 31, 2025, to $2,000 (indexed for inflation after 2026) to relieve businesses of some of the administrative burdens relating to the reporting requirements.
The BBB also proposes a similar change to the backup withholding threshold, only requiring backup withholding when payments total at least $2,000 (indexed for inflation after 2026)—an increase from the current $600 threshold, with such change becoming effective for payments made after December 31, 2025.
III. Changes Affecting Tax-Exempts and Universities
Endowment Excise Tax. The BBB would expand the existing excise tax on university endowments by imposing a tiered rate structure based on endowment size per student.
The BBB expands upon an existing excise tax on university endowments, which was originally enacted as part of the TCJA. Under current law, Code § 4968 subjects private colleges and universities with at least 500 tuition-paying students (more than half of whom are located in the United States) and endowments exceeding $500,000 per student (excluding assets used directly for educational purposes) to an excise tax equal to 1.4% of the institution’s net investment income for the taxable year.
The Bill introduces several key modifications to the excise tax on investment income of certain colleges and universities. The proposal replaces the 1.4% excise tax rate with a new tiered rate structure based on an institution’s assets-to-students ratio (referred to as a “student-adjusted endowment ratio”). The new rate structure is as follows:
The BBB also modifies the calculation methodology by excluding from the denominator any students who are not (1) U.S. citizens or nationals, (2) lawful permanent residents (green card holders), or (3) individuals present in the U.S. for other than a temporary purpose with the intent to become a U.S. resident. As a result, institutions would calculate the student-adjusted endowment ratio without regard to students present on F, J or M visas, or undocumented students.
Institutions subject to the tax would face enhanced reporting obligations to ensure compliance and transparency.
Tax-Exempt Employee Compensation. The BBB expands the scope of the Code § 4960 excise tax to include all highly compensated current and former employees of applicable tax-exempt organizations and their related entities.
The proposed change to Code § 4960 expands the definition of “covered employee” to include all current and former employees of an applicable tax-exempt organization, and includes those individuals employed by related entities. Code § 4960 currently imposes a 21% excise tax upon most tax-exempt organizations and related organizations (including certain government entities and government-affiliated entities) that pay compensation to the top five highest compensated employees (or former employees) of the tax-exempt organization (“covered employees”) of either: (i) amounts exceeding $1 million on a combined basis, or (ii) an excess parachute payment on certain separation events.
Code § 4960 is generally intended to mirror Code § 162(m), which limits deductions for “excessive” compensation paid to the top-compensated individuals of publicly traded corporations. Since tax-exempt organizations operating for exempt purposes do not recognize taxable gross income where a deduction limitation would have any effect, Code § 4960 instead imposes an excise tax directly upon the organization and related organizations in similar circumstances.
The current statute limits the number of “covered employees” to the top five highest-compensated employees. It also exempts compensation from publicly traded companies to the extent that deductions are disallowed under Code § 162(m). The proposal removes the five-employee cap, expanding the scope to all current and former employees meeting the relevant compensation thresholds, and applies the rule to individuals employed solely by related organizations. This change has the potential to significantly increase exposure to the excise tax for larger exempt organizations and their affiliates.
[The following provision has been removed from the bill being considered the House Rules Committee, however, because it may be replaced in later iterations, a summary is included.]
Name and Logo Royalties of Tax-Exempts. The BBB would treat the licensing or sale of a tax-exempt organization’s name or logo as unrelated business income.
The bill proposes a change to the royalty exemption from unrelated business taxable income (UBI) to treat any sale or licensing by a tax-exempt organization of its name or logo (including any related trademark or copyright) as an unrelated business regularly carried on by such organization, and to accordingly include gross income from such sale or licensing in UBI of the exempt organization.
Code §§ 511 through 514 of the Code contain the unrelated business income rules, which generally impose income tax on net income from any regularly carried on business that is not substantially related to a tax-exempt organization’s exempt purpose. Historically, the Code has exempted most “passive” sources of income of an exempt organization from UBI, including royalties representing payments for the use of valuable intangible rights. Certain passive income payments from controlled organizations to an exempt parent, including royalties, have long been excepted from this exemption and are thus taxable to the parent exempt organization if the subsidiary receives a tax deduction.
The new proposal would carve out sales or licenses of any exempt organization’s name or logo rights, including related trademarks and copyrights, from the royalty exemption, deeming these transactions to be an unrelated business regularly carried on. The gross income from such sales or licenses would accordingly be included in UBI.
This provision may have a dramatic and negative tax effect on many longstanding tax-exempt organizations that have used their well-known names and logos to generate lucrative royalties from third parties. The proposal also does not exempt name and logo sale or licensing arrangements, including those with controlled subsidiaries, that substantially further the exempt organization’s mission—raising the possibility that some longstanding, mission-aligned relationships may now trigger tax liability.
For questions concerning this alert, contact any member of your Pillsbury Tax team.