Key Takeaways
- President Donald Trump signed wide-ranging tax legislation, P.L. 119-21 (the Legislation), on July 4. The Legislation will affect nearly every sector of the economy and every type of taxpayer.
- We previously published a comprehensive alert that provides a summary and an analysis of the Legislation.
- In this alert, part of an eight-part series that takes a deeper dive into the various portions of the Legislation (International Tax; Opportunity Zones and Related Tax Credits; Estate Planning and Individual Taxes; Renewable Energy Credits; Employer-Related and Executive Compensation; Startup Investors and Business Owners; Healthcare; and Tax-Exempt Organizations and Charitable Giving), we explain and analyze the implications of the exempt organizations provisions of the Legislation.
- With respect to tax-exempt organizations, notable provisions in the Legislation include the following: increasing the university endowment tax under Section 4968, expanding the tax on excess compensation under Section 4960, creating a new tax credit for donations to scholarship granting organizations (new Section 25F) and modifying the charitable contribution deduction rules under Section 170.
The Legislation combines spending and policy priorities from 11 congressional committees and will reshape federal policy across nearly every sector of the U.S. economy. There is a possibility for one or more additional budget reconciliation bills before the end of 2026. Therefore, additional opportunities for enactment of new tax law, as well as changes and improvements to the Legislation, can be expected. Meanwhile, the spotlight turns to the Executive Branch. The importance of engaging with the IRS and U.S. Department of the Treasury as they develop guidance to implement some of the more complex provisions cannot be overstated.
Increased University Endowment Tax (Section 4968)
The Legislation introduces a tiered excise tax on the net investment income of private colleges and universities, effective for tax years beginning in 2026. The tax rates range from 1.4 percent for institutions with a “student adjusted endowment” between $500,000 and $750,000 up to 8 percent for institutions with a student adjusted endowment above $2 million. Schools with student adjusted endowments between $750,000 and $2 million per student will be taxed at 4 percent. The Legislation excludes schools that have either fewer than 3,000 tuition-paying students in the preceding tax year or have at least 50 percent of their tuition-paying students outside the U.S.
Assets and net investment income of related organizations generally are included in the income calculation, as are student loan interest and royalty income from federally funded intellectual property. The American Enterprise Institute estimates this tax will cost universities more than $10.5 billion over five years.[1]
Universities have several planning opportunities to consider in order to help avoid, reduce or defer the impact of the new tiered endowment tax:
- Manage net investment income by changing the mix of endowment investments to defer income recognition.
- Reduce the number of tuition-paying students below the 3,000 threshold: The tax only applies to private institutions with at least 3,000 tuition-paying students in the preceding taxable year. Some universities may be able to reduce the number of students who are considered “tuition-paying” by waiving tuition or paying it only with university or governmental funding. Any students retaining scholarships from nongovernmental external sources would have to use that funding only for expenses other than tuition or fees required for enrollment.
- Manage the student adjusted endowment value: The tax rates (1.4 percent, 4 percent or 8 percent) are directly tied to an institution’s student adjusted endowment – the aggregate fair market value of its assets, not including its assets used directly in its exempt purpose, divided by the number of students. Universities may review their assets and the usage of significant assets to maximize the assets that are “used directly” in the university’s exempt purposes to reduce the calculated student adjusted endowment value. Changes in the relationships with affiliated organizations, including supporting organizations, may also be useful to manage the calculated endowment value.
- Further guidance: The Legislation directs the IRS and Treasury to issue regulations to prevent tax avoidance, possibly addressing the restructuring of endowment funds, royalty structures and related entities, making early involvement in the regulatory process an important aspect of planning.
Expansion of the Tax on Excess Compensation (Section 4960)
The Legislation expands the application of the existing 21 percent excise tax on compensation paid by applicable tax-exempt organizations (ATEOs) from the five highest-paid employees to any employee of an ATEO who receives more than $1 million in compensation. The compensation is aggregated across the ATEO and its related entities and includes current as well as former employees. Compensation paid by related entities also may trigger the excise tax if the individual was employed by the ATEO, even if the ATEO is no longer paying them. The Joint Committee on Taxation estimates that the expanded tax will cost exempt organizations over $3.8 billion over ten years.[2] Employees providing medical services continue to be excluded. Organizations should review past compensation records to identify all “covered employees” under the new definition as well as identify related entities. In some cases, deferred compensation arrangements may help reduce or avoid the excise tax.
Modification to Charitable Contribution Deduction (Section 170)
The Legislation permanently extends the provision in the Tax Cuts and Jobs Act of 2017, which had temporarily increased the percentage of an individual’s adjusted gross income (AGI) the individual could claim as a charitable contribution deduction for a gift of cash to a public charity, from 50 percent to 60 percent.No change was made to the limitations applicable to cash gifts to private foundations or gifts of appreciated property to public charities and private foundations.
The Legislation also reinstates a partial charitable contribution deduction for individuals who do not itemize deductions in the amount of $1,000 for single filers and $2,000 for joint filers, at an estimated cost to the federal government of $73.8 billion over 10 years.[3] The reinstated deduction for non-itemizers has specific exclusions: It does not apply to contributions made to supporting organizations, donor-advised funds (DAFs) or private, nonoperating foundations. Additionally, this $1,000/$2,000 deduction is not indexed for inflation.
The cost of the modifications described above is offset by a range of other changes, including:
- 0.5 percent individual AGI floor: A 0.5 percent floor applies to the deduction of contributions for those who do itemize. For example, an individual taxpayer with an AGI of $500,000 would only be able to deduct charitable contributions that exceed $2,500. The 0.5 percent AGI floor for itemizers applies not only to current-year deductions but also to carry-forward donations made in 2025 or later.
- 1 percent C corporation AGI floor: A similar 1 percent floor limits C corporation charitable contributions. Disallowed contributions may be carried forward only if the corporation’s total contributions in the taxable year exceeded the 10 percent ceiling for contributions. This means that a corporation making contributions below the 1 percent floor, but also below the 10 percent ceiling, would not be able to carry forward those disallowed amounts. Corporations may wish to consider paying charities for sponsorships and other types of deductible or amortizable expenditures starting in calendar year 2026 in lieu of making nondeductible charitable contributions.
- New cap on itemized deductions for high-income taxpayers: A new limitation on itemized deductions for individuals in the 37 percent tax bracket means that the tax benefit of itemized charitable deductions is capped at 35 percent. For example, a $1,000 donation would yield a $350 tax benefit instead of $370 by reducing the after-tax value of charitable contributions for high-income donors.
The new AGI floors and caps may well cause taxpayers to accelerate gifts into 2025, prior to the floors and caps taking effect in 2026, to take full advantage of the greater tax benefits still available this year. Contributions by individuals to a DAF this year would be especially useful to “pool” funds to be distributed over future years to help avoid both the 0.5 percent AGI floor and the 35 percent cap on the tax benefit associated with itemized deductions (both of which would apply to contributions by an individual to a charity, including a DAF, starting in 2026). Similarly, C corporations may contribute to a DAF in 2025 to avoid the 1 percent floor that will apply to charitable contributions starting in 2026.
The introduction of the 0.5 percent AGI floor and the 35 percent deduction cap for high-income earners also enhances the appeal of qualified charitable distributions (QCDs). QCDs allow individuals 70 1/2 or older to transfer funds directly from their individual retirement account (IRA) to a qualified charity. The annual limit for QCDs is $108,000 per individual for 2025, indexed annually for inflation. For a married couple where both spouses are 70 1/2 or older and have IRAs, each may exclude up to this amount. The key benefits of QCDs under the new tax rules described above include:
- Satisfying the required minimum distributions (RMDs) without increasing taxable income: For IRA owners who are subject to RMDs, a QCD counts toward their RMD for the year, and the amount transferred as a QCD is not included in their taxable income. This is a significant advantage over a regular IRA distribution, which would otherwise be taxed.
- Reducing AGI: Because QCDs are excluded from gross income, they reduce the taxpayer’s AGI, which may increase eligibility for other deductions or credits that are subject to AGI phaseouts.
- Bypassing the need to itemize deductions: QCDs are helpful to those who take the standard deduction. The Legislation increased the standard deduction amounts, and fewer taxpayers will benefit from itemizing.
- Avoiding the new AGI floor and deduction caps: QCDs are especially beneficial under the new rules on floors and caps. QCDs are not subject to either the new 0.5 percent AGI floor or the 35 percent itemized deduction cap on the value of charitable deductions. For taxpayers with substantial charitable intent or large RMDs, QCDs may be a more tax-efficient way to give compared with donating appreciated assets or making cash gifts that are subject to the new itemization rules.
Tax Credit for Donations to Scholarship Granting Organizations (Sections 25F, 139K)
The Legislation creates a new federal tax credit scholarship program in the new Section 25F. This nonrefundable federal income tax credit is for cash contributions to qualified scholarship granting organizations (SGOs) that fund scholarships for K-12 students’ qualified education expenses, including tuition, books, supplies, tutoring and special needs services.
State-level SGO programs, operational in Arizona, Florida, Georgia, Indiana, Ohio, Pennsylvania and Virginia, among other states, have existed for many years. These state programs typically offer state tax credits (often dollar for dollar up to a cap, such as Ohio’s $750 per individual or $1,500 per married couple) to donors who contribute to SGOs. The SGOs then typically award scholarships to eligible students (from low- to middle-income families) to attend private schools or cover other educational costs.
The new Section 25F builds on these state models and extends the concept nationwide with the following requirements:
- Credit rather than deduction: Section 25F mirrors certain state programs’ frameworks by offering a 100 percent tax credit (up to $1,700 annually) for qualified contributions to SGOs, rather than a Section 170 charitable contribution tax deduction. The $1,700 maximum credit is per tax return, which presumably is the same for single or joint filers.
- Funds used for scholarships by 501(c)(3) organizations: The SGOs must be Section 501(c)(3) public charities distributing scholarships only to in-state-eligible students. Private foundations are ineligible, but DAFs and supporting organizations may well be “scholarship granting organizations” under section 25F(c)(5). Eligible students are defined as those from households with incomes up to 300 percent of the area median gross income. SGOs must use at least 90 percent of contributions for scholarships, award them to at least 10 students across multiple schools, prioritize renewals and siblings, and conduct annual audits. These requirements are similar to the terms of many state tax credit programs. Funds provided by an SGO to an individual or their dependent as a scholarship for qualified elementary or secondary education expenses are specifically excluded from the recipients’ income under the new Section 139K.
- Coordination with state tax credits: The federal credit is reduced dollar for dollar by any state tax credit received for the same contribution. For example, if a donor in Ohio claims the full $750 state credit on a $750 contribution, the donor cannot claim a federal credit on that same amount but could make an additional donation to qualify for the $1,700 federal credit. This allows donations to SGOs to be credited by both state and federal tax credit programs but not double-credited.
- Additional rules: The federal credit prohibits earmarking donations for specific students or self-dealing, requires recipient family income verification and allows donors to carry forward unused credits for up to five years.
This tax credit program is effective for taxable years ending after Dec. 31, 2026, giving states time to (i) opt in to the program and (ii) designate qualifying SGOs, both of which are requirements for SGO qualification.
Conclusion
With this first Trump administration budget reconciliation bill enacted, taxpayers should determine the expected impacts and consider adjustments and compliance issues as appropriate for this year and beyond.
Some of the proposed changes and spending cuts that were dropped solely because the Senate Parliamentarian ruled that inclusion would have violated the Byrd Rule that governs the reconciliation process may be revisited during the FY 2026 appropriations process and through stand-alone bipartisan legislation during the remainder of the 119th Congress. With respect to provisions included in the Legislation, taxpayers should turn their focus toward offering input as the Treasury and IRS develop and issue implementing regulations and related guidance.
There will likely be one or more additional budget reconciliation bills during late 2025 and in 2026, and therefore additional opportunities for enactment of additional provisions, as well as changes, corrections and improvements to the Legislation. BakerHostetler will continue to assist our clients with advancing their federal policy goals; challenging and, when necessary, litigating IRS enforcement missteps; and keeping our clients and friends updated on federal tax and budget-related developments.
Associate James Wise contributed to this alert.
[1] https://www.aei.org/education/how-much-will-universities-pay-in-endowment-tax/
[2] https://www.jct.gov/publications/2025/jcx-35-25/
[3] Id.
[View source.]
