Recent Tax Law Changes Affecting Tax-Exempt Organizations

Signed into law on July 4, 2025, the Reconciliation Bill includes provisions that are important for tax-exempt organizations to consider. This article identifies significant changes impacting tax-exempt organizations and items management needs to know to effectively navigate the developing tax policies surrounding charitable contributions, scholarships, and excise tax for excess compensation.

Individual Charitable Contributions

Previously, only those taxpayers who itemize were able to deduct charitable contributions. Starting in 2026, the Act creates a permanent cash contribution deduction, ($1,000 for single filers, $2,000 for joint filers), for those taxpayers who do not itemize.

For those who itemize, a 0.5% floor was introduced, which means, before any deductions are claimed, charitable contribution deductions are reduced by 0.5% of the taxpayer’s adjusted gross income (AGI). Also, if taxable income is higher than the 37% tax bracket threshold, the IRS will reduce itemized deductions using a new formula. This formula takes away 2/37 of either total itemized deductions or the amount of income over the 37% threshold—whichever is less.

Tax-exempt organizations have a huge opportunity to leverage the permanent cash contribution deduction as taxpayers will receive direct benefit from the smaller-dollar donations who previously did not receive the tax break.

Corporate Charitable Contributions

Previously, charitable contribution deductions of corporate taxpayers were limited to 10% of taxable income. Under the new Act, although still limited to 10% of the corporation’s taxable income, it establishes a 1% floor on those deductions, which means only those contributions in excess of 1% of the corporation’s taxable income are allowable. Excess contributions, along with the amount disallowed under the 1% floor, are carried over for up to five years.

Some of the new floors and caps may potentially reduce donations from itemizers and corporations. Tax exempt organizations may encourage corporations and itemizers to bunch their giving every few years to overcome these new floors and receive the most tax benefit.

Contributions to Scholarship-Granting Organizations

A dollar-for-dollar tax credit, up to $1,700, is now available for individuals who make contributions to state-approved, federally recognized tax-exempt organizations that distribute scholarships to eligible children (SGO). This tax credit will be available in taxable years ending after December 31, 2026. The credit is reduced by any state tax credit for the same gift and cannot be double counted as a charitable deduction. The SGO must be state-certified and federally recognized.

SGOs are likely to experience increased donor participation because of this tax credit incentive.

Tax on Excess Compensation with Tax-Exempt Organizations

Previously, there was a 21% excise tax imposed on tax-exempt organizations for any covered employees who receive compensation over $1 million in a given year and any excess severance or other separation-related payment greater than three times their average annual compensation. Covered employees referred to one of the five highest-compensated employees in a given year. The Act retains the 21% excise tax and expands the definition of covered employee to include any employee or former employee who receives pay greater than $1 million, regardless of whether they are included in the five highest-compensated employees. This provision takes effect for taxable years beginning after December 31, 2025, including former employees who were employed by the organization for tax years beginning after December 31, 2016.

Tax-exempt organizations are encouraged to evaluate executive compensation packages. Since this tax is paid by the organization, not the individual, it could impact the funds available for the organization to carry out its mission.

Recent tax updates affecting tax-exempt organizations emphasize the importance of staying educated and proactive. Various changes including charitable contribution deductions and new rules around executive compensation and tax credits have important economic and operational implications.

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