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Tax Reform and Nonprofit Bankruptcy

posted by Pamela Foohey

It's Tax Day! When the new tax bill was debated late last year, a few reports noted an unintended consequence of the bill's expansion of the standard deduction might be decrease people's charitable contributions, in turn harming nonprofits. After the bill passed, I continued to hear comments about the increased standard deductions' potential to cause financial problems for nonprofits, and saw estimates of a loss of $2 billion to the sector. Financial problems, of course, make me think of bankruptcy. And nonprofits make me think about religious organizations, which are the nonprofits I've studied the most in the context of bankruptcy. Tax Day seems like an appropriate day for some thoughts about the tax reform's possible connection to nonprofits' chapter 11 filings, particularly churches' chapter 11 filings.

That the increased standard deduction could lead to a decrease in contributions to churches, which in turn could lead to bankruptcy is not outside the realm of the possible. Indeed, one of the main reasons that churches cite in their chapter 11 filings for their financial problems is a decline in contributions. For many churches, including some that end up in chapter 11, smaller individual contributions comprise most of their revenue. And for many churches that filed bankruptcy, when revenue decreased, they eventually were unable to meet payments on their buildings’ mortgages, which led them to bankruptcy courts to try to keep their “spiritual homes.” Filing chapter 11 often made sense because it provided a venue to negotiate with secured creditors, often successfully. A majority of churches’ chapter 11 cases filed in the past decade ended in a confirmed reorganization plan or a consensual resolution with a key secured creditor that allowed them to continue holding services and otherwise operating out of their original buildings (see this and this paper).

Nonetheless, it still takes a couple of "could"s to get from tax reform to nonprofit bankruptcy. The hypothesized loss of revenue caused by the tax reform is linked directly to more sophisticated donors who give in part as a tax planning strategy. Most of the churches that have used chapter 11 in the past decade are smaller, non-denominational churches with 200 to 300 members. I suspect that most congregants do not give to their churches with tax planning in mind. I also suspect that the same is true for individuals’ donations to many nonprofits that similarly are reliant on accumulated contributions. People give to churches (and other nonprofits) as part of a community. And pastors and other leaders, in times of financial troubles, according to what they told me, called on their community for help, which increased revenue sufficiently for churches to be able to negotiate with their secured lenders, albeit in chapter 11. In short, renewed pleas to nonprofits’ members and potential donors are the likely consequence of the tax reform. And that is exactly what I found when I searched online for advice to nonprofits in the wake of the tax reform – revisit fundraising strategies and motivate people to give to make a difference.

To everyone, good luck on Tax Day!

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