September 7, 2018
Along with all the changes affecting individuals and for-profit businesses, nonprofit organizations were handed their own corner of tax reform when the Tax Cuts and Jobs Act (TCJA) was passed in late 2017. While changes related to employer matters are no different for nonprofits, there are a few issues pertaining to unrelated business income to be aware of, including taxation of certain employee fringe benefits and separate taxation of net income from lines of business within an organization.
Certain fringe benefits provided to employees will now be taxed as unrelated business income, even for organizations who do not actually have any activities unrelated to their exempt purpose. These include qualified parking and transportation benefits and provision of an on premise athletic facility. Many employers either provide stipends for these benefits or allow a reduction in employees’ taxable compensation to be used to pay for these expenses, all in accordance with prior tax law. Beginning January 1, 2018 such benefits are no longer tax deductible to for-profit entities; correspondingly, nonprofit entities, for which tax deductions are generally irrelevant, must now pay corporate income tax on the cost of these expenditures. The federal tax rate in 2018 is 21%, and state taxes may also apply. Individual states will hopefully provide guidance for this. A form 990-T will need to be filed, along with any related state filing.
“Siloing” of Unrelated Business Income Categories
For organizations that have more than one unrelated business activity, net income and losses will need to be computed and taxed separately. Prior to 2018, a loss in one activity could be used to offset income in another. Now losses will need to be carried forward to offset future gains within the same activity. There had been no guidance on what constitutes an “activity” until late August, when the IRS stated that the NAICS Classification System, which groups together similar economic activities, could be used. This is a framework already in use on Forms 990 and 990-T. The IRS also provided instruction on how to treat multiple instances of debt-financed income or payments from certain controlled entities. They also acknowledged the administrative burden of separately tracking gains and losses on each taxable investment activity, income from which is often generated from multiple industries. Proposed regulations are planned to allow aggregation of these as one activity.
Steps to Take
These new provisions have created much confusion in the nonprofit community and there has been little guidance provided by the IRS. Currently there are bills in both the House and Senate to repeal or delay various aspects of these provisions. Of course, whether any of the proposed legislation becomes law is of great uncertainty, so for now these provisions are currently applicable. Organizations should determine the impact of providing these specific fringe benefits and consider whether taxes should be paid currently. Additionally, if you do have more than one unrelated business activity, evaluate whether they can properly be grouped together using the NAICS system.
We are happy to assist you with assessing the impact to your organization, and will provide updates if any further guidance is issued or changes to the law are made. Please contact your MW&A advisor or reply to this message and we will put you in touch with the right person.