New Guidance Helps Clarify Tax Reform for Exempt Organizations
This article augments and supersedes our January 15, 2018, article Tax Reform Implications for Exempt Organization Employers and Employees.
The scope and scale of the 2017 Tax Act is so great that the IRS continues issuing new guidance for taxpayers in virtually every industry, including tax-exempt organizations. In addition, nuances of the statutory text have become apparent. The article we published in January was written very soon after the bill was passed, but we have since gained clarification on some key issues for nonprofits. Following is a review of those issues and possible actions you should discuss with your tax and legal advisors.
Fresh guidance on transportation benefits, flexible spending accounts, and UBI
Under the provisions of the tax reform law, employers may not deduct the value of certain employee transportation fringe benefits from taxable income. If the employer is a tax-exempt organization, the nondeductible benefits must be reported as unrelated business income (UBI) on Form 990-T, Exempt Organization Business Income Tax Return. Such benefits include employer-provided parking, parking passes, transit passes, bus or rail passes, van pools, and similar payments or reimbursements to cover an employee’s normal commuting expenses (reimbursements of business travel is not affected).
The scope and scale of the 2017 Tax Act is so great that the IRS continues issuing new guidance for taxpayers in virtually every industry, including tax-exempt organizations.
The IRS recently updated Publication 15-B, Employer’s Tax Guide to Fringe Benefits, providing clear guidance that a tax-exempt employer is required to report as UBI:
- Direct payments for parking and transportation
- Any amount an employee contributes to a flexible spending account (FSA) (sometimes called a compensation reduction agreement) for transportation costs on or after January 1, 2018, regardless of the employer’s tax year.
Quarterly estimated payments are due on the 15th day of the fourth month, the sixth month, the ninth month, and the 12th month of an organization’s tax year. For example, a calendar-year organization should make estimated payments on April 17, June 15, September 17, and December 17, 2018. With so many of the UBI provisions being applicable for tax years beginning after December 31, 2017, this provision will greatly impact organizations beginning January 1, 2018.
All employers should determine the direct payments for transportation benefits and the employee pre-tax contributions to a transportation FSA for January through March and make a payment equal to 21 percent of the total. Federal tax payments should be made through the Electronic Federal Tax Payments System (EFTPS).
Continuing debate on “bucketing” of net operating losses
The new tax law requires that tax-exempt organizations track their UBI activities separately, and losses from one activity cannot be used to offset taxable income from another activity. However, the provision applies only to activities that are an unrelated trade or business. Since the courts have generally concluded that passive investments are not a trade or business, some legal professionals have suggested investment income from debt-financed property and passive investments from partnerships generating UBI (such as on Form K-1, Box 20V) are not subject to the so-called “bucketing” requirements.
If this position is accurate, the bucketing provision does not apply. Ultimately, losses generated from such activities could be used to offset any other UBI activity producing taxable income. Again, this position is currently being debated within the tax-exempt sector. Organizations choosing to take this position with UBI activities should consult their legal and tax advisors.
Reporting of excess executive compensation
The tax reform legislation imposes a 21 percent excise tax on compensation paid by a tax-exempt organization in excess of $1 million to any covered employee for tax years beginning after December 31, 2017. The Internal Revenue Code (IRC) treats this as an excise tax, not an income tax. At this time, it is still unknown whether the taxable portion of the compensation will be reported on Form 990-T, or Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the IRC.
Since excise taxes are not subject to quarterly estimated payment requirements, it would appear that tax-exempt organizations are not required to include excess executive compensation in their computation of 2018 estimated taxes. Rather, the tax will be due by the initial due date of the return, for example, May 15, 2019, for a calendar year organization.
Expenditures on athletic facilities are not UBI
Initially, it appeared that the tax reform law required employers that operate an on-premise athletic facility, such as a gym, golf course, pool, or tennis court, to include the expenditures on these benefits as UBI. However, while the law amended IRC Sec. 512(a)(7), it failed to amend IRC Sec. 274. Both sections need to be amended in order to cause the athletic facilities to be UBI. As a result, tax-exempt organizations are not required to report these expenses as UBI. The IRS may try to close this oversight by regulation.
Find out if (or when) your state will conform with federal tax laws
How states will comply with the 2017 Tax Act is still unknown. As with all forms of tax legislation, states conform to changes in the federal IRC in a variety of ways:
- Fixed-date conformity ― A state adopts the IRC as of a specific date; for example, December 31, 2015. Changes to the IRC after that date are not adopted by the state until the state chooses to update the date of conformity. New Hampshire is an example of a state with fixed-date conformity, so none of the provisions of the new law are applicable to New Hampshire.
- Moving conformity ― A state adopts the current IRC as amended. Illinois is an example of a state with moving conformity, so all of the provisions of the new law are applicable to Illinois.
- Decoupling ― This means that a state will specifically address which changes to the IRC will be adopted, accepting some and rejecting others. For example, Virginia does not conform to most of the provisions of the 2017 Tax Act that are effective for tax years beginning on or after 2018.
In order to comply with state tax reporting requirements, a tax-exempt organization must determine whether or not the relevant states have adopted the provisions of the federal law. In general:
Transportation benefits and flexible spending accounts
Since this provision is an income tax, states with moving conformity can be expected to subject the expenditures to tax. For states utilizing fixed-date conformity, the provisions only apply if the applicable date is after December 22, 2017. It is important to note that such states may update the applicable date at any time. As such, organizations must monitor the situation in those states and report the UBI accordingly, along with quarterly estimated payments. Also be aware of decoupling provisions, such as in Virginia, that specifically accept or reject the UBI treatment of transportation benefits.
Exercise caution before deciding to discontinue either direct transportation benefits or transportation FSAs. Certain jurisdictions, such as the District of Columbia, require that employers offer either direct transportation benefits or the ability to make pre-tax contributions for transportation.
“Bucketing” of net operating losses
This requirement applies to states with moving conformity, and will apply to states with fixed-date conformity if the applicable date is after December 22, 2017. Note that such states may update the applicable date at any time, so organizations should monitor the situation in those states and report the UBI accordingly, including quarterly estimated payments. Also be aware of specific decoupling provisions, such as in Virginia, that specifically accept or reject the NOL bucketing requirement.
Conforming states may automatically adopt certain NOL provisions, such as the 80 percent limitation, but many believe that each state must pass specific legislation before changing the carryback and carryforward periods. For federal purposes, NOLs generated in years beginning after December 31, 1017, are limited to 80 percent of taxable income. NOLs generate in years ending after December 31, 2017, may not be carried back but may be carried forward indefinitely.
Since IRC Sec. 4960 imposes an excise tax (not an income tax) on excess executive compensation, we do not anticipate the excess executive compensation to be subject to taxation by states unless a specific statute is passed authorizing such an excise tax.