New Tax Reform Guidance Helps Credit Unions Calculate UBIT
The tax reform bill, commonly referred to as the Tax Cuts and Jobs Act (TCJA), was enacted in December 2017, and ushered in a number of provisions that impact credit unions and other tax-exempt organizations, including:
- Changes to the corporate tax rate
- Separate reporting of unrelated trades or businesses
- New rules related to net operating losses (NOLs)
- Reporting certain fringe benefits (commuter transportation, mass transit passes, parking facilities, etc.) as unrelated business income
- Excise taxes on excess executive compensation, among others
While we are waiting on guidance regarding how to apply many of these provisions, the IRS recently released Notice 2018-67, which provides interim guidance on how the new rules affect the calculation of unrelated business income tax (UBIT) and NOLs.
Separate reporting of trades and businesses for UBIT activities
Prior to the enactment of the tax reform bill, exempt organizations with two or more unrelated activities could net the losses and income from these activities when determining taxable income. Under tax reform, losses from one trade or business can no longer be used to reduce income from another trade or business. For example, if a state-charted credit union had a loss from ATM non-member surcharges and income from the sale of life insurance, total UBIT for the year would be the income from the sale of life insurance because the loss from one activity cannot offset income from another activity. The loss from ATM non-member surcharges would become an NOL carryover. Ultimately, the new rules may increase your institution’s UBIT liability.
Defining separate activities for UBIT
The tax reform bill left many credit unions wondering where to draw the line that separates trade or business when determining taxable income. For example, if a state-chartered credit union sold life insurance and health insurance, is the sale of life insurance separate from the sale of health insurance, or is it part of a single activity of selling insurance?
Notice 2018-67 indicates that until regulations are issued, tax-exempt organizations may rely on a reasonable, good-faith interpretation — taking into account all facts and circumstances — when determining whether the organization has more than one unrelated trade or business. The notice indicates that a reasonable method to determine separate trades or businesses would include using the North American Industry Classification System’s (NAICS) six-digit codes.
If a credit union relies on the six-digit NAICS codes to identify separate trades or businesses, the credit union’s sale of life insurance (NAICS code 524113) and health insurance (524114) would be considered separate trades or businesses. Accordingly, the credit union would not net gains and losses from the two separate trades or businesses.
While the notice indicates that exempt organizations can use NAICS codes to identify separate trades or businesses, it does not require use of NAICS codes. However, the notice suggests that the IRS favors use of these codes because they provide a more objective standard, so it is possible that subsequent guidance will require use of these codes to identify separate trades or businesses.
In this example, it may be possible for the credit union to treat the health insurance and life insurance as a single business, particularly if the health insurance and life insurance are part of a single insurance division, where there is significant overlap in customers, each employee of the division helps customers with both types of insurance, and the organization uses a single insurance division profit and loss (P&L) for financial reporting purposes. However, if health and life insurance are part of separate divisions with different employees servicing unique customers and separate P&L reporting, then the institution would presumably be required to treat the sale of life insurance as a separate business from the sale of health insurance.
Net operating losses
Prior to the enactment of the tax reform bill, exempt organizations could net the losses and gains from unrelated activities. If the result was a net loss, the NOL could be carried back to two years and carried forward for 20 years to offset up to 100 percent of taxable income. Under the tax reform, NOLs generated during tax years beginning after December 31, 2017:
- May not be carried back to prior years
- May be carried forward indefinitely
- May only be applied against the same trade or business that generated the loss
- May only be used to offset 80 percent of taxable income
Before the tax reform bill, NOLs generated in tax years beginning before January 1, 2018, continue to be subject to a 20 year carryover limitation, are not restricted to the same trade or business that generated the loss, and are not subject to the 80 percent of taxable income limitation.
For the first taxable year under tax reform, a tax-exempt organization with a pre-tax-reform NOL carryover can take a NOL deduction against total UBIT calculated under the new rules.
Transition rule allows carryover of NOLs
There is a transition rule included in Notice 2018-67 that permits the carryover of NOLs from pre-tax reform trades or business. For the first taxable year under tax reform, a tax-exempt organization with a pre-tax-reform NOL carryover can take a NOL deduction against total UBIT calculated under the new rules. Since the NOL deduction in this case is from a pre-tax reform NOL carryover, the 80 percent limit would not apply.
For the second taxable year under tax reform, an exempt organization with more than one trade or business may have both pre- and post-tax reform carryovers. The IRS is requesting comments on how exempt organizations should take into account pre- and post-tax reform carryovers. However, the notice suggests that post-tax reform NOLs may be taken into account to offset income from a particular business before pre-tax reform NOLs are applied.
How we can help
The new rules for computing UBIT could substantially increase your institution’s tax liability, so it is important to understand how these new rules will impact your organization. At CLA, our credit union professionals are watching for changes and clarifications to the tax reform bill, and can help you understand how these rules and other tax reform policies impact your institution today and in the future.
As we wait for additional tax reform guidance, the Treasury Department and the IRS are currently requesting comments regarding the bill’s rules for exempt organizations with more than one unrelated trade or business. Submit your comments on or before the December 3, 2018, deadline.