Nonprofit Report - May 2018

Date: May 17, 2018

Significant Changes Regarding Fringe Benefits Under the New Tax Law
By: Megan C. Spratt

The Tax Cuts and Jobs Act was signed into law on December 22, 2017, and went into effect for taxable years starting January 1, 2018.  Among its many changes to the tax code are certain provisions prohibiting tax exempt organizations from deducting expenses for certain fringe benefits provided to their employees.  The change puts tax exempt organizations on a level playing field with for-profit entities with regard to certain employee benefits.  

Effective January 1, 2018, employers in the tax-exempt sector may no longer deduct expenses for direct payments or reimbursements made to employees as certain employer-provided fringe benefits, including qualified transportation benefits, parking facilities, and on-premises athletic facilities.  A qualified transportation fringe benefit encompasses all commuting benefits provided by an employer, including mass transit passes, parking passes, buses, and van pools.  Unrelated Business Income Tax (“UBTI”) must now be paid on the amounts the exempt employer spends on all of these benefits.  Reimbursements to employees who commute to work via bicycle and transportation provided to ensure employee safety are still deductible.    

Many people, including tax specialists, found the treatment of fringe benefits under the new law to be confusing and vague.  In response, the Internal Revenue Service recently released an updated Publication 15-B, “Employer’s Tax Guide to Fringe Benefits,” to provide clarification to employers on how the Service interprets the new tax law’s provisions on fringe benefits.  Unfortunately, the guidance leaves many questions unanswered, especially for nonprofit organizations.  The guidance does directly address the treatment of pre-tax compensation reduction agreements.  Specifically, the guidance confirms (much to employers’ disappointment) that employers must pay UBIT not only on subsidies paid to employees for transportation and parking benefits, but also to employee deferrals through pre-tax compensation reduction agreements (i.e., transportation costs paid for by employees themselves through pre-tax payroll deductions).  The new guidance does not, however, offer clarification regarding on-premise athletic facilities, leaving many to wonder if the requirement on the employer to pay UBIT is triggered if the gym is simply on the employer’s property but is not operated by the employer.  

The new tax law and associated guidance has resulted in a mad rush by tax-exempt organizations to try to recalculate their taxes owed.  As a result, on March 28th, the American Society of Association Executives (“ASAE”) submitted a letter to Treasury Secretary Steven Mnuchin making him aware of the upheaval the changes have caused association employers.  Further, the ASAE letter asks the Treasury to delay implementation of the new tax rules until further guidance is released clarifying how tax exempt employers are to determine the increased tax costs resulting from offering transportation and parking benefits, as well as on-premise athletic facilities.

To summarize, many questions remain regarding these new requirements including (i) whether an exempt employer should pay cash to its employees in lieu of the benefit; (ii) whether athletic and parking facilities included as part of the employer’s lease agreement with its landlord should be taxed and, if so, how; and (iii) what impact state laws requiring certain fringe benefits will have.  Future guidance from the IRS is expected regarding these new requirements.  Until the IRS provides additional guidance, all exempt employers should consider how to best address these changes.  One option is to treat the benefits as taxable compensation to its employees, which could subject both the employee and the employer to tax payments.  Another option is to continue to provide the fringe benefit, and subject the cost of the benefit to UBIT.

UBI Now Calculated for Each Unrelated Trade and Business Activity
By: Mark C. Franco

The Tax Cuts and Jobs Act that became effective on January 1, 2018, brought sweeping changes to the way organizations calculate and report federal taxes.  Organizations exempt from federal tax were not spared from these changes.  One change that could result in significant unrelated business income tax (“UBIT”) and/or operational burdens on exempt organizations is the change in the manner in which exempt organizations must calculate certain taxable income and the resulting UBIT.

Prior to January 1, exempt organizations aggregated their unrelated trade or business income from all sources and applied aggregate net operating losses to calculate the resulting UBIT.  This aggregate approach especially benefited exempt organizations that had multiple unrelated business activities, some of which incurred losses.  

The new tax law requires exempt organizations to calculate and report unrelated business income separately for each unrelated trade or business activity.  No longer will an organization be able to use losses from one activity to off-set gains from another.  This change may result in some exempt organizations paying UBIT for the first time and in other cases paying significantly more UBIT than in the past, notwithstanding the reduction in tax rate that will apply.  In addition, net carryover losses incurred following the law change from one activity only may be applied in the future against the same business activity and are limited to 80% of taxable income from that activity.

Complicating this change is the fact that the Internal Revenue Service (“IRS”) has not defined what constitutes a separate unrelated trade or business activity.  The Second Quarter Update to the IRS 2017-2018 Priority Guidance Plan identifies this topic as an IRS priority for the period ending June 30, 2018.  Exempt organizations should look out for future guidance from the IRS regarding this subject.

Even though there remains uncertainty as to the how unrelated trade or business activities should be separated for purposes of calculating the tax, there are certain things exempt organizations can do now to prepare to report UBIT under the new calculation and reporting requirements.  First, exempt organizations should modify their internal accounting methods immediately to begin tracking and reporting each unrelated trade or business activity and its associated expenses separately.  Exempt organizations should assume that the IRS will require very narrow reporting, because it is always easier to adjust from a narrow to broad reporting regime.

Second, exempt organizations should consider creating a taxable subsidiary for the purposes of conducting all of the organization’s unrelated trade or business activities.  Since taxable entities are not subject to UBIT, the taxable subsidiary would be able to aggregate the gains and losses from trade or business activities in the same manner as an exempt organizations did before the Tax Cuts and Jobs Act.

Third, exempt organizations should review all of their unrelated trade and business activities to determine whether these activities should continue, in light of the new tax regime.  Without the benefit of offsetting unrelated trade or business activity income with losses, it may no longer be viable to continue certain programs.  

Finally, exempt organizations should consult their preferred tax and legal professionals now to understand and prepare for proper calculation and reporting of UBIT.  Waiting until it is time to prepare the required IRS Form 990 may be too late.