The newly enacted Tax Cuts and Jobs Act (H.R. 1) will affect every taxpayer. While the general public is mainly focused on the changes affecting for-profit taxpayers (corporations, partnerships, etc.) and individual taxpayers, the significant effects on tax-exempt organizations have yet to be discussed in great detail.
One of the most important impacts of the tax reform legislation involves unrelated business income, which will certainly affect a tax-exempt organization’s tax filings and potentially require additional disclosure in its financial statements.
Here are the key points in question for unrelated business income:
Tax Rate Changes
Under the new legislation, the tax rate on unrelated business income has been dramatically altered. A tax-exempt organization structured as a corporation will see the 2017 tiered tax tables (with a low tax rate of 15 percent and a high tax rate of 39 percent) shift to a flat 21 percent tax rate for tax years beginning after December 31, 2017. This change matches the newly-enacted corporate tax rates.
A tax-exempt organization structured as a trust will see a reduction in the tiered tax rates—from 39.6 percent to 37 percent at the highest rate and from 15 percent to 10 percent at the lowest rate. This goes into effect for tax years beginning after December 31, 2017.
Alternative Minimum Tax (AMT)
The new tax legislation repeals AMT and allows prior year AMT credits to offset regular tax liabilities for any other tax year. AMT credit carryforwards, however, are limited to 50 percent of any available credits for tax years 2018 through 2021. Any remaining AMT credits are fully useable beginning in tax year 2021.
Net Operating Losses
Under Internal Revenue Code Section 512(a)(6), tax-exempt organizations that generate unrelated business income will no longer be allowed to offset the losses of one trade and business with the activity of another trade and business. The losses from one trade or business may be carried forward to offset the income from the same trade or business in a future taxable period; however, the offset will be limited to 80 percent of that future tax year’s taxable income.
Net operating losses generated prior to 2018 do not appear to be limited in use. Future guidance is expected to confirm the usefulness of the pre-1998 net operating losses as well as how the Internal Revenue Service will define a “trade or business.”
Internal Revenue Code Section 512(a)(7) states that a tax-exempt organization shall increase unrelated taxable income “by any amount for which a deduction is not allowable under this chapter by reason of section 274 and which is paid or incurred by such organization for any qualified transportation fringe (as defined in section 132(f)), any parking facility used in connection with qualified parking (as defined in section 132(f)(5)(C)), or any on-premises athletic facility (as defined in section 132(j)(4)(B)).”
The fringe benefit amounts to include do not apply to any amounts paid or incurred with another regularly carried on unrelated trade or business. However, if the organization includes the value of the fringe benefits within the employee’s W-2, then the organization is not subject to unrelated business income. The organization may eliminate or limit its exposure to unrelated business income tax by doing this. However, both the employee and the organization would see an increase in payroll taxes.
Let’s review a quick example to understand the potential impact of this change:
A tax-exempt organization has 100 employees who each receive a $100 per month pretax fringe benefit, previously non-taxable to the employee. The organization prefers not to add this benefit to the employees’ W-2s. As a result, the organization would now have a Form 990-T filing requirement to report the $120,000 (100 Employees x $100 Benefit per Employee x 12 months) of unrelated business income. The taxes associated with this unrelated business income would be $25,200 ($120,000 x 21 percent tax rate), in addition to the cost of filing and planning for this new taxable income source.
We discussed these topics as part of our February 13 webinar Tax Cuts and Jobs Act: What Non-For-Profit Organizations Need to Know. You can view a rebroadcast of this webinar on our website here.
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