Tax Reform Impact: Not-for-Profits Not Always Tax-Exempt

If you thought the Tax Cuts and Jobs Act would not impact most tax-exempt organizations, you were wrong.  There are new provisions in place which can cause 501(c)(3), (4), 501(d) organizations, as well as 401(a) Trusts to be subject to unrelated business income tax.

Unrelated Business Taxable Income (UBTI) is normally generated from an activity that is not related to the nonprofit organization’s mission, other than income items excluded by statue (i.e. interest, dividends, royalties and most rentals). The code sections governing Unrelated Business Income (UBI) are 511–514.

The new law, IRC Section 512(A)(7), increases UBI for disallowed fringe benefits.

UBI of an organization will be increased by any amount for which a deduction is not allowable for income tax purposes because of section 274 (Trade or Business code section) and which is paid or incurred by such organization for any:

  • Qualified transportation fringe (as defined in section 132(f));
  • Parking facility used in connection with qualified parking (as defined in section 132(f)(5)(C));
  • On-premises athletic facility (as defined in section 132(j)(4)(B)).

Here are the details:

The benefits referred to by this change include any of the following fringe benefits provided by an employer to an employee:

  • Transportation in a commuter highway vehicle if such transportation is in connection with travel between the employee’s residence and place of employment. A commuter highway vehicle is defined as a vehicle with seating capacity of 6 or more adults, excluding the driver, and 80% of the mileage is for transporting employees for travel between their home and the business.
  • Any transit pass, token, fare card, voucher or similar item to be used by an employee for commuting.
  • Qualified parking – Parking provided to an employee on or near the place of business or on or near the location from which the employee commutes to work by transportation in a commuter highway vehicle or car pool.
  • Any qualified bicycle commuting reimbursement (benefits listed in this section have been suspended for amounts paid after December 31, 2017 and until the 2026 tax year).

Furthermore, if any of the above commuter expenses are paid pre-tax by an employee, they are also subject to UBIT.

State Responses

New York law imposes a state Unrelated Business Tax whenever federal law does. As a result, New York will automatically follow the new federal statute, imposing an additional 9% tax.

Connecticut law imposes tax on unrelated business income from unrelated trade or business under the provisions of the IRS. While the State has not come out with a formal response to Section 512 (A)(7), we should assume they will follow the federal.

Takeaways:

  1. The effective date is January 1, 2018.
  2. Calendar year organizations would pick up the income on their Form 990T due May 15,
  3. Fiscal year organizations would pick up the income from January 1, 2018 through their year-end. The form 990T would be due 4 ½ months after the year-end.
  4. The language above applies to direct and indirect expenditures, i.e.:
  • Amounts paid directly to a 3rd party for parking, transit or commuter transportation
  • Amounts paid to the employee as pre-tax fringe
  • Amounts paid as a part of rent, but charged separately for parking spaces for employee use
  1. As of now, there will be no expenses allowed against the income, outside of the $1,000 specific deduction.
  2. The federal tax rate is a flat 21%, the same as the new “C” corporation rate.
  3. It appears the only way to avoid the tax is to add the benefit to the employee’s compensation, subject to all federal taxes.

If you have any questions relating to the disallowed fringe benefits, or how tax reform is impacting the non-profit community overall, please reach out to a Sax Advisor at (973) 472-6250 or contact Marqus White, Tax Partner within Sax’s Not-For-Profit Practice at [email protected]