Prevent unwelcome surprises when filing 2018 returns with must-know details on the changes impacting the Unrelated Business Income Tax ("UBIT") Under the Tax Cuts and Jobs Act ("TCJA").
Read on to learn how unrelated business activities will be taxed to stay compliant and maximize your nonprofit's tax position.
What are the four major changes effective January 2018?
- The rate and calculation of the tax;
- Taxation of each business activity separately;
- Inclusion of certain employer-provided fringe benefits; and
- Excise tax on executive compensation.
How is the new tax rate applied and calculated?
Prior to the TCJA, UBIT was based on a graduated rate structure that started at 15% of taxable income and increased to a maximum rate of 35%. The new corporate flat tax rate of 21% will now be used to compute UBIT. If your organization has a fiscal year ending after January 1, 2018, you will be required to use blended rates. These blended rates are based on the number of days prior to January 1, 2018 at the old rates and the number of days since January 1, 2018 until the end of the fiscal year at the new rate.
What does separate taxation mean for your organization?
In the past, organizations could net gains and losses among multiple unrelated business activities and pay UBIT on the net amount. Now, if your organization has more than one unrelated business activity, it will no longer be allowed to offset gains from one activity with losses from other separate activities.
Net operating losses generated before January 1, 2018 may offset all unrelated business income generated after the effective date. Pre-2018 losses may be carried forward for 20 years and carried back two years. Net operating losses generated after December 31, 2017 may only offset future income from that same activity, subject to an 80% limitation. There is no time limitation on carryforwards of post-2017 losses, but they cannot be carried back.
It’s important to note that TCJA does not define what comprises a separate unrelated business activity. As we await further guidance, you should consider the following questions:
- Are debt-financed rental activities separate for each property? Should rental activities be aggregated?
- What about partnership activities? Some partnerships have multiple activities (i.e., ordinary income (loss), rental activities, portfolio activities, etc.). Will partnerships be required to report activities differently than what is currently required?
- How are alternative investments treated?
How does UBIT impact employer-provided fringe benefits?
The value of certain fringe benefits provided by exempt organization employers are now subject to UBIT. These benefits include transportation benefits and certain onsite gyms and other athletic facilities.
The qualified transportation fringe benefits that are excluded from employee income under Code Sec. 132(f) include:
- Transportation in a commuter highway vehicle for travel to and from work;
- Transit passes and vouchers;
- Qualified parking; and
- Qualified bicycle-commuting reimbursement.
Before the TCJA, payment of the above fringes were deductible to taxable employers under the ordinary and necessary business deduction rules. Under the TCJA, no deduction is allowed for qualified transportation fringe benefits provided to employees. Exempt organizations are now required to increase UBIT by the amount of these benefits for which a deduction would be denied if the employer were taxable.
Onsite gyms and other athletic facilities include employer-operated facilities located on the business premises. These facilities must be used exclusively by employees and their families. However, if your organization has such a facility and it’s only being used by highly paid employees you may want to consider restructuring it to avoid UBIT. Open the facility for others to use, for example students, patients or volunteers. The value of use will be tax-free to employees, and costs to operate the facility will not be subject to UBIT.
As an exempt organization, you have several options for dealing with these fringe benefits. You can maintain the pre-TCJA benefits and pay UBIT at the new rate of 21% on the fair market value of the benefits provided. Alternatively, UBIT can be avoided if you:
- Eliminate such benefits, or
- Maintain such benefits and include the fair market value of the benefits in an employee’s taxable wages. If this option is employed, consideration should be given to the tax consequences of payroll taxes to both the employer and employee as well as personal income taxes to the employee.
How does UBIT impact executive compensation?
The TCJA imposes a new 21% excise tax on compensation in excess of $1,000,000, applicable to the five highest paid employees for the current year and any employee subject to the excise tax in a prior year. Compensation includes remuneration and deferred compensation (employer and employee contributions to retirement plans) and compensation paid by related organizations. Note that compensation to licensed medical professionals, including veterinarians, for performance of medical or veterinary services are excluded.
How you can plan ahead.
Review the below checklist as part of your tax planning framework as we await further guidance:
- Evaluate internal accounting and related cost allocations for each unrelated business activity.
- Review fringe benefits provided and assess the tax impact to both the organization and to the affected employees. It’s important to consider the effect this will have on payroll calculations and withholdings.
- Project UBIT to determine if estimated tax payments are now required.
- Review compensation packages to highly compensated executives and evaluate timing of compensation in light of the new excise tax.
For more information on changes caused by the Tax Cuts and Jobs Act, visit our exclusive Tax Reform Resource Center and speak directly to your Friedman LLP nonprofit professional advisors for specific questions on changes caused by UBIT.