Tax Reform Update for Tax Exempt Organizations, and it isn't Good News
Earlier this year, guidance was provided by Marcum regarding the impact of the new tax law on tax exempt organizations. We advised everyone to stay tuned for further guidance as much of how the law would be specifically interpreted and applied was uncertain. This was especially true for the new rules regarding certain fringe benefits creating unrelated business income (UBI) and UBI “silos”. Since then, more information has become available to us from the IRS and more recently through an IRS publication and informal comments by Treasury officials at industry conferences that have shed additional light on these topics.
All Qualified Transportation Benefits Are Taxable…regardless of who is paying
As you are likely already aware, Section 512(a)(7) of the new law requires tax exempt organizations to report as UBI amounts paid or incurred for qualified transportation benefits, which would include parking, metro, or other similar commuting benefits. This rule was included in the tax law to maintain parity with for-profit organizations who were now no longer able to deduct such expenses by way of Section 274.
Immediately, those in the sector began wondering whether this rule includes both employer subsidies paid to employees as well as employee deferrals through a pre-tax cafeteria plan. Many in the industry thought the law couldn’t possibly apply to employee deferrals of wages reasoning that these were the employees own wages and that there was no benefit deduction to be disallowed.
The IRS recently updated Publication 15-B, “Employer’s Tax Guide to Fringe Benefits,” which clarified the interpretation of the regulations and confirmed the non-deductibility of qualified transportation benefits, whether provided directly by the company, through a bona fide reimbursement arrangement, or through a compensation reduction agreement. Pre-tax deferrals through cafeteria plans are a type of compensation reduction agreement. Once the employee decides to convert their compensation into a payment of these benefits, the amount paid for these benefits through the employee’s pay is not deductible to a for-profit corporation. Under the new tax act, this would require tax exempt organizations to pick up these amounts as taxable income and pay tax at the applicable corporate tax rates.
In summary, any situation where an employee receives a nontaxable qualified transportation benefit, whether paid by themselves through a payroll deduction in a pre-tax manner or provided by an employer who treats it as a nontaxable benefit to the employee, will create UBI to a tax exempt employer which will be taxed at the regular corporate tax rates, which starting in 2018 will be a flat 21%.
Furthermore, regardless of what your tax year end is, these rules apply to amounts incurred or paid since January 1, 2018. Therefore, fiscal year end organizations (i.e. 3/31/18 and 6/30/18 year ends) will need to plan on including this as UBI for the current year and will likely be required to file a 2017 Form 990-T. If the tax payments are significant, estimated quarterly tax deposits should be considered. We can help with both the quarterly deposits and the filing of the Form 990-T.
We also recommend tax exempt organizations work with Marcum to examine their specific tax fact pattern to determine if any changes could be made to the benefit offering in order to mitigate negative tax consequences. In many cases, employers may choose to adapt their plan offering to address the added tax costs discussed here. It should be noted that in some jurisdictions it is mandatory for certain sized companies to provide access to these tax-free benefits to their employees which limits the ability to eliminate such a benefit if desired. For example, the District of Columbia requires any employer with more than 20 employees to provide either 1) an employee paid pre-tax benefit, 2) an employer paid direct benefit or 3) employer provided transportation.
Costs Related to Athletic Facilities Are Generally Non-Taxable…for now
Section 512(a)(7) also includes on-premises athletic facility benefit costs being reported as
UBI. However, since the law was passed, it has become clear by practitioners that this will likely not be required to be reported as UBI by tax-exempt organizations due to the fact the proposed changes to Section 274 were not included as part of the final bill and the current language does not list on-premises athletic facilities as a disqualified expense.
Guidance Related to UBI Silos is Coming…but can we wait?
Since passage in late December, there has been precious little guidance on how the UBI silos rule is expected to be implemented. Section 512(a)(6) states that tax exempt organizations with multiple lines of UBI should be computing their tax separately with respect to each trade or business activity. This means that a loss on one trade or business activity cannot be offset against a gain from another activity. The key question here is what defines a trade or business activity?
While guidance is not yet available on that, we do understand Treasury is currently drafting regulations that should provide us guidance to assist tax exempt organizations with multiple lines of UBI to comply with the new rules. Note that like most provisions in the law, the “Silos Rule” only applies for organizations with tax years beginning after 12/31/2017. Fiscal year organizations have time left to plan for the silos rule coming into effect once their 2018 fiscal year begins.
Estimated Payments…to pay or not to pay?
Given that the new tax rules are in effect for years beginning after December 31, 2017, estimated payments will need to be updated reflecting the law changes. For calendar year end organizations, April 15th is the first quarter due date. Many in the industry are writing letters to Treasury asking for administrative relief in the form of waived penalties and even delayed implementation of elements of the tax law that require more guidance and time to fully understand. If you would like your thoughts known to the Treasury, we would encourage writing a letter communicating your concerns.
We will continue to keep you apprised of new understanding as it becomes available to us in the coming weeks and months.