Many not-for-profit organizations are concerned about the provisions of the Tax Cuts and Jobs Act (TCJA) that are affecting charitable giving. But the law also contains some important requirements involving unrelated business income tax (UBIT). If you engage in "unrelated business" — and even if you don't — you could find that your UBIT liability increases under the law.
The most significant change related to the UBIT comes into play when you're computing your unrelated business income. Under the TCJA, not-for-profit organizations must calculate unrelated business income separately for each unrelated trade or business, with the total equaling the sum of those amounts. (None may be less than zero.) The determination for each business is made without regard to the $1,000 deduction generally allowed. That deduction is applied to the aggregate unrelated business income.
Importantly, net operating losses (NOLs) can only be claimed against future income from the specific business that generated the loss. (You can still use NOL carryovers from years prior to 2018 to offset all unrelated business income.) Previously, you could apply NOLs from one business to reduce the taxable income of another, as well as to gains from alternative investments or pass-through entities also considered unrelated business income. The loss of this option could mean that nonprofits with multiple unrelated businesses will have more unrelated business income than in the past.
The TCJA also changes the corporate tax rate to 21% from a range of 15% to 35%. Because not-for-profit organizations pay the corporate rate on unrelated business income, your tax liability potentially could fall even if your unrelated business income grows.
Unrelated business income also might increase due to a change in the treatment of certain fringe benefits. Until now, you could provide your employees with qualified transportation benefits (including commuter transportation and transit passes), qualified parking fringe benefits and on-site athletic facilities free of income tax for both you and employees. While these benefits are still not taxable to employees, the TCJA treats your cost to provide them as unrelated business income unless they're directly connected with an unrelated business (for example, parking benefits provided employees of the unrelated business).
As a result, not-for-profits may owe UBIT even without operating any unrelated businesses. This change, and several others under the TCJA, is intended to treat not-for-profit organizations more like for-profit businesses.
Your not-for-profit may be able to minimize the effects of the changed rules for unrelated business income. For example, if you operate multiple unrelated businesses, consider housing them in a single taxable corporate subsidiary. This will allow you to offset the businesses' income and losses against each other. Bear in mind, though, that such restructuring can have additional tax and legal implications.
You also might want to conduct an audit of all of your unrelated businesses to ensure you've been accurately capturing all expenses that are allocable to each business. Otherwise, you could be inflating UBIT. Every nonprofit with unrelated business income should have effective methods for tracking and allocating income and expenses, including compensation, investment management fees and overhead.
As for the inclusion of certain fringe benefits, think about replacing them with alternative forms of compensation. It might make sense to simply increase employees' income commensurately so you don't have to worry about triggering UBIT. Who knows? Your employees may well prefer cash. Yes, it will be taxable to them, but the TCJA cut individual tax rates, too, and cash gives employees more discretion.
The unrelated business income rules, like many of the TCJA's changes, will take some time to understand. Your tax advisor can help you stay on top of developments and chart the way ahead.
In general, exempt organizations are subject to a tax (at a rate depending on the type of organization) on unrelated business taxable income. Form 990-T is used to report and pay UBIT. The imposition of UBIT doesn't affect an organization's tax exempt status.
What is unrelated business? It involves a trade or business regularly carried on (including seasonally) by an organization, which isn't substantially related to the exercise or performance of its exempt purpose or function.
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