As the new tax bill worked its way through Congress last fall, nonprofits across the country raised their voices high to share concerns about its disincentives for charitable donations — as well as the proposed repeal of the Johnson Amendment. Little was heard, though, about changes to the rules for unrelated business income tax (UBIT). And it turns out that the final law, the Tax Cuts and Jobs Act (TCJA), includes several provisions that could boost your organization’s liability for the tax, regardless of whether you operate an unrelated business.
Why your UBI could grow
The most important change relates to how unrelated business income (UBI) is computed. The new law requires nonprofits to calculate UBI separately for each unrelated business, with the $1,000 deduction typically allowed applied to the aggregate UBI for all businesses.
Your UBI also could increase because net operating losses (NOLs) can only be claimed against future income from the specific business that generated the loss. Under previous law, you could use NOLs from one business to offset the income of another or to offset gains from alternative investments or pass-through entities, also considered UBI.
UBI also might grow due to a change in how certain fringe benefits are treated under the TCJA. In previous years, you could provide your employees 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.
The TCJA, however, treats the payments for such benefits as UBI unless they’re directly connected to an unrelated business (for example, parking benefits provided employees of an unrelated business). Congress made the change to create parity between nonprofits and taxable organizations. For-profit businesses lost a previous tax exemption for certain fringe benefits under the TCJA. The end result, though, is that nonprofits could owe UBIT even without operating any unrelated businesses.
It’s not all bad news. The new law also changes the corporate tax rate that nonprofits pay on UBI to 21% from a range of 15% to 35%. So your UBIT liability might fall despite your higher UBI.
What you can do
Fortunately, you have some options to avoid the worst effects of these changes. For example, you could conduct an audit of your unrelated businesses. You might find that you’ve been over-reporting your UBI because you haven’t captured all the related business expenses.
Another option for nonprofits with multiple unrelated businesses is forming a single taxable corporate subsidiary to hold all of them, which would permit you to again offset their income and losses. Any restructuring will likely carry some implications, whether tax-related, financial or operational.
The treatment of certain fringe benefits can pose a problem for organizations that don’t want to revoke benefits, especially in today’s competitive job market. Perhaps you could replace benefits with alternative forms of compensation. Many employees may prefer the cash up front, even though it would be taxable to them.
Changes to the UBIT rules haven’t received as much coverage as some of the other TCJA provisions. But that doesn’t mean they won’t have negative repercussions for your organization. Consult with your CPA to determine steps you can take to minimize the impact of the TCJA on your bottom line.
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.