Taxing Tax Exempts and Other Oxymorons in the New Tax Law

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The Tax Cuts and Jobs Act, enacted in late December, cuts taxes on corporations and wealthier taxpayers while imposing new taxes on tax-exempt organizations, including charities and houses of worship. Two new provisions stand out as particularly oxymoronic: an income tax on nonprofit expenses and a change to the unrelated business income tax (UBIT) rules to make sure the government reaps the financial benefits of any and all successful nonprofit business operations. We’ll explain those two provisions in more detail, but because of the urgency of the need for nonprofits to take action now, we’ll start with the call to action:

  • Go to the IRS public comment form and insist that Treasury and the IRS delay implementing the two new UBIT subsections until one year after Final Rules are promulgated. (For the line, Form/Instruction/Publication Number, fill in “Form 990-T.” The webform can be finicky; please keep trying.)
  • Please also share with us both the comments you submit and the questions you have about the new taxes so we can work to get clear answers for you and all nonprofits.

In a preliminary letter to Treasury and the IRS and in this more comprehensive letter, we point out the many questions that must be resolved before nonprofits can begin to manage their unexpected tax liabilities. The nonprofit community’s request for delayed implementation is both fair and necessary given the lack of official guidance required for compliance and a reasonable transition period so nonprofits can adjust their record-keeping to reflect these unexpected consequences of the new tax law. The request for delay is made more urgent because government officials have indicated informally that they are interpreting the statutory language far more broadly than Congress wrote, surprising nonprofits and their professional advisors. Plus, with each passing day many nonprofits are facing an increase in late-filing penalties for failure to file the Form 990-T that they are not even familiar with, and/or aren't aware of this tax liability.

Taxing Tax-Exempt Transportation Benefits

Section 512(a)(7) of the tax law inexplicably uses the structure of unrelated business income tax liability to impose a tax on expenses for employee fringe benefits. Elsewhere in the new tax law, Congress declares transportation fringe benefits to be expenses that for-profit businesses cannot deduct from their taxes. This new UBIT tax was imposed on nonprofits ostensibly to even out the playing field because the same tax law took away the ability of for-profit companies to deduct the expenses of providing transportation fringe benefits for their employees. Now, profitable companies can’t deduct these expenses while every nonprofit providing the benefits must pay the new tax. Here are some of the challenges receiving the most attention:

  • Taxing nonprofits for their employees’ self-directed pre-tax benefits: At a conference recently, an IRS official told attendees that the IRS would interpret the new subsection 512(a)(7) as imposing UBIT on not only employer subsidies for transportation fringe benefits, but also on the payments employers make using funds that employees voluntarily asked to be deducted from their paychecks and placed into pre-tax qualified plans to pay for employees’ expenses for commuting to work. In the view of the IRS (which hasn’t conducted formal rulemaking as required under law), nonprofit employers will now have to pay a 21 percent income tax on the amount that nonprofit employees voluntarily reduce their salaries to pay for their own commuting expenses. An employee who asks the nonprofit employer to reduce her salary by $100 per month to pay for a Metro card in Washington, DC is adding an additional $21 per month to the organization’s UBIT liability, raising the obvious question of whether nonprofits will be able to continue to afford to provide their employees with transportation benefits.
  • Taxing mandated commuter benefits: To date, five local governments, including New York City and Washington, DC, mandate that certain employers provide their employees with transit cards, allow pre-tax salary reduction agreements, or provide shuttle services. Because of the new law, each of those expenses would impose new UBIT liability on these mandated expenses, even though the new tax is supposed to apply only to “fringe benefits.” Fringe benefits are by definition voluntary; but the application of this new tax is on items local governments mandate employers provide. For affected employers, this new law is the equivalent of taxing expenses to provide a safe workplace, and other legally required conditions. We believe the IRS should follow its own requirements to hit “pause” and start the necessary rulemaking process to clarify its position.
  • Taxing Churches: Many of the normal rules governing nonprofit operations, disclosures, and operations don’t apply to houses of worship. For example, churches, synagogues, and mosques have until now been exempt from the requirement to file annual informational tax returns (Form 990 or the Form 990-N e-postcard.) Not anymore. With this unusual new provision to tax transportation fringe benefits, the new tax law upends the exemption for houses of worship, requiring them to file annual tax returns (Form 990-T) like all other tax-exempt organizations. Not only do houses of worship now have to file the forms, but they also must pay taxes on employee transportation benefits, such as the parking space provided for the minister, rabbi, or iman.

Taxing Tax-Exempt Unrelated Trades and Businesses

Section 512(a)(6) of the tax law directs nonprofits “with more than 1 unrelated trade or business” to somehow compute their unrelated business income (and related losses) earned “separately with respect to each such trade or business.” The law does not provide any definition about what constitutes a “separate” trade or business, creating uncertainty about how nonprofits are supposed to document, compute, and report unrelated business income and losses. Those in the nonprofit community who are even aware of this new tax burden are overwhelmed with questions:

  • When a nonprofit school earns revenue from other organizations using its facilities during the summer – such as for a basketball camp, an arts program, and a learn-to-swim program – is all the income to the school that summer treated as one “trade or business,” or are the three programs each separate “trades or businesses”?
  • When a charitable nonprofit has advertising income from more than one source, is each source of advertising – such as a digital newsletter, a print magazine, and another publication - a “separate trade or business”?
  • When a charitable nonprofit runs a social enterprise that sells various goods, do all sales emanate from the same “trade or business,” or are sales of clothing a separate “trade or business” distinct from sales of used computer parts?”
  • When a nonprofit that has debt-financed property rents out its facilities for a private event in July and then rents out the same space to a different private entity at several other times during the year, is each instance of renting out space to a different entity a “separate trade or business”?

Until these and similar questions are answered through guidance from the Treasury and the IRS, nonprofits and tax preparers have no way of knowing for sure what is meant by “computed separately,” or know how to allocate incomes/losses. Without relief, they may have to completely rework their books – long after the year began and expenses were incurred – in an after-the-fact attempt to document and report the income/losses to comply with the new way of looking at their nonprofit’s activities.

Ignorance Is Taxable – Delay of the Taxes Is Imperative

The tax meter for nonprofits started running on January 1, 2018, but nonprofits have received no guidance from the IRS on how to deal with these new provisions. The absence of any official guidance puts nonprofits in the untenable position of having to speculate about how to comply with the unknown, putting them unfairly at risk of filing inaccurate reports, making insufficient or inaccurate payments, and suffering other adverse consequences. Lack of guidance is compounded by the fact that for many nonprofits the due date for the first UBIT Form 990-T (for quarterly estimated tax payments) was April 15 or will be May 15, 2018 (for first-time filers).

This lack of guidance taxes not only charitable nonprofits but also the individuals and communities they serve. If in an abundance of caution a nonprofit speculates what may be due and overpays, that means that money that could have gone to mission is instead re-routed to Treasury. If a charitable nonprofit mis-guesses and pays late and/or underpays, then it will be subjected to penalties, taking money away from mission.

To be fair to the nonprofit community – and to avoid manifest injustice, taxpayer confusion, ineffective assistance of tax practitioners (who also are at a loss over how to interpret these new provisions), and risky speculation and filings of potentially unnecessary forms by hundreds of thousands of nonprofits, Treasury and the IRS should delay implementation of these provisions, review comments that nonprofits are just now submitting, and taking those comments into consideration issue a Final Rule. Implementation should not take effect until at least one year after Final Rules have been promulgated to provide the nonprofit community time to transition to the new requirements.

Take Action

We encourage all readers to write to the IRS and join your voices with many others who are also insisting on a delay of these new UBIT liabilities. Your message can be as simple as:

“For legal, policy, and practical reasons, and consistent with established precedent, Treasury and the IRS should immediately delay implementing those two new UBIT subsections until one year after Final Rules are promulgated, to provide both the necessary official guidance for compliance and a reasonable transition period for nonprofits to develop the necessary record-keeping systems.”

While taxing tax-exempts may not make sense to us, what does make sense is for charitable nonprofits, houses of worship, and foundations to speak up in a loud, unified voice on this topic. For more information you can read our preliminary letter, our updated letter, and review the resources we’ve posted on the new tax law.  

This post was updated on July 10, 2018.


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