Introduction
Organizations exempt from federal taxation must still pay taxes on unrelated business income (UBI) (i.e. income gained from a regularly conducted trade or business that is unrelated to the organizations exempt purpose). In 2017, Congress passed the Tax Cuts and Jobs Act (“TCJA”) which made major revisions to how unrelated business taxable income (UBTI) was determined by tax exempt organizations which are required to report such income on Form 990-T. Interim guidance on how organizations were to apply these revisions was issued in Notice 2018-67 by the IRS. Additionally, on April 23, 2020, the IRS issued proposed regulations regarding how organizations should apply the rules of the TCJA.
Separating Unrelated Business Activity
- Before 2018, organizations engaged in multiple unrelated businesses could offset gains from one unrelated business with losses from another.
- Effective January 1, 2018, organizations must report gains and losses from unrelated businesses separately. Net UBI will therefore be the aggregate amount of gains from all unrelated business that an organization engages in.
- The TCJA does not specify how to separate businesses, but the IRS has given interim guidance in Notice 2018-67. The Notice allows organization to use a “reasonable, good-faith interpretation” of the current rules when making a determination.
- The notice does not specifically define what a “reasonable, good-faith interpretation” is, but it does state that the North American Industry Classification (NAIC) codes will qualify as a reasonable method to make a determination of what constitutes separate activities. The North American Industry Classification codes are already used on the Form 990-T and the Form 990.
- On April 23, 2020, the IRS issued proposed regulations that would establish the use of only the first two digits of the NAIC codes, which describe the sector of economic activity as the method to determine how to separate unrelated business activity.
- The code cannot be changed once reported unless shown that the selection was based on unintentional error or if it can be shown that another code more accurately reflects the activity.
Changes to Net Operating Losses
- Before 2018, net operating losses (NOL) created in one year could be carried forward by a tax exempt organization to offset any gains from an organization’s unrelated business activity. An NOL could be carried forward for a maximum of 20 years or it could be carried back up to two years.
- Effective January 1, 2018, an NOL can only be carried forward to apply to the business activity in which it was originally created due to the requirement that organizations now must report their unrelated business gains and losses separately.
- NOL’s created before January 1, 2018, can still be applied to the entirety of an organization’s UBI and does not have to apply to a separate business activity.
- In proposed regulations issued by the IRS on April 23, 2020, exempt organizations may order the use of NOLs in order to make full use of pre-2018 NOLs in a given year by deducting pre-2018 NOLs from the total unrelated business taxable income before deducting any post-2017 NOLs.
- The TCJA also eliminated the ability to carry back NOLs and eliminated the 20 year maximum for carrying NOLs forward.
- Finally, the TCJA mandates that NOLs can only be used to offset 80% of net UBI.
Fringe Benefits
- Effective January 1, 2018, tax exempt organizations must include in UBI amounts paid for employee parking, transportation, parking passes, transportation passes, and similar fringe benefits.
- UBI can be avoided by having the employee pay the tax.
Conclusion
The TCJA, Notice 2018-67, and the proposed regulations go into far more depth about the above topics and even address other topics regarding how to report certain partnership and investment income. If you have questions about how to specifically report anything mentioned in this post, we encourage you to discuss your situation with your accountant or tax professional.
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The above article is for general information purposes only and should not be relied upon as specific legal advice. This article, or contacting Apex, does not in any way form an attorney-client relationship. If you have any questions or would like to learn more, please contact Jacob Ferrari at jacob@apexlg.com.