The Tax Cuts and Jobs Act[1] (“Act”), as it is commonly known, significantly altered our Tax Code, affecting individuals, for-profit organizations, and nonprofit organizations alike. We have previously discussed some of the changes that impact nonprofit organizations on our blog. This article discusses particular changes under the Act specific to unrelated business taxable income (“UBTI”). UBTI is the gross income derived from any trade or business that is not substantially related to the organization’s tax-exempt purposes and that is regularly carried on by the organization. For a refresher on UBTI, see our blog post When Are Nonprofit Revenues Taxable?: UBIT Basics.
The Act provides that UBTI from each unrelated business must now be calculated separately. This requirement has become known as “siloing”. The Act also requires that the value of certain activities now to be treated as UBTI, even when such activity does not generate income (i.e., treating the value of certain employee fringe benefits as UBTI, see Taking a Strange Turn on Employee Transit Benefits and Taking Aim at New Nonprofit Parking Tax: Can This Please Be Undone?!). These changes to UBTI stirred up numerous questions concerning compliance that remain unanswered today, nearly eight months after the Act was signed into law on December 22, 2017. This article provides an overview of the changes to UBTI under the Act and their resulting complexities.
UBTI Before the Act
Prior to the Act, a nonprofit organization could aggregate its income, expenses, and other deductions from all of its unrelated businesses to calculate its UBTI and determine the unrelated business income tax, or UBIT, owed. This helped reduce the tax liability owed by many nonprofit organizations because it allowed them to offset UBTI from one unrelated business with the allowable deductions of another unrelated business, including its net operating losses (“NOLs”). NOLs that exceeded an organization’s total UBTI in a taxable year could generally be treated as an NOL carryback and applied to UBTI in the two preceding tax years or be treated as an NOL carryover and applied to UBTI in the following tax years (up to twenty years).
The UBTI Shift
The Act has caused a major shift in the nonprofit sector with respect to calculating a nonprofit organization’s potential UBIT liability. For tax years beginning after 2017, section 512(a)(6) of the Internal Revenue Code (“Code”) now requires that the UBTI of each unrelated business be calculated separately. In other words, the NOL of one unrelated business may no longer offset UBTI from another unrelated business. How a nonprofit determines what qualifies as a single trade or business and, accordingly, what UBTI and allowable expenses need to be calculated separately is yet to be resolved. What is clear, however, is that this siloing requirement means that some nonprofit organizations will end up paying UBIT for the first time. In fact, the Joint Committee on Taxation estimates that separately computing UBTI for each trade or business activity will increase federal revenue by approximately $3.5 billion over the next ten years.[2]
The Act also makes changes to the treatment of NOL carrybacks and carryovers under section 172 of the Code. Section 172 no longer allows general NOL carrybacks for any taxable year[3] and it caps NOL deductions at 80% of taxable income[4]. The Act does, however, allow NOL carryforwards to be applied to UBTI in proceeding tax years indefinitely.[5]
Finally, the Act requires nonprofit organizations to treat certain activities as UBTI, even though such activities do not themselves constitute a “trade or business”. This “statutory” UBTI includes debt-financed income under sections 512(b)(4) and 514 of the Code, payments from controlled entities under section 512(b)(13), and certain employee fringe benefits under section 512(a)(7). It is not entirely clear how this statutorily created UBTI should be valued and computed, particularly in light of the new siloing requirements. For example, does each statutory category constitute its own silo? And how does a nonprofit organization calculate the value of certain employee fringe benefits, like parking?
The Waiting Game
As mentioned above, there are serious gaps in the Act’s provisions affecting UBTI that have left nonprofit organizations in the dark when it comes to compliance. Most notable is the lack of clear guidance regarding what “one unrelated trade or business” means. Thus, many organizations will be unable to fully plan for these new provisions until the Treasury Department provides guidance on how to categorize activities into separate trades and businesses, whether activities of the same type of trade or business may be aggregated, and whether each type of statutory UBTI will be considered one unrelated trade or business.
Pending legislation, however, may make Treasury guidance unnecessary. On June 7, 2018, the Nonprofits Support Act[6] was introduced in the House of Representatives. This bill would repeal the requirement that UBTI be computed separately for each trade or business activity and repeal the increase of UBTI by certain disallowed fringe benefits. A similar bill, the Protect Charities and Houses of Worship Act[7], was introduced in Senate on August 1, 2018.
[1] Public Law 115-97.
[2] Joint Committee on Taxation, “Estimated Budget Effects of the Conference Agreement for H.R. 1, the ‘Tax Cuts and Jobs Act,’” JCX-67-17 (12/18/17).
[3] 26 U.S.C. § 172(b)(1)(A)(i).
[4] 26 U.S.C. § 172(a)(2).
[5] 26 U.S.C. § 172(b)(1)(A)(ii).
[6] Nonprofits Support Act, H.R. 6037, 115th Cong. (2018).
[7] Protect Charities and Houses of Worship Act, S. 3317, 115th Cong. (2018).
