Recent Tax Law Developments
Q: Last year, I noted a number of articles regarding changes in the tax laws relative to exempt organizations, like our association. What do I need to know?
A: These shifts signal both new learning needs and updated demands for delivery. They also necessitate a new awareness that the players serving the continuing education market are more diverse and more sophisticated than ever before.
CEOs, here’s what CLOs want you to know.
Over the past year, the federal government adopted several changes relating to the taxation of exempt organizations. Most stem from the December 2017 adoption of the Tax Cuts and Jobs Act (TCJA), which includes new unrelated business income tax (UBIT) rules for exempt organizations. The government has issued interim guidance, but has not yet published proposed regulations, with respect to those new rules. In addition, the IRS has modified long-standing rules regarding reapplication for exempt status. The following is a brief explanation of the most talked about changes, each of which has the potential to affect a broad range of tax-exempt associations.
New Silo Rules under UBIT. The TCJA called for the adoption of new Section 512(a)(6) of the Internal Revenue Code (IRC), which requires exempt organizations with more than one unrelated trade or business to calculate their unrelated business taxable income (UBTI) separately for each. In the past, exempt organizations could offset profits realized from one unrelated business activity against losses incurred from another. The new rules require “siloing” of profits and losses by activity. In August 2018, the IRS released Notice 2018-67 to provide guidance regarding the new rule. The Notice acknowledges that “Congress did not provide criteria for determining whether an exempt organization has more than one unrelated trade or business or how to identify separate unrelated trades or businesses for purposes of calculating UBTI.” Thus, it permits reliance on a reasonable, good faith interpretation of the IRC, including use of the North American Industry Classification System (NAISS) codes for classifying separate trade or business activities. Nonetheless, organizations with unrelated business income (UBI) from activities such as advertising, insurance programs, and partnership investments will need additional guidance in meeting their compliance obligations.
Excise Tax on Executive Compensation. The TCJA also requires employers to pay a 21% excise tax on the sum of compensation in excess of $1 million and any excess parachute payment to a covered employee for taxable years beginning after December 31, 2017. Notably, the IRS has stated that “compensation” subject to the new tax includes not only base salary, but also the cash value of retirement benefits, certain retention payments, and benefits that have vested but have not been received. As a result, the new tax is likely to affect a range of exempt organizations. On December 31, 2018, the IRS issued Notice 2019-09 to provide interim guidance on the excise tax, but questions remain with respect to such matters as the potential exemption (“grandfathering”) of employment agreements that were in place prior to the change in the law; the treatment of compensation vested but not paid prior to the TCJA’s effective date; and the concept of “substantial risk of forfeiture.” As with the new silo rules, the IRS will allow exempt organizations to rely on a good faith reasonable interpretation of the statute, including guidance provided by the Notice, in determining whether, and how much, excise tax is due.
“Parking Tax” on Exempt Employers. The TJCA also called for the adoption of new Section 512(a)(7) of the IRC, which taxes exempt employers that provide parking or on-premises athletic facility benefits to their employees. Specifically, beginning January 1, 2018, the expenditures associated with providing those benefits will represent taxable UBI. As with the siloing and executive compensation excise tax rules, the IRS issued Notices to provide preliminary guidance. Among other things, the Notices confirm that the cost of providing the benefits, not their value, represents the amount of UBTI to the exempt organization. Where the benefit consists of a specific third-party payment per employee, or a pretax reduction in employee salary, those amounts will be subject to tax. Additional rules apply to employers that own or lease parking lots with parking spaces for employee purposes. Significantly, exempt organization employers will have until March 31, 2019, to reduce or eliminate the number of spots they reserve for employees, and thereby reduce their tax liability retroactive to January 1, 2018.
Reversal of IRS Policy Triggering Reapplication for Exempt Status. Last year, the IRS also issued Revenue Procedure 2018-15, which reversed the Service’s long-standing policy requiring exempt organizations to re-apply for tax-exempt status if they change their state of incorporation or otherwise restructure through incorporation or merger. The government explained that “requiring a new exemption application after a corporate restructuring often is unnecessary and duplicative, because the IRS requires exempt organizations to report significant organizational changes on their annual Forms 990.” In making the change, the IRS reasoned that it is less burdensome to resolve issues when the restructuring organization and the surviving organization can continue to use the same Employer Identification Number (EIN) on their annual Form 990 Information Returns. Thus, the IRS concluded that a surviving organization need not file a new exemption application if it is a domestic business entity classified as a corporation, provided the organization or organizations involved in the restructuring are in good standing. In addition, the articles of incorporation of organizations exempt under Section 501(c)(3) must continue to meet the organizational test regarding dedication of assets for exempt purposes. The new Revenue Procedure does not apply to limited liability companies, foreign business entities, or partnerships; those organizations are still required to file a new exemption application following any restructuring.
Last year’s tax law changes affect organizations differently. Regardless of the immediate consequences, however, it is important for exempt organizations to familiarize themselves with the new rules so that, going forward, they can take the new tax rules into account in making informed policy and financial decisions.
The answers provided here should not be construed as legal advice or a legal opinion. Consult a lawyer concerning your specific situation or legal questions.