The 2017 Tax Cuts and Jobs Act that was enacted late in 2017 made several changes to the tax laws affecting tax‑exempt organizations, including a new Unrelated Business Taxable Income (“UBTI”) tax rate at a flat 21% for any UBTI over the $1,000 standard deduction. Caution: These changes will make some nonprofit organizations pay federal tax that have never been taxpayers in the past. Contact your tax professional at Peterson Sullivan if you have any questions as to how the items discussed below affect your organization.
UBTI is increased by certain disallowed fringe benefits
Under the new law, tax‑exempt organizations that provide certain fringe benefits to their employees will generate UBTI on the value of those benefits.
The fringe benefits involved are:
- Payment of qualified transportation fringe benefits
- Costs associated with any parking facility used to provide employee parking
- Costs associated with any on‑premises athletic facility
A “qualified transportation fringe benefit” includes anything provided by the employer to an employee for commuter transportation including buses, van pools, transit passes, parking passes or reimbursements, and bicycle commuting reimbursements.
Under the old rules, not‑for‑profit employers were able to provide these benefits to employees as tax‑free items. Starting in 2018, if an organization wants to continue providing these benefits tax‑free to employees, the organization is required to include the value of the benefits in UBTI and pay tax on them.
Example 1: A tax‑exempt organization provides bus passes and parking benefits to its employees during 2018. The value of these benefits (measured by their cost) is $25,000. Assuming no other UBTI items, the organization would be liable for $5,040 of tax if it provides the benefits tax‑free to the employees. Here’s how that’s calculated:
|Value of benefits||$ 25,000|
|Less: UBTI standard deduction||1,000|
|Taxable UBTI||$ 24,000|
|Tax due||$ 5,040|
The total outlay for providing these benefits is $30,040 ($25,000 plus $5,040). As in the past, under this scenario the employees would not incur taxable income and would not be subject to any additional personal income tax.
If the organization wants to avoid this new tax, it can provide the benefits as taxable items to the employees (and include the cost of the benefits in the employees’ Forms W‑2), or it can stop providing the benefits (and consider adjusting the employees’ wages accordingly). This is a business decision that each affected organization needs to make.
If the organization chooses to treat these benefits as taxable wages, the organization is not required to pay tax on the benefits. However, the organization will be subject to higher FICA and Medicare payroll taxes and the employees will have increased personal income taxes.
Example 2: A tax‑exempt organization provides bus passes and parking benefits to its employees during 2018, but treats the benefits as taxable wages. The value of these benefits is $25,000. Assume that the employees are in the 25% personal tax bracket.
|Value of benefits||$ 25,000|
|Tax paid by employees||6,250|
|FICA/Medicare taxes – Employer (7.65%)||$ 1,913|
|FICA/Medicare taxes – Employees (7.65%)||$ 1,912|
|Total taxes to organization||$ 1,913 (additional FICA/Medicare taxes)|
|Total taxes to employees||$ 8,162 ($6,250 plus $1,912)|
The total outlay by the organization and its employees for these benefits would be $35,075 ($25,000 plus $1,913 plus $8,162). This option increases the total cost of the benefits by $5,035 ($35,075 minus $30,040) over just including them as UBTI.
The stated purpose of this rule is to put tax‑exempt organizations on par with taxable organizations. Under the new tax law, for‑profit entities are no longer allowed to deduct the fringe benefits listed above that are provided tax‑free to their employees.
Other provisions to be aware of in case they apply to your organization
There is a new 1.4% excise tax on net investment income of certain private colleges and universities.
There is a new 21% excise tax on annual compensation paid in excess of $1 million to the organization’s top five highest compensated employees.
The 80% charitable contribution deduction for amounts paid to colleges in exchange for preferential seating at college athletic events (or in exchange for the ability to purchase tickets to those events) has been eliminated.
Organizations with multiple unrelated business activities are no longer allowed to offset UBTI from activities that generate profits with losses from other unprofitable activities. Each unrelated activity is now viewed separately for unrelated business income tax purposes. Any losses incurred must be carried forward to future years and can only be used to offset profits generated in the same unrelated activity.
These provisions are effective for tax years beginning after December 31, 2017.
Estimated tax payments
If you believe your organization will be subject to tax under these new rules, please contact us so we can help you determine whether advance estimated tax payments should be made to avoid or minimize underpayment penalties. Organizations that have never filed Form 990‑T before, or that filed but had zero tax due in the previous year, are not protected under the “last‑year’s tax safe harbor” and may need to make estimated tax payments. For 2018 calendar year entities, the due dates for estimated tax payments are April 17, June 15, September 17, and December 17, 2018.