As the Tax Cuts and Jobs Act (TCJA) made its way through Congress, many nonprofits understandably focused on the provisions likely to affect charitable giving. But the law also contains some significant requirements affecting unrelated business income (UBI). If you engage in “unrelated business” — and even if you don’t — you could find that your unrelated business income tax (UBIT) liability increases under the new law.
Calculation of your income
The most significant change related to the UBIT comes into play when computing your UBI. Under the TCJA, nonprofits must calculate UBI separately for each unrelated trade or business, with the total UBI equaling the sum of those amounts (not less than zero). The determination for each business is made without regard to the $1,000 deduction generally allowed. That deduction is applied to the aggregate UBI.
Importantly, net operating losses (NOLs) can only be claimed against future income from the specific business that generated the loss. Previously, you could apply NOLs from one business to reduce the taxable income of another, as well as to gains from alternative investments or pass-through entities also considered UBI. The loss of this option could mean that nonprofits with multiple unrelated businesses will have more UBI than in the past. However, NOL carryovers from years prior to 2018 can still be used to offset all UBI.
The TCJA also changes the corporate tax rate to 21% from a range of 15% to 35%. Because nonprofits pay the corporate rate on UBI, your tax liability potentially could fall even if your UBI grows.
Inclusion of certain fringe benefits
UBI also might grow due to a change in the treatment of certain fringe benefits. Until now, you could provide your employees with qualified transportation benefits (including commuter transportation and transit passes), qualified parking fringe benefits and on-site athletic facilities free of income tax for both you and your employees. While these benefits are still not taxable to employees, the TCJA treats your cost to provide them as UBI unless those costs are directly connected with an unrelated business (for example, parking benefits provided to employees of the unrelated business).
As a result, nonprofits may owe UBIT even without operating any unrelated businesses. This change, and several others under the TCJA, is intended to treat nonprofits more like for-profit businesses.
Your nonprofit may be able to minimize the effects of the changed rules for UBI. For example, if you operate multiple unrelated businesses, consider housing them in a single taxable corporate subsidiary. This will allow you to offset the businesses’ income and losses against each other. Bear in mind, though, that such restructuring can have additional tax and legal implications.
You also might want to conduct an audit of all of your unrelated businesses to ensure you have been accurately capturing all expenses that are allowable to each business. Otherwise, you could be inflating UBIT! Every nonprofit with UBI will need effective methods for tracking and allocating income and expenses, including compensation, investment management fees and overhead.
As for the inclusion of certain fringe benefits, think about replacing them with alternative forms of compensation. It might make sense to simply increase employees’ income commensurately so triggering UBIT is not an issue. Who knows? Your employees may well prefer cash. Yes, it will be taxable to them, but the TCJA cut individual tax rates, too, and cash gives employees more discretion.
Navigating the ins and outs
The new UBI rules, like many of the TCJA’s changes, will take some time to shake out. Clarifying regulations are likely to follow over the next few months or years. Your CPA can help you stay on top of developments and chart the way ahead.