The New Calculations for Unrelated Business Income Tax – The Good, the Bad, and the Downright Ugly

The recent Act To Provide the Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018, Pub. L. No. 115-97 (the Act), made four changes to calculating the taxable amount of the unrelated business taxable income (UBTI), effective for tax years beginning after December 31, 2017: 

  • The Act, §13702, added §512(a)(6), which changed the method for calculating unrelated business taxable income (UBTI). Prior to January 1, 2018, Reg. §1.512(a)-1(a) allowed for the aggregation of all unrelated business income, related expenses, and modifications in determining the UBTI. The regulation was in response to complaints about the complexity in applying proposed regulations meant to comply with §512(a)(1). The new §512(a)(7) requires that the UBTI from each separate unrelated trade or business (UT/B) be calculated separately, ostensibly to avoid an exempt organization using the loss from one UT/B to offset the income from another UT/B. This new requirement for separate calculations is the downright ugly part of the UBTI calculations.

  • Now for the good news: Section 13001 of the Act made changes to the §11 rate, applicable to nontrust exempt organizations, but to the advantage of both exempt and nonexempt corporations. While taking away the aggregation ‘loophole,’ the tax rate for corporations, even exempt ones, is governed by §11. Instead of the graduated rates previously in effect (15% of the UBTI less than $50,000; 25% of the UBTI between $50,000 and $75,000; 34% of the UBTI between $75,000 and $10 million; and 35% of the UBTI over $10 million), §11 now applies a flat rate of 21%. That means that UBTI over $90,385 per each trade or business is paying a lower tax bill than they would have before Pub. L. No. 115-97. 

  • The Act, §13703, added §512(a)(7), which made an addition to the amount subject to the unrelated business income tax (UBIT), arguably without changing the definition of UBTI. If an exempt organization pays any qualified transportation fringe (as defined in §132(f)), any parking facility used for qualified parking (as defined in §132(f)(5)(C)), or any on-premises athletic facility (as defined in §132(j)(4)(B)) for the benefit of an employee, and these benefits are not directly related to UBTI, the amount paid is added to the UBTI. While it is understandable that Congress does not want moneys meant for charitable purposes used to provide what is arguably a private benefit to employees, those employees often work for sub-par wages because of his or her belief in the organization’s mission. In addition, this UBTI addition does not apply if the same type of benefits are provided to volunteers.  You can decide if this is bad policy, or just a bad remedy.

  • Finally, §13302 of the Act amended §172, which limits net operating losses (NOLs), including those generated by an exempt organization’s UT/B. The Act limits the NOL deduction to 80% of the UBTI and restricts amounts carried to other years by adjusting the NOL applied to account for the loss limitation arising in tax years beginning after December 31, 2017. The Act generally eliminates carrybacks for UBTI and allows unused NOLs to be carried forward indefinitely. Note also that §13702 of the Act effectively limits NOL applications to the particular UT/B, and the IRS has consistently viewed consistent long-term losses of an endeavor as lacking a profit motive, thus eliminating them from UBTI consideration.

For small exempt organizations with a single UT/B, the major impacts should be (i) the lower corporate tax rate, and that will be an advantage if the UT/B is generating over $90,385 of taxable income per year, and (ii) losing the NOL carryback. Since a single UT/B offers little advantage in intentionally creating an NOL, smaller exempt organizations should actually benefit from the changes. 

For a larger exempt organization with UBTI from more than one trade or business, the impact will vary widely, depending on whether there is a loss in one or more UT/B, what costs are allocated to UT/Bs, and how those costs are allocated among the UT/Bs, among a myriad of other factors. Since the separate calculation requirement for each UBTI will mean additional accounting, this could be a major cost for exempt organizations, particularly during the initial implementation of new accounting systems. However, there is fairly plentiful guidance on how a separate UT/B is defined (versus separate products within a trade or business), how different endeavors may be fragmented into related businesses, UT/B or multiple UT/Bs, and what are reasonable cost allocations. Since UT/B income, expenses, and modifications have previously been accounted for in a single calculation, there is little available data to indicate what results will be for different sets of facts.  As the Act has also been dubbed the ‘CPA Full-Employment Act,’ it will at least fulfill that function, keeping CPAs busy figuring out how to apply the new law.  Whether it raises any revenue, or deters exempt organizations from using loopholes, remains to be seen. 

The IRS will also face similar hurdles in enforcing the new law. Short of resources, the IRS will now have the additional work of examining the allocations, as well as the stated costs, used to determine UBTI.

While the Act apparently addressed a regulation meant to ease both taxpayer and IRS burdens, it also provided unexpected, and perhaps unintended, benefits to exempt organizations in the form of lower UBIT rates. It took Congress some 50 years to address the UBTI calculation issue – so don’t expect Congress to provide immediate relief from the new requirements.

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