The 2017 Tax Cut and Jobs Act (TCJA) created a number of significant roadblocks for non-profit organizations. The roadblocks came in two forms—transportation benefits and other. The Act itself created a great deal of uncertainty insofar as part of the effective dates were as of January 1, 2018, while others were for years beginning January 1, 2018. The treatment of transportation benefits is a lack of coordination between Treasury and the IRS. The ambiguity associated with this area will be covered in the transportation part of this article. This article will discuss (1) excise tax on excess executive compensation; (2) excise tax on investment income of private colleges; and (3) unrelated business taxable income calculated separately for each trade or business.

Executive Compensation

Prior to the TCJA, what was considered reasonable or unreasonable for exempt organization executives was very subjective. While, to a certain degree, that is still true, the Act puts limitations on “acceptable” compensation; whereby the Act imposed a 21% tax on compensation over $1 million paid to a select group of “covered employees.” As a second category, the act also imposes the tax on “excess parachute payments” payed to a covered employee. Application is based on understanding several definitions. Covered employees are defined as one of the five highest compensated current or former employees or was a covered employee of the organization, or any predecessor of the organization for any tax year after December 31, 2016. Inclusion in the category “wages” was also not clear. Wages, or remuneration, include compensation except designated Roth contributions and any amounts required to be included in income under a 457(f) retirement plan from the organization or a related organization. Further, a “parachute payment” is any payment treated as compensation to or for the benefit of a covered employee if: (a) the payment is contingent on the employee’s separation from employment ; (b) the aggregate value of the payments are equal to or greater than three times the base amount [as defined in Code section 4960(c)(5)(B)]. In this case, these rules apply to covered employees except payments to licensed medical professionals. There are a number of exceptions applicable to calculation of compensation. Some of the more common include: (1) payments under a qualified plan; (2) payments under 403(b) or 457(b) plans; and (3) those individuals who do not meet the definition of highly compensated. Refer to IRS Notice 2019-09 for interim guidance. In the event that an excise tax is determined, it is reported on section N of Form 4720.

Colleges and Universities

Prior to the TCJA, private foundations were unique in the area of excise tax on net investment income. The Act brought certain endowments from colleges and universities under closer scrutiny on their investment activities. This was to target certain academic institutions that were more focused on an accumulation of wealth through their endowments than to using the income to make education more affordable. The Act imposes a 1.4% tax on the net investment income of  an “applicable educational institution.” Applicable educational institutions include all accredited public, nonprofit, and proprietary postsecondary institutions. The excise tax is applicable to an educational institution that has at least 500 tuition-paying students during the prior year where more than 50% of the students are located in the U.S. In determining the 500 students,  part-time students are counted based on equivalent units. For example, 100 students attending 50% of normal time would be counted as 50 equivalent units. This tax is not applicable to state colleges and universities. Exposure to the excise tax is based on endowments where there is at least $500,000 per student determined on a daily average using equivalent units. The calculation of net investment income is similar to the methodology used by private foundations. Additional guidance can be found in IRS Notice 2018-55. In the event that an excise tax is determined, it is reported on section O of Form 990. This provision of the Act is applicable for tax years beginning after December 31, 2017.

UBTI – Separate Lines of Business

Typically, unrelated business taxable income (UBTI) occurs when a non-profit is involved with a trade or business, regularly carried on and not related to its exempt purpose. For most organizations, this is limited to their alternative investments. However, it can also arise from debt financed income (Code section 514) or conducting a business activity with a profit motive, even though the net proceeds are used to further the organization’s exempt purpose. The Act takes these various sources of income and effectively puts them in “silos.” Prior to the Act a loss from one activity could off-set the gain from another activity. This is a similar issue that country clubs have faced for years with the separation of their investment income and their non-member use of the club facilities. The new rules are applicable to years beginning after December 31, 2017. Each line of business would be taxed at 21% or, in the case of a loss, the accumulation of losses could only offset income from the same line of business. There are a fairly complicated set of rules governing the treatment of net operating losses applicable to periods before the date of enactment. These rules as well as an overall understanding of “siloing” can be found in IRS Notice 2018-67 and Code section 5-12(a)(6). The separate lines of business are reported on the organization’s Form 990-T or, in the case of multiple lines, Form 990-T Schedule M.

Transportation Tax

The most far reaching and confusing aspect of the tax impact of the TCJA on non-profits concerns the transportation tax. Conceptually, Code section 512(a)(7) came about with a desire to bring parity between non-profits and their for-profit counterparts. Because of the lack of IRS guidance, it created mass confusion on everyone’s part. Transportation benefits are broken primarily into two categories – (1) on transit passes; and (2) parking facilities. The transit pass issue is particularly an issue in New York City, Washington, D.C., and San Francisco, which require employers with over 20 employees to provide the benefit. These transit passes are generally done on a pretax basis. Where applicable, this has absolutely no impact on the employee, only the employer. Because Code section 274 disallows deductions for the expenses of any qualified transportation fringes, non-profits must pay a 21% excise tax on the pretax/parking benefit. This tax is reported on Form 990-T, line 34. However, it is only reported on the Form 990-T as a way to pay the tax similar to proxy tax. It is not unrelated business taxable income. As such it is not a separate line of business referred to above in the “silo” section.

The second part of the transportation issue enumerated in IRS Notice 2018-99 has to do with parking facilities and qualified parking. Qualified parking is parking provided to an employee on or near a location from which the employee commutes to work by public transportation, in a commuter highway vehicle, carpool, or in their own vehicle. The guidance is extremely complicated as enumerated in IRS Notice 2018-99, which should be reviewed to fully understand the issue.

The Act was not consistent in its effective dates. Transportation benefits were provided as of January 1, 2018, while most of the other provisions were for years after December 31, 2017. The issue of blended tax rates was not addressed by the IRS until well after the due date for June 30 fiscal year filings (May 15, 2019). IRS has recently announced that the use of blended rates, pursuant to Code section 15, will apply to fiscal year 2017 returns even though the disallowance of transportation benefits was not applicable until January 1, 2018 when the rate was 21%.

This is a brief overview of the presentation concerning the impact of Code sections 512(a)(6) and 512(a)(7). Historically, most tax acts have had a single effective date. However, this Act is particularly confusing due to the different dates and a lack of overall guidance. As noted above, regarding transportation, the Service waited until virtually all the fiscal year returns for 2017 were filed before publishing guidance on how to determine the tax. Their rationale makes no sense because they are taxing income at a rate where the income was not taxable in the first part of the year. The notices referred to in this article provide additional “how to” guidance and should be consulted as necessary. There are still many open-ended questions regarding the Act, many which will be the subject of litigation in the future.