As the new tax bill worked its way through Congress last fall, nonprofits across the country raised their voices high to share concerns about its disincentives for charitable donations — as well as the proposed repeal of the Johnson Amendment. Little was heard, though, about changes to the rules for unrelated business income tax (UBIT). It turns out that the final law, the Tax Cuts and Jobs Act (TCJA), includes several provisions that have the potential to boost your organization’s liability for the tax, regardless of whether you operate an unrelated business.
Why your UBI may grow
The most important change relates to how unrelated business income (UBI) is computed. The new law requires nonprofits to calculate UBI separately for each unrelated business, with the $1,000 deduction typically allowed applied to the aggregate UBI for all businesses.
Your UBI also can increase because net operating losses (NOLs) can only be claimed against future income from the specific business that generated the loss. Under previous law, you could use NOLs from one business to offset the income of another or to offset gains from alternative investments or pass-through entities, also considered UBI.
UBI also might grow due to a change in how certain fringe benefits are treated under the TCJA. In previous years, you could provide your employees 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 employees.
The TCJA, however, treats the payments for such benefits as UBI unless they are directly connected to an unrelated business (for example, parking benefits provided employees of an unrelated business). Congress made the change to create parity between nonprofits and taxable organizations. For-profit businesses lost a previous tax exemption for certain fringe benefits under the TCJA. The end result, though, is that nonprofits may owe UBIT even without operating any unrelated businesses.
It’s not all bad news. The new law also changes the corporate tax rate that nonprofits pay on UBI to 21% from a range of 15% to 35%. In some cases, a nonprofit’s UBIT liability might fall despite your higher UBI.
What you can do
Fortunately, you have some options to avoid the worst effects of these changes. For example, you may conduct an audit of your unrelated businesses. You might find that you have been over-reporting your UBI because you have not captured all the related business expenses.
Another option for nonprofits with multiple unrelated businesses is forming a single taxable corporate subsidiary to hold all of them, which would permit you to again offset their income and losses. Any restructuring will likely carry some implications, whether tax-related, financial or operational.
Changes to the UBIT rules have not received as much coverage as some of the other TCJA provisions, but they may impact your organization. Consult with your CPA to determine steps you can take to minimize the impact of tax reform on your bottom line.