Fringe Benefits and Unrelated Business Taxable Income

Under the 2017 Tax Cuts and Jobs Act (TCJA), Congress imposed an unrelated business income tax on certain fringe benefits a nonprofit employer might provide to its employees.

What does that mean in plain English?

Well, it means that, if a nonprofit pays $10,000 a year for parking spots reserved for management and other employees, that $10,000 might be treated as taxable income to the organization and taxed at the corporate rate of 21% on Form 990-T.

Fringe benefits that could become taxable income to nonprofit employers under the new tax law include:

• Qualified Transportation Benefits

• Qualified Parking Benefits

• On-Premises Athletic Facilities, and

• Entertainment Expenses

To provide context on this new tax on nonprofit organizations, let's discuss § 274 of the Internal Revenue Code.

§ 274 of the Internal Revenue Code

The TCJA increased the list of nondeductible business expenses under § 274. For for-profit businesses, this list includes certain entertainment expenses, qualified transportation benefits and other specified expenses.

Since nonprofits are tax-exempt entities that technically do not take "tax deductions," the IRS and the Treasury provided interim guidance on December 10, 2018 to explain what the revised list under § 274 meant for nonprofit organizations.

The interim guidance explained that the IRS' definition of unrelated business income had been expanded to include qualified transportation benefits disallowed under § 274 , and that a "tax-exempt organization’s unrelated business taxable income (UBTI) is increased by the amount of the qualified fringe transportation expense that is nondeductible."

QUALIFIED TRANSPORTATION FRINGE BENEFITS

The IRS and Treasury defined the following expenses as qualified transportation fringe benefits:

• qualified parking benefits

• commuter transportation benefits,

• transit passes and

• any qualified bicycle commuting reimbursement.

Qualified parking benefit were specifically defined as

• Parking provided to an employee on or near the business premises of the employer, or

• On or near a location from which the employee commutes to work by transportation.

IRS Notice 2018-99 further explains that qualified parking benefits taxable to the nonprofit employer can include parking paid to a third party, parking facilities owned by the nonprofit and parking facilities leased by the nonprofit.

These benefits are reported as "Amounts paid for disallowed fringes" on Part III, Line 34 of the Form 990-T. This line item is added to to Total UBTI and cannot be reduced by any expenses, deductions (other than the Specific Deduction), or credits.

If a nonprofit organization treats the benefits as taxable wages, it is not required to include the benefits in UBTI and pay tax on them, but the organization will incur additional payroll taxes.

OTHER EXPENSES TAXABLE AS UBTI

The new tax law also states that a nonprofits UBTI should increase by the cost of employee use of on-premises athletic facilities. However, the expanded definition of UBTI under IRS code section 512(a)(7) does not include the employee cost of on-premises athletic facilities and it is not clear whether or not the cost should be reported on Form 990-T. It is possible that future provisions of the law may make these benefits taxable. These benefits include expenses paid for use of athletic facilities located on property that the organization owns or leases.

The new tax law also states that UBTI should increase by certain entertainment expenses. Section 13304 of TCJA disallows the deduction of certain entertainment expenses that are not “directly related to” or “associated with” the tax-exempt organization’s trade or business. Entertainment expenses are considered to be “directly related to” the business when:

• The main purpose of the combined business and entertainment is the active conduct of business,

• The organization engages in business during the entertainment period,

• The organization has more than a general expectation of getting income or some other specific business benefit at some future time, and

• The entertainment takes place in a clear business setting.

Entertainment is considered to be “associated with” the organization's trade or business if there is a clear business purpose for the expenditure, such as to get new business or to encourage the continuation of an existing business relationship.

STATE CONFORMITY AND FEDERAL REPEAL

Many states, including California, have not conformed to the UBTI changes implemented under the TCJA. This means that many nonprofit organizations affected by the TCJA changes will only have to pay federal tax.

In addition, the House and the Senate both have legislation in place to repeal the requirement to report qualified transportation benefits as unrelated business taxable income. Churches and other nonprofit organizations have banded together to sign petitions to move this legislation forward so they can spend less dollars on tax liabilities and more dollars on their mission.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.