Effect of unrelated business income tax: Most universities are considered tax-exempt entities. If the university runs a restaurant that serves both the students and the public, the proceeds from the restaurant would be considered unrelated business income. The restaurant is a business that is regularly carried on by the university, and isn’t substantially related to the school’s exempt purpose.
In February, House
Ways and Means Committee Chairman Dave Camp (R-Mich.) released a draft of the
Tax Reform Act of 2014. This proposal includes multiple major federal tax
code changes affecting individuals, businesses and not-for-profit
organizations. Here are four areas that would significantly affect the
not-for-profit community.
Charitable contributions
The draft proposes a
couple notable provisions regarding charitable contribution deductions on an
individual’s tax return:
· Contributions can only be deducted to the extent they exceed 2
percent of the adjusted gross income (AGI); an individual with $200,000 AGI
will receive no benefit for the first $4,000 of donations.
· Individuals may elect to treat contributions paid after the
close of the tax year, but before filing the return the following April, as
part of the current tax year’s deduction.
While supporters
believe the simplification and extension of time will increase the amount of
charitable giving, others believe the contrary. According to a 2011
Congressional Budget Office (CBO) study, the average taxpayer gave between 2.5
percent and 3.4 percent of their income to charity in 2008. The proposed 2
percent floor could decrease the incentive to donate since the tax benefit
would be much lower. The CBO estimates charitable giving to fall by
approximately $3 billion after the passing of such a provision, seriously
affecting future contribution revenue.
Unrelated business
income tax
The proposal alters
the calculation of unrelated business income tax (UBIT) for tax-exempt entities
in several ways:
· All tax-exempt entities under Internal Revenue Code (IRC) Section
501(a) will be subject to UBIT rules regardless of the organization’s exemption
under another IRC provision. For example, a government-sponsored organization
exempt under Section 115(1) and Section 501(a) will now be subject to taxes on
any income derived from a regularly carried out trade or business not
substantially related to the organization’s tax-exempt function.
· Royalty revenue for licensing an organization’s name or logo
will be subject to UBIT.
· Organizations will separately calculate their net UBIT for each
line of unrelated business, as opposed to calculating UBIT from aggregate gross
income across all unrelated trades. Net operating losses derived from each line
will be carried forward to offset any future income from that same line of
business.
· Income derived from research made available to the public will
be the only research income exempt from UBIT; proprietary research currently
exempt will be subject to UBIT.
· Qualified sponsorship payments could be subject to UBIT as
advertising income if the organization uses or acknowledges any of the
sponsor’s product lines as a result of the payment. Payment of more than
$25,000 for any one event must be acknowledged in the same manner as a
significant portion of the other donors of the event. This means an
organization may not give special treatment or list the name or logo of the sponsor
in a different format than any other donor.
· The specific deduction of $1,000 against income subject to UBIT will
be increased to $10,000.
This provision may result in increased areas of business that could be subject to UBIT; however, the increase of the specific deduction could significantly reduce the number of organizations paying tax on unrelated business income.
Excise taxes and
excess benefits
The intermediate
sanctions regarding excise taxes also will change considerably by the proposed
provisions:
· Tax-exempt entities under §501(c)(5) and §501(c)(6) will be subject to the excess benefit transaction rules.
· When an excess benefit excise tax is imposed on a disqualified
person, the organization also will be subject to an excise tax of 10
percent of the excess benefit unless the organization follows minimum levels of
due diligence, including:
o
Approval by an independent body within the organization
o
Reliance on comparability data prior to the approval
o
Documentation of the basis for approval
· The definition of the disqualified person mentioned above also will
expand to include athletic coaches and investment advisors.
Unfortunately, the levels of due diligence above will no longer establish the “rebuttable presumption of reasonableness” supporting the organization’s valuation of reasonable compensation paid to the top management officials. If the IRS disputes compensation, the organization now would carry the burden of proving the transaction is equitable. The relating safe harbor for managers who rely on professional advice for excess benefit transactions also will be eliminated with the provisions.
Additional excise
taxes proposed by the reform draft include the following:
· Compensation in excess of $1 million paid to any of the five
highest-compensated employees will trigger a 25 percent excise tax for an
organization. Currently, this rule only applies to publicly traded
organizations, but the new legislation will expand it to all not-for-profits.
· Private colleges and universities will be subject to a 1 percent
excise tax on net investment income. This tax will only apply to schools with
at least $100,000 in assets per full-time student.
· A 20 percent excise tax will be imposed on an organization for
any donor-advised funds not distributed within five years.
· A private foundation excise tax for net investment income will
be a flat 1 percent for all organizations, rather than the current 1 percent
rate or 2 percent rate dependent on meeting distribution requirements.
The authors of the Camp tax reform draft believe these additional excise tax provisions will either reduce or have a minimal effect on future revenue. While this may be true for many organizations, it is important to monitor your organization’s practices to ensure these new taxes (if enacted) won’t be triggered.
Additional
requirements for tax-exempt organizations
The requirements for
organizations to obtain tax-exempt status also will change with the passage of
these reforms, and a number of organizations will lose their exempt status,
including:
· Professional sports leagues, e.g., the National Football League
· Property & casualty insurance companies
· Qualified health insurance issuers
· Type II and Type III supporting organizations
The change for Type II and III organizations will have the biggest impact. Organizations will be able to qualify only as a Type I supporting organization or risk treatment as a private foundation.
Conclusion
While there are
advantages to this proposal, such as the increased UBIT deduction and the
simplification of tax on net investment income, there also are disadvantages
that may seem daunting. Fortunately, the not-for-profit community likely has
little to fear from this proposal for the immediate future. As it is an
election year, it is very unlikely the legislation will make it out of
committee anytime soon. However, while we may not see overall tax reform for
several years, many not-for-profit provisions seem to make their way into
numerous pieces of legislation that pass quickly. Therefore, exempt
organizations should stay on top of legislative developments.
If you have any additional questions or concerns about how these
provisions may affect your organization, please contact your BKD advisor or Paige Gerich or Noelle Alberto.
This information was written by
qualified, experienced BKD professionals, but applying specific information to
your situation requires careful consideration of facts and circumstances. Consult your BKD advisor before acting on any
matter covered here.
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