Provision May Substantially Increase Tax-Exempt’s UBIT
Berdon Tax Team
09.12.2018 | Client Alert
A little-noticed provision in the Tax Cuts and Jobs Act (TCJA) could significantly impact tax-exempt organizations by increasing their unrelated business income tax (UBIT). New section 512(a)(7) specifically targets transportation fringe benefits provided by tax-exempts to employees by, somewhat unusually, including in unrelated business taxable income (UBTI) certain fringe benefit amounts that would be disallowed as deductions to a taxable entity.
The new provision works in tandem with new section 274(a)(4), which disallows a deduction for certain transportation fringe benefits. This can be problematic when it comes to parking arrangements and facilities and transit passes to name a few common transportation fringe benefits tax-exempts provide to employees, and it arguably captures pre-tax arrangements as well as employer-funded plans. Unfortunately, there is much that is unclear, and numerous groups have pushed for immediate guidance, or a delay in implementation, if not outright repeal.1
The new provision is somewhat unusual in that it frames an income inclusion in terms of an expense amount —including, in a tax-exempt’s UBTI, certain transportation fringe benefit amounts disallowed under section 274(a)(4). Important aspects include the following:
- It impacts most section 501(c) and (d) organizations, including hospitals, churches, colleges, and other not-for-profit entities;
- While not entirely clear, it may affect tax-exempts without other UBIT or otherwise engaging in an unrelated trade or business, and may require a Form 990-T, a complex and time-consuming form, for tax-exempts that have never filed one before;2
- It may require a tax-exempt that has never paid tax to pay tax (and make estimated tax payments);3
- Since it applies to expenditures after December 31, 2017, fiscal-year tax-exempts must consider the implications for fiscal year 2017;
- It, arguably applies to direct and indirect (pre-tax, employee funded) arrangements;
- It may raise tax rates on the UBIT inclusion to 21% for corporate tax-exempts and as high as 37% for tax-exempts organized as trusts; and
- It raises numerous questions surrounding its application and the calculation of the UBTI inclusion.
Regulatory guidance is authorized and needed but is not on Treasury’s priority list.
Both taxable entities and tax-exempts may provide transportation benefits, including parking – on owned or leased property – and transit pass and voucher programs. Parking arrangements may be reserved for employees (e.g. a church pastor or hospital staff) but shared with others, exclusively for employees, or not reserved at all. Costs of the plan may vary as well. Parking may be free, employees may pay for parking pre-tax or after-tax, or employers may pay for parking. Similarly, with respect to transit passes, employers may pay or employees may bear that cost on a pre-tax basis.
Section 132 excludes from gross income many of these transportation-related fringe benefits. Prior to the TCJA, these costs were deductible, but new section 274(a)(4) now disallows these deductions. And the TCJA’s new section 512(a)(7), makes this an issue for tax-exempts.
Understanding the new provision starts with section 274(a)(4), which disallows a deduction for any “qualified transportation fringe” (QTF). QTF, in turn, is defined in section 132, which, as mentioned, excludes certain fringe benefits, including QTFs, from gross income. Under section 132(f), QTFs include “qualified parking” and “transit passes.” Qualified parking generally includes parking provided to employees at or near the employer’s business. Transit passes include passes, fare cards or similar items used for mass transit.
Section 512(a)(7) is intended to align taxable and tax-exempt entities in the treatment of transportation fringe benefits. Section 274(a)(4) denies the deduction to taxable entities, and section 512(a)(7) subjects tax-exempts to tax on the amount of what would be, to a taxable entity, the disallowed expenditure. It increases a tax-exempt’s UBTI by certain amounts:
- Paid or incurred after December 31, 2017; and
- Disallowed under section 274
By its terms, section 512(a)(7) applies with respect to amounts paid or incurred for “any [QTF], any parking facility used in connection with qualified parking, … or any on-premises athletic facility … .” The statute authorizes regulations, but none have been issued to date.
Clarity is Lacking
Unfortunately, the statutory language is uncertain in at least two respects:
- Parking facilities used in connection with qualified parking are, under section 132(f), arguably already a category of QTF, so the reference to “parking facilities” in section 512(a)(7) seems superfluous. Note also that section 274 lacks any specific reference to parking facilities, referring solely to QTFs.4 There is disagreement in the commentary on section 512(a)(7) whether the absence of a reference to parking facilities in section 274(a)(4) implies that the costs of maintaining parking facilities are outside the scope of section 512(a)(7). These are issues regulatory guidance will have to address.
- The inclusion of on-premises athletic facilities may be a drafting error because these facilities are not disallowed under section 274, a requirement of section 512(a)(7). This, like the reference to parking facilities, is likely a result of the legislative path of the statute in which section 512(a)(7) adopted the House version, whereas section 274(a)(4) adopted the Senate version. The House version of 274 included athletic facility language.
Struggle to Comply
The provision raises numerous questions for tax-exempts, many of which are struggling to comply. It is not clear, for example, whether:
- Section 512(a)(7) applies to employee-funded, pre-tax parking and transit pass programs and what amounts pursuant to such plans, if any, are “paid or incurred” by the exempt organization for purposes of section 512(a)(7).5
- The expenses to maintain a parking facility or lot that does not reserve spots for employees are subject to section 512(a)(7). Arguably, such a facility does not provide qualified parking for employees absent designated spots for employee use, but this issue is unclear.
- In cases where the fair market value of the QTF differs from the exempt organization’s cost of providing the QTF, the basis for the UBTI inclusion is cost or fair market value. Guidance is needed to clarify the proper measurement of the UBTI inclusion;
- Administrative and overhead costs in administering qualified transportation fringe plans are subject to section 512(a)(7).6
Clearly, guidance is needed, but according to Treasury’s Priority Guidance Plan, the priority is on new section 512(a)(6), not 512(a)(7).7
Here is the potential impact on the tax-exempt community:
- The provision broadly reaches most, if not all, section 501(c) and (d) organizations, including hospitals, churches, colleges and other not-for-profit entities;
- Given 512(a)(7)’s broad application, many tax-exempts, even those otherwise without UBTI, may have to file form 990-T;
- Tax-exempts not otherwise subject to tax may have to pay tax (and make estimated tax payments);
- The provision applies to expenditures after December 31, 2017, so fiscal-year tax-exempts need to consider the implications for fiscal year 2017;
- Arguably it applies to direct and indirect (pre-tax) arrangements;
- Tax rates on the UBIT inclusion could be as high as 37% for tax-exempts organized as trusts; and
- Numerous questions remain, but no regulatory guidance is on the horizon
Obviously, the application of section 512(a)(7) will depend on the tax-exempt’s unique facts and circumstances.
Questions? Reach out to your Berdon tax advisor.
Berdon LLP New York Accountants
1 See, for example, https://www.councilofnonprofits.org/sites/default/files/documents/final-ubit-letter-of-national-council-of-nonprofits-6-21-2018.pdf.
2 The American Bar Association (ABA) has recommended guidance mitigating the burden on tax-exempts subject to a Form 990-T filing requirement solely because of section 512(a)(7) by allowing such organizations to complete only certain sections of the form.
3 Estimated payments are required if expected tax exceeds $500.
4 This disparity between sections 512(a)(7) and 274(a)(4) with respect to parking facilities is related to the legislative evolution of the statute. The final section 512(a)(7) reflects the original House version (the Senate had no counterpart), whereas the final section 274(a)(4) reflects the Senate version (rather than the House version, which had included similar language to section 512(a)(7)).
5 As noted by the Council of Nonprofits, see note 1, the IRS apparently views employee-funded plans as subject to section 512(a)(7). The NY State Bar Association, in a report to Treasury with comments on provisions in the TCJA affecting tax-exempts, noted that this is the more “reasonable” interpretation of section 512(a)(7) in light of the legislative history and purpose.
6 The ABA believes a reasonable reading of both section 274(a)(4) and section 512(a)(7) excludes such overhead costs from the UBTI inclusion.
7 Section 512(a)(6) requires the calculation of UBIT on an activity-by-activity rather than aggregated basis. Guidance on section 512(a)(6) – in the form of Notice 2018-67 – was issued on August 21, 2018.