by Gregory S. Dowell
December 28, 2017
Much of the focus has been on individuals and businesses, but a couple of key changes effecting nonprofits were in the recently passed tax legislation, both of which will take effect in 2018.
One of those changes was that unrelated business taxable income, known as “UBTI”, must be separately calculated for each trade or business activity. UBTI is just what it labeled: It is income from activities that are not directly related to the tax-exempt organization’s primary function. UBTI is determined by a nonprofit by subtracting the deductions related directly to the unrelated trade or business from the gross income of the unrelated trade or business. Based on prior law, an organization that might have more than one unrelated trade or business would aggregate the results of the various businesses’ gross income and then aggregate the deductions of the unrelated trade or businesses. The result was that an organization could use a deduction from one unrelated trade or business to offset income from another, which would reduce the total unrelated business taxable income.
Under the recent tax act, losses from an unrelated trade or business may not be used to offset the income derived from another unrelated trade or business, which results in net income or net losses being calculated separately for each activity. Note, however, that there is an exception for net operating loss carryforwards arising in a tax year from 2017 or earlier. For nonprofits so impacted, this will result in higher levels of UBTI and higher taxes.
Another area that will impact charities under the new tax act is the excise tax that will be assessed on excess executive compensation. The prior law had reasonableness requirements and a prohibition against private inurement with respect to executive compensation for nonprofits, but no excise tax was assessed on the executive compensation. For tax years beginning after Dec. 31, 2017, however, a nonprofit will be subject to a tax at the corporate tax rate of 21% on the sum of:
(1) the remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee by an applicable tax-exempt organization for a tax year; and
(2) any excess parachute payment (as newly defined) paid by the applicable tax-exempt organization to a covered employee.
A covered employee is an employee (including any former employee) of an applicable tax-exempt organization if the employee is one of the five highest compensated employees of the organization for the tax year or was a covered employee of the organization (or a predecessor) for any preceding tax year beginning after December 31, 2016. Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to such remuneration.
These are two of the changes in the tax act that will impact a number of tax-exempt organizations. Bear in mind that regulations and procedures do not exist for either of these changes as of this date.