Article Written By:
Tyler Gabalski, CPA
The Tax Cuts and Jobs Act signed into law by President Trump on December 22, 2017 delivered significant changes to organizations nationwide, including nonprofits. Among those were changes to how unrelated business income is calculated and taxed.
What is unrelated business income (UBI)?
The IRS defines UBI as activity that is a trade or business, is regularly carried on and is not substantially related to furthering the exempt purpose of the organization. In other words, if an exempt organization generates business income unrelated to the organization’s primary purpose, that income may be taxable as UBI. There are exceptions to this including if substantially all of the work is performed by volunteers or if the items being sold were received as gifts or contributions.
As an example, an organization aimed at teaching and promoting classical music in a community charges $5 admission to its monthly concerts to help fund the organization. The income from ticket sales would not be UBI because the concert is related to the exempt purpose of the organization. However, if the same organization opened a convenience store with the proceeds used to fund its activities, this would be taxable as UBI because it is a regularly performed business activity unrelated to the organization’s exempt purpose.
How does the calculation of UBI change beginning in 2018?
Historically, nonprofit organizations have been able to combine income and expenses from all UBI activities to come up with one taxable income amount. Beginning in 2018, all activities will be taxed individually. So if an organization has one activity that generates $2,000 of net income and another activity that generates a $2,500 net loss, the $2,000 of net income will be taxed at the corporate tax rate of 21% and the $2,500 net loss will be carried forward as a net operating loss (NOL).
In addition, there are changes for UBI purposes related to “qualified transportation fringes” (i.e., parking or transit passes), “on premises athletic facilities” and entertainment expenses. Beginning in 2018, tax-exempt entities shall increase UBI for these items.
What does it mean for nonprofit organizations?
For nonprofit organizations with multiple UBI activities, it may be time to reevaluate those activities if a net loss from one activity was used to offset other UBI income in the past. One option may be to consider consolidating UBI activities into a separate taxable organization. Fringe benefits that now may be includable in UBI should also be reevaluated to determine the impact to the organization.
There is some good news. While NOL’s carried forward from 2018 for UBI can only be applied to the same activity in future years, any NOL carried forward prior to 2018 can be applied to any UBI activity. UBI will also now be taxed at the lower corporate rate of 21% rather than the higher corporate tax rates in the past.
The overall impact to nonprofit organizations will depend upon each entity’s particular situation. Please consult your GBQ advisor to determine how these changes will affect your organization and what planning steps may be available to you.