Taxing the Tax-Exempt?

PYA Tax Manager Emily Smithson's presentation will analyze the impact of the Tax Cuts and Jobs Act on tax-exempt organizations.

1. 2019 Health Care Industry Conference April 26, 2019 Emily Smithson, CPA, Manager Florida Institute of Certified Public Accountants Taxing the Tax-Exempt? Impact of the Tax Cuts and Jobs Act on Tax-Exempt Organizations

2. Tax Cuts and Jobs Act of 2017 Signed into law on December 22, 2017 Sweeping revisions to current tax law impacting individuals, estates, businesses, and tax-exempt organizations “In the news” changes: Reduction in corporate tax rate and elimination of corporate Alternative Minimum Tax (AMT) Lower individual tax brackets Significant increase to standard deduction for individuals

3. Tax Cuts and Job Acts of 2017 Provisions Impacting Tax-Exempt Organizations Include: Executive Compensation Unrelated Business Income Activities Change in Tax Rate Various Employer-Provided Fringe Benefits

4. Background: Executive Compensation – For-Profit Corporations Internal Revenue Code (IRC) 162 (m) limits deduction to $1 million for compensation paid to: CEO CFO Any other covered employee that is one of the three highest compensated Applies to publicly traded corporations regulated under the Securities and Exchange Commission (SEC) Rule has no impact on non-SEC corporations or tax-exempt organizations

5. An Attempt at Parity The Tax Cuts and Jobs Act of 2017 (TCJA) adds an excise tax to tax-exempt organizations that pay compensation to a covered employee in excess of $1 million per year or on any excess parachute payment paid The new corporate tax rate is 21%, therefore the excise tax rate on excess compensation is also 21% Excise tax only applies to the compensation over $1 million per covered employee Applies to taxable years after December 31, 2017

6. Definitions: Compensation Include: Wages--as defined in Section 3401 (a) Amounts required to be included in gross income under Section 457 (f) Exceptions: Roth contributions Renumeration not allowed under Section 162 (m)

7. Definitions: Covered Employee “Any employee (including any former employee) of an applicable tax-exempt organization if the employee is one of the 5 highest compensated employees of the organization for the taxable year” (IRC 4960) Five year lookback – first applicable year is 2017

8. Definitions: Covered Employee Does not include compensation paid for services performed as a medical or veterinary professional A member of the C-suite may provide both medical and administrative services Compensation would be allocated to each type of duty $1M test only applies to compensation for administrative services

9. Definitions: Related Organizations “A person or government entity shall be treated as related to an applicable tax-exempt organization if such person or government entity – Controls or is controlled by the organization Is controlled by one or more persons that control the organization Is a supporting organization during the taxable year with respect to the organization”

10. Compliance Issues Period covered in measuring compensation: Section 4960 references “taxable year” – employer or employee? Notice 2019–09 clarifies taxable year is the calendar year with or within the employer’s taxable year

11. Compliance Issues Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code This form has historically been used for “punitive” taxes levied on tax-exempt organizations Proposed regulations issued on November 5, 2018, indicate Form 4720 be filed by the 15 th day of the fifth month after the end of the organization’s taxable year when the excise liability was incurred Form 4720 updated to include Schedule N, Tax on Executive Compensation Because this burden is an excise tax, quarterly estimated payments are not required

12. Compliance Issues: Consolidated Groups Top 5 determination – appears to apply in aggregate to a consolidated group Compensation includes that which is paid by all of the members of the consolidated group to the employee Liability for excise tax is allocated to each organization pro rata based on its proportion of compensation paid to the employee How does reporting work if employee splits time between a for-profit related organization and a tax-exempt entity?

13. Planning Opportunities Identify top 5 covered employees and determine if compensation exceeds or will exceed $1 million Track former employees (in years after 2016) for post-termination compensation Consider consolidating all highly compensated employees into one employer, such as the parent entity Carefully review executive employment contracts, severance agreements, and non-qualified deferred compensation (NQDC) plans Vesting in NQDC plans may trigger the tax in future years (even if the executive is not normally paid in excess of $1M) Opportunities for longer vesting schedules?

14. Planning Opportunities If applicable, organizations should accrue the 21% tax on the books (and file necessary excise tax forms, without need for estimated payments) Consider licensed medical professionals – track clinical vs. nonclinical pay

15. Planning Opportunities Regardless of compensation (even if well under $1M), Intermediate Sanctions still apply Do not neglect the requirements for reasonable compensation! Keep watching for additional guidance on the TCJA

16. Taxing the Tax-Exempt? Is it “parity” if the for-profit corporation incurs a taxable loss and, therefore, is not harmed by a disallowed deduction for excess compensation? Does the 21% excise tax benefit the communities served by applicable tax-exempt organizations? Many states are increasing tax assessments of tax-exempt organizations or revoking tax-exemption for other state and local taxes, such as property taxes Will the “requirements” of tax-exemption become too burdensome? How will this impact executive compensation and what is considered fair market value (FMV)?

17. Unrelated Business Activities: New Tax Rate 21% Executive Compensation UBI Tax Tax rate treats tax-exempt entities same as taxable entities

18. Unrelated Business Activities Historically: Unrelated business activities aggregated for purposes of reporting on Form 990-T Profitable activities may be offset by activities generating losses

19. Unrelated Business Activities New Rules: Losses from one unrelated activity may not offset the income from another unrelated trade or business Calculate UBI tax separately for each UBI activity Consistent with IRS position to view perpetual losses as not maintaining a profit motive Effective for tax years beginning after December 31, 2017 Create “buckets” for each UBI activity to determine the net income or loss from each Unrelated business activities generating losses in one taxable year may be used to offset income from the same activity in a subsequent taxable year

20. Unrelated Business Activities No criteria defined for determining separate UBI activities Notice 2018-67 Rely on a “reasonable, good-faith interpretation” NAICS six-digit codes Aggregate all debt-financed income or all income from controlled entities Aggregate investment activities

21. Unrelated Business Activities Net Operating Losses: May be carried forward indefinitely but eliminated carryback period Post 2017 NOLS limited to 80% of taxable income (all organizations, not just tax-exempt organizations) Ordering of NOLS Pre-2018 Post-2017

22. Planning Opportunities Multiple activities? Consider conducting them in a single taxable corporate subsidiary or within a subsidiary of a consolidated group Audit activities to verify all expenses captured

23. Parking Qualified transportation fringe – parking garages Disallow deductions for “the expense of any qualified transportation fringe (as defined in Section 132 (f)) provided to the employee of the taxpayer”

24. Parking What is qualified parking? Qualified parking is defined as either: On or near the employer’s business premises At a location from which employee commutes to work

25. Parking Employer’s expense of providing the parking, rather than the value, determines the amount considered UBI What is considered expenses?

26. Parking Parking expenses subject to 512 (a) (7) Included: Repairs Maintenance Utilities Insurance Property taxes Interest Snow and ice removal Leaf removal Trash removal Cleaning Landscaping Parking lot attendant expenses Security Rent or lease payments Contract fees with outside parties to maintain the parking area Excluded: Depreciation Expenses paid for items not located on, or in, the parking facility, such as landscaping and lighting Expenses for parking area where employees pay to park Expenses for parking that is included as wages in an employee’s W-2

27. Parking Do you have UBI related to providing parking to your employees? Step 1: Calculate costs of reserved employee costs Step 2: Determine primary use of the remaining parking spots Step 3: Calculate the allowance for specifically reserved nonemployee spots Step 4: Determine remaining use and allowable expenses

28. Parking Eliminate reserved parking spots? Mixed use parking Include the value in compensation to employees?

29. Fringe Benefits Request for Guidance June 7, 2018, Rep. Mike Conway introduced Nonprofits Support Act (H.R. 6037) to repeal sections 512 (a) (6) and 512 (a) (7) June 21, 2018, National Council of Nonprofits sends correspondence to Secretary Mnuchin and Commissioner Kautter July 11, 2018, Council on Foundations sends correspondence to Members of the 115 th Congress

30. Fringe Benefits On-Site Athletic Facilities New Law – Value of use of on-site athletic facilities to employees subject to UBI tax On-Premises athletic facility is defined as: Located on premises of the employer Operated by employer Substantially all of the use is by employees, their spouses, and dependent children

31. Fringe Benefits Moving Expenses New Law May no longer exclude income reimbursements for moving expenses from income May no longer deduct any unreimbursed qualified moving expenses Effective in 2018

32. Questions

33. Emily J. Smithson Manager – Tax Services PYA, P.C. [email protected] [phone] www.pyapc.com