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How Much Tax Will Your Organization Pay? IRS Releases Draft Form 990-T
The IRS recently released drafts of the 2018 Form 990-T, new Schedule M and related instructions. Tax preparers and nonprofits have anxiously awaited these new forms and instructions after numerous changes were made to unrelated business taxable income (UBTI) and other areas as a result of the Tax Cuts and Jobs Act (TCJA). Previous BKD Thoughtware® articles have addressed many of these changes individually, and the draft forms and instructions help to provide a more complete picture of how these provisions will be implemented and reported.
One of the significant changes to UBTI that resulted from the TCJA was the siloing of unrelated trade or business activities. The draft Form 990-T highlights this change on items E and H in the header, which allows for only one activity code and description and requires the organization to list the number of unrelated trades or businesses. Organizations with more than one source of UBTI will now complete the new Schedule M for each additional activity. The Schedule M is identical to Form 990-T, Parts I and II. In fact, the instructions indicate to refer to the instructions for the Form 990-T, Parts I and II, for the corresponding lines on Schedule M. If the trade or business requires any Schedules A through K, then the appropriate schedule also should be attached for each Schedule M. There are several instances where the instructions indicate to refer to IRS guidance regarding reporting separate trades or businesses, unrelated debt-financed income, the organization’s distributive share of partnership income and deductions directly connected with such income. While some guidance has been issued thus far suggesting the NAICS code will be the determination, additional guidance is still necessary as implied by these draft instructions. See "Guidance Released for UBIT Reporting by Activity" for the most recently issued guidance.
Another provision is the increase in UBTI by disallowed fringe benefits. Under new Internal Revenue Code Section 512(a)(7), UBTI is increased by any amount for which a deduction isn’t allowable because of §274 and that is paid or incurred by the organization after 2017 for any qualified transportation fringe. This means organizations will need to look at certain types of expenses to determine if they should be reported as part of UBTI. See IRS Releases Guidance on Qualified Transportation Benefits for information on how organizations may calculate the disallowed amount. Unrelated trade or business income under §512(a)(7) isn’t treated as an unrelated trade or business, so organizations that are required to file Form 990-T only because they have UBTI in excess of $1,000 under this section must complete only the heading (above Part I) except for items C, E, H and I; relevant lines of Parts III and IV; and the signature area. Organizations are required to file Form 990-T if the sum of gross income from a regularly conducted unrelated trade or business and UBTI under §512(a)(7) attributable to expenses for certain qualified transportation fringe benefits is $1,000 or more. The UBTI is entered on the new line 34. If any amounts are directly connected with an unrelated trade or business that’s regularly carried on, they’re not includible as UBTI.
There are several TCJA provisions affecting expenses as well. The first relates to interest expense under §163(j), subject to a gross receipts test. If average annual gross receipts are more than $25 million for the three prior tax years, a taxpayer must limit business interest expense to the sum of business interest income, 30 percent of adjusted taxable income and floor plan financing interest. Business interest expense includes any interest paid or accrued on indebtedness properly allocable to a trade or business. Gross receipts include the aggregate gross receipts from all persons treated as a single employer, such as a controlled group of corporations and commonly controlled partnerships. If the organization has a trade or business and claims a deduction for business interest, Form 8990, Limitation on Business Interest Expense Under Section 163(j), generally is required. Form 8990 also must be filed by any taxpayer who owns an interest in a partnership with current- or prior-year carryover excess business interest expense allocated from the partnership. This will be a new attachment to the 990-T.
The TCJA also changed expensing rules for entertainment, and the 990-T instructions reflect this change. The instructions state that an organization can deduct ordinary and necessary travel, meals and nonentertainment expenses. In general, entertainment expenses, membership dues and facilities used in connection with these activities can’t be deducted. No portion of skybox rentals are deductible now, entertainment-related meals generally are disallowed and many organizations’ membership dues are no longer deductible. It’s important to emphasize that even if these entertainment expenses have a direct connection with the unrelated trade or business, they’re no longer deductible in calculating UBTI. This provides uniformity with the deductibility on taxable organizations.
The charitable contribution deduction calculation also is affected by the TCJA. Charitable contributions have always been allowed as a deduction in the calculation of UBTI even if they weren’t directly connected with the conduct of an unrelated trade or business, subject to a limit. While this hasn’t changed, an organization with more than one unrelated trade or business must determine an allocation of charitable contributions and may allocate the charitable contribution deduction using any reasonable method. The limitation is based on 10 percent of UBTI without regard to the charitable deduction and capital loss carrybacks. This limitation no longer references the addback of the domestic production activities deduction (DPAD) or any net operating loss (NOL) carryback, as these were both eliminated under the TCJA. Also, California wildfire disaster area contributions can temporarily suspend the 10 percent limit on charitable contributions. The limit doesn’t apply to qualified contributions made after October 7, 2017, and before January 1, 2019, to a qualified charitable organization that provides a contemporaneous written acknowledgment showing the contribution will be used for disaster relief efforts. These changes may create planning opportunities for organizations to determine a reasonable method to allocate these contributions among multiple sources of unrelated business income to efficiently apply the deduction.
As described above, the TCJA eliminated DPAD, so this can no longer be claimed on line 28, “Other deductions.” DPAD was most commonly claimed for tax-exempt organizations from pass-through K-1s received from partnership or S corporation interests.
Prior to the TCJA, an organization could choose to carry back an NOL two years or carry it forward 20 years. The TCJA eliminated the option to carry back an NOL, but carryforwards will no longer expire. An additional complication when calculating NOLs from UBTI exists because the NOL must be tracked by separate activities and a carryforward can only apply to the same activity from which it originated. The draft Form 990-T and Schedule M have the new line 31 for the deduction for an NOL arising in tax years beginning on or after January 1, 2018, which will be reported for each activity. Line 35 of Form 990-T, Part III, then has the deduction for an NOL arising in tax years beginning before January 1, 2018. The instructions for the NOL deduction from prior years state that the amount can’t exceed the sum of the total UBTI from Form 990-T and all Schedules M, nor can it exceed the amounts paid for disallowed fringes, addressed above. This conforms to TCJA provisions indicating that NOLs carried forward from these tax years will be able to offset all UBTI, including amounts paid for disallowed fringes. However, it also clarifies that only these prior NOLs can be used to offset the disallowed fringes—any NOLs generated in tax years beginning on or after January 1, 2018, can’t be used to offset the disallowed fringes.
The tax computation is another area affected by TCJA provisions and generally was simplified. The TCJA implemented a flat corporate tax of 21 percent effective January 1, 2018, so UBTI will now be taxed at 21 percent. Prior to the TCJA, controlled groups had to allocate their graduated tax brackets among entities. These calculations are removed; therefore, controlled groups will no longer file Schedule O, Consent Plan and Apportionment Schedule for a Controlled Group. Remember that for fiscal year filers beginning before January 1, 2018, and still filing on a 2017 form, a blended rate will still apply for the last year on the 2017 form. While this simplification of a flat tax rate of 21 percent will decrease tax for many corporations, many tax-exempt organizations may actually end up paying a higher tax rate. The previous tax rate schedule had the first tax bracket at 15 percent up to $50,000, so those with $50,000 or less in UBTI will actually have an increased rate from 15 percent to 21 percent.
Alternative minimum tax (AMT) will now only apply to trusts, as the AMT was eliminated for corporations. Therefore, Form 4626 (which calculated AMT) will no longer be filed, but Schedule I will still be attached for trusts. If the organization was subject to AMT in the past, it could have a minimum tax credit. Corporations may treat a portion of their prior-year AMT credit carryover as refundable, with 50 percent refundable until 2020 and then 100 percent refundable beginning in 2021. This will be claimed on IRS Form 8827.
There may still be other taxes that apply to the organization and are reported on line 47. One new tax is the base erosion minimum tax under §59A, known as the BEAT. Section 59A applies to base erosion payments paid or accrued in tax years beginning after 2017. If the organization had gross receipts of at least $500 million in any one of the three tax years preceding the current tax year, Form 8991 will be required and attached to the 990-T. The inclusion of global intangible low-taxed income (GILTI) is the new §951A, which requires U.S. shareholders of controlled foreign corporations to determine and include their GILTI in taxable income every year—users should attach Form 8992 to figure the GILTI. The foreign-derived intangible income (FDII) is the newly enacted §250, which allows a domestic corporation a deduction for the eligible percentage of FDII and GILTI. Use Form 8993 to determine the amount of the eligible deductions for FDII and GILTI under §250 and attach it to Form 990-T. For additional information regarding the BEAT, GILTI and FDII, see "BEAT or GILTI? Tax Reform’s Effect on Transfer Pricing."
A new line was added to Part V for the net 965 tax liability. Commonly referred to as repatriation, the treatment of deferred foreign income upon transition to participation exemption system of taxation is the §965 net tax liability. U.S. shareholders of specified foreign corporations may have an inclusion under §965 based on the post-1986 deferred foreign income of the specified foreign corporations determined as of November 2, 2017, or December 31, 2017. If the organization has a §965(a) inclusion for the tax year, the net amount is entered on the new line 49. The organization also must complete and attach Form 965. If an election to pay the §965 net tax liability in eight installments has been made under §965(h), the organization also must complete and attach Form 965-B. For more information on repatriation, see "IRS Large Business & International Campaigns Target Foreign Repatriation" or IRS Publication 5292.
The TCJA provided numerous significant changes, and UBTI was certainly no exception. With the increase in UBTI for disallowed fringes, there will likely be more organizations completing a Form 990-T and paying tax than ever before. The provisions outlined above will create the need for organizations to revisit a review of potential sources of UBTI for reporting and examine expenses for parking and transportation for possible UBTI. Organizations also should prepare for additional required forms and time spent tracking NOLs, allocating charitable contributions and updating expense allocations for new limits and deductibility. For more information, contact Krystal or your trusted BKD advisor.