IRS rules for reporting UBI for nonprofits close to being released

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The Internal Revenue Service is getting set to unveil its proposed regulations for the reporting of unrelated business income for tax-exempt organizations.

Early this month, the White House announced that it is reviewing the proposed regulations on how to implement the changes, which were included in a provision of the Tax Cuts and Jobs Act of 2017 and became Section 512(a)(6) of the Tax Code. That means the final rules could be imminent. IRS attorney Stephanie Robinson told attendees at a tax conference Friday that the IRS is “getting very close to the finish line,” according to Bloomberg Tax.

Nonprofits have been waiting for the proposed regulations, as the provision already took effect for the 2018 tax year. But the rules, when they’re eventually finalized by the IRS and the Treasury Department, could lead to some extra complexity in reporting. They’re likely to affect tax-exempt organizations such as colleges and universities that earn revenue from activities like sports and apparel sales.

“My impression is that they will provide some guidance with respect to how organizations and their tax advisors will interpret and properly report unrelated business income under the new Section 512(a)(6),” said Marc Berger, national director in BDO USA’s nonprofit tax services practice. “The proposed rules under 512(a)(6) would require organizations to report their unrelated trades or businesses separately on the Form 990-T, with the stated goal being that a loss from one unrelated trade or business activity could not be used to offset net income from another unrelated trade or business activity.”

The rules could help the IRS crack down on those nonprofits and tax-exempt organizations that may be playing fast and loose with offsetting the income from their revenue-generating activities with losses from another part of the organization. “I think many organizations report unrelated business income, and they’re reporting activities that on an annual basis generate losses, which are being used to offset income from other activities they net out to zero or a loss, and the organization owes no unrelated business income tax,” said Berger. “The IRS has had difficulty in the past identifying those activities that are getting reported with losses that maybe aren’t proper unrelated business income activities. So in lieu of examining each organization to try to ferret out those loss activities that shouldn't be reported, they’ve taken the position that you just can’t use those losses to offset income-producing activities.”

The IRS is more likely to find such practices at bigger organizations with lucrative business activities. “I think it’s more the larger organizations that are a little bit more complex than your run-of-the-mill charitable foundation,” said Berger. “It’s those organizations with different types of activities generating unrelated revenue streams. It could be hospitals, it could be colleges and universities, and those types of organizations that are involved in a lot of different activities that generate revenue. Those seem to be the biggest target of the change in the provision.”

Signs of trouble

The IRS published a report in 2013 on tax-exempt colleges and universities based on questionnaires about their unrelated business income and other matters, supported by compliance checks by IRS examiners (see our story).

“Their findings showed that they thought that unrelated business income was being underreported by a large percentage of those looked at, and that the computation of unrelated business income was incorrect, also in a high percentage of those studied,” said Berger.

The proposed regulations haven’t yet been issued, but the IRS sent out a notice in 2018 asking for comments about the calculation of unrelated business income for tax-exempt organizations (see our story). One of the groups that weighed in with a comment letter last November was the American Institute of CPAs. The AICPA suggested, among other recommendations, a de minimis exception for tax-exempt organizations reporting less than $100,000 of gross unrelated business income. “They seemed to try to put in an exemption for smaller tax-exempt organizations,” said Berger. “I wouldn’t be surprised if the regs implemented that, but it’s hard to be sure on that.”

The National Association of College and University Business Officers also submitted a comment letter in response to the 2018 notice. NACUBO suggested, among other things, that the IRS clarify that deductions for certain expenses, such as charitable contributions, could be used to offset unrelated business taxable income that’s not separately computed, including the tax on qualified transportation fringe benefits.

Religious groups and charities have been especially focused on the issue of qualified transportation fringe benefits, which also arose from the 2017 tax overhaul. The law limited their ability to provide free parking for their employees, along with other transit-related benefits. After intense lobbying, Congress repealed that provision last December.

“Those groups are more concerned with the transportation fringe benefit parking provision and provided a lot more input on that provision, which helped in the recent repeal of that provision at the end of last year,” said Berger. “The repeal of the parking tax provision was made retroactive to enactment. As a result, to recover the taxes that they paid, organizations are filing amended returns in order to get those taxes back.”

Tax-exempt organizations can prepare for the upcoming regulations by doing what they should have been doing anyway since the passage of the 2017 tax law. “Based on the way the law and the statute currently read, these organizations are going to have to keep separate books and records and separate profit and loss statements for each of those potentially unrelated activities, and more importantly indirect expenses, those expenses that might apply to multiple activities, whether related or unrelated,” said Berger. “They’re going to have to allocate those indirect expenses to each particular activity in a reasonable and documentable manner.”

Whatever modifications are eventually made through the regulations, the provision is already in effect for organizations’ 2018 tax year and forward, he noted, but the proposed rules are likely to come out soon.

“I wouldn’t be surprised if the regulations were made retroactive to the implementation or the effective date of the provision,” said Berger. “But, based on experience, the regulations, until they’re issued, they're not issued. It could be next week. It could be next month. It could be three months.”

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Tax regulations Tax laws Tax exemptions IRS Non-profits BDO USA