Taxes generally aren’t a top business concern for nonprofits, but if your organization has unrelated business income, it’s an issue even tax-exempt organizations have to keep track of.
What’s unrelated business? It involves a trade or business regularly carried on (including seasonally) by an organization, which isn't substantially related to the exercise or performance of its exempt purpose or function.
It’s an issue that’s been the subject of tax pursuits and even a lawsuit in Allentown. The city has recently started seeking business privilege taxes on nonprofit organizations’ profit generating activities. Good Shepherd Rehabilitation Network filed a lawsuit against the city about the tax pursuit.
The Pennsylvania Institute of Certified Public Accountants’ State Taxation Committee recently discussed the issue. Scranton also has started pursuing business privilege taxes from nonprofits and it’s expected other Pennsylvania municipalities will follow Allentown and Scranton’s leads.
While it’s always been important for nonprofits to track their unrelated business income, the possibility of having to pay municipal business privilege taxes on that income is an added reason. Allentown’s business privilege tax rate is $1.50 per $1,000 of gross volume business for retail businesses and $3 per $1,000 of gross volume business for service businesses.
The National Council of Nonprofit warns income from advertising and corporate sponsorships is often considered unrelated. Any ads or tickets included with sponsorships are often taxable, as is possibly the option of being an “exclusive” sponsor, as the IRS considers exclusivity to be a significant benefit, and therefore taxable.
Tax Reform Changes to Unrelated Business Income
The Tax Cuts and Jobs Act – enacted in late 2017 – includes some changes affecting unrelated business income. Under the TCJA, nonprofit organizations must calculate unrelated business income separately for each unrelated trade or business, with the total equaling the sum of those amounts. (None may be less than zero.) The determination for each business is made without regard to the $1,000 deduction generally allowed. That deduction is applied to the aggregate unrelated business income.
Importantly, net operating losses (NOLs) can only be claimed against future income from the specific business that generated the loss. (You can still use NOL carryovers from years prior to 2018 to offset all unrelated business income.)
Previously, you could apply NOLs from one business to reduce the taxable income of another, as well as to gains from alternative investments or pass-through entities also considered unrelated business income. The loss of this option could mean that nonprofits with multiple unrelated businesses will have more unrelated business income than in the past.
The TCJA also changes the corporate tax rate to 21% from a range of 15% to 35%. Because nonprofit organizations pay the corporate rate on unrelated business income, your tax liability potentially could fall even if your unrelated business income grows.
Your nonprofit may be able to minimize the effects of the changed rules for unrelated business income. For example, if you operate multiple unrelated businesses, consider housing them in a single taxable corporate subsidiary. This will allow you to offset the businesses’ income and losses against each other. Bear in mind, though, that such restructuring can have additional tax and legal implications.
You also might want to conduct a review of all of your unrelated businesses to ensure you've been accurately capturing all expenses that are allocable to each business. Otherwise, you could be inflating UBIT. Every nonprofit with unrelated business income should have effective methods for tracking and allocating income and expenses, including compensation, investment management fees and overhead.
We’ve helped many nonprofits track and separate their unrelated business income to both reduce taxes and protect their tax exempt status. Contact our Nonprofit Team for a personalized assessment.
Content from Thomson Reuters’ Checkpoint Marketing is included in this article.