Unrelated Business Income - More Than Income These Days
The tax-exempt community has long been immune from many of the tax provisions meant to raise tax revenue from the business community by determining certain expenses are not tax deductible. For example, businesses may deduct only 50% of the amount spent on business meals and certain expenses for business autos may be limited. Since tax-exempt entities do not calculate tax on their regular operations, these rules have never affected them.
The Tax Cuts and Jobs Act of 2017 (the Act) provides lower tax rates on business activities, but it also reduces several deductions for various business expenses. One of the deduction eliminated by the Act is the elimination of deductions for expenses paid by an employer for qualified transportation fringe benefits provided to employees.
Qualified transportation fringe benefits, defined by Internal Revenue Code (IRC) Section 132(f), include:
- Commuter transportation in a commuter vehicle;
- Transit passes;
- Qualified parking at regular work facilities; and
- Qualified bicycle commuting reimbursement.
Prior law allowed these benefits to be provided to employees, within certain limitations, tax-free and allowed the employer to deduct the costs of the benefit. Therefore, the benefits were a win-win for the employer and the employee. The Act still allows for an employer to provide the benefits to employees tax-free, but the employer may no longer deduct the cost of the benefit for federal income tax purposes. (Since most state tax laws follow federal tax law, the expenses are also not deductible for state income tax purposes.)
How does this affect the tax-exempt community? The Act also enacts a new provision for unrelated business taxable income creating a taxable event when a tax-exempt employer pays these same expenses for its employees. Since other employers will pay tax on the costs of the benefits through the disallowance of the deduction for the benefit, the tax-exempt employers will join them in paying tax on the costs. IRC Section 512(a)(7) now states that any expenses incurred for qualified transportation fringe benefits and are disallowed by IRC Section 274, will be included in unrelated business taxable income (UBTI). [The provision in IRC Section 512(a)(7) also includes costs associated with on premises athletic facilities, but the Act did not create a corresponding disallowance under IRC Section 274 for these expenses. Therefore, at this time, the costs for on premises athletic facilities are escaping the effect of IRC Section 512(a)(7).]
A church, in a large metropolitan downtown area, has limited parking facilities. Because of limited parking facilities, employees must pay to park in nearby facilities. The church reimburses its 10 ministers for these parking expenses. The parking expenses are $260 per minister, per month, so the full parking reimbursement is a qualified transportation fringe benefit and is excluded from the ministers’ taxable income. (The parking benefit is limited to $260 per month.) Because of the new provisions, the church must file Form 990-T reporting the cost of the benefit, $2,600, as UBTI. After the standard deduction of $1,000 allowed in computing UBTI, the net taxable income is $1,600. The church's tax owed is $336 (calculated at the corporate rate of 21%).
While the provision does not affect most churches, it may affect churches in metropolitan areas providing parking or transit passes to employees. Churches providing these benefits must understand the benefit has limitations on the tax-free amount available to employees and the potential of the benefit to create an income tax and a requirement to file Form 990-T. The new provisions are effective for amounts paid or incurred after December 31, 2017.
The essence of the law requires someone to pay tax on the transportation costs. Therefore, the tax burden may be shifted to employees by opting to include the value of the benefits in employees’ taxable income. Employers, both taxable and tax-exempt, must decide who will bear the new tax burden, the employer or the employee.