Massachusetts emergency paid sick leave (MA EPSL)

Are you spending enough time on your paid time off plan?
Many questions arise regarding paid time off (PTO) plans and the constructive receipt of income, which can cause payroll complications for employers and phantom income inclusion for employees. In order to avoid being subject to penalties for not withholding income and payroll taxes and having employees be subject to tax on cash they have not received, certain steps need be followed if an employer wants to properly allow employees to cash-out PTO.

What the IRS is looking for.
The Internal Revenue Service (IRS) has issued a number of Private Letter Rulings (PLRs) that examine earned time cash-out programs. While such rulings don’t serve as precedent, it appears the IRS has come up with the following factors that it deems important in order to avoid constructive receipt in a PTO cash-out situation:

1. Employees must make a written election before the end of December in the year prior to the year they will be earning and receiving the accrued earned time to be cashed-out.  This is an election to receive a cash payout of the earned time to be accrued in the following year.
2. The election must be irrevocable.
3. The payout can only happen once the employee has actually earned and accrued the earned time in the following year. Payouts are generally once or twice per year, but may happen more frequently.

The IRS appears to generally require that the earned time being paid out be substantially less than the accrued earned time owed to the employee. This is to ensure that the earned time program remains a bona fide sick or vacation pay plan and not a plan of deferred compensation. This particular requirement can get tricky and may be different in each employer’s case.

Why does it matter?
The danger of failing to follow IRS guidelines regarding earned time cash-outs is that the IRS could claim that the employees offered a choice to cash-out are in constructive receipt of their accrued earned time balances regardless of their choice. This would result in immediate taxation of all accrued amounts to the employees, even if they hadn’t received the cash. The employer would also be subject to penalties for not properly withholding federal and state taxes.

It is important to review your PTO plan to be sure there are no issues regarding constructive receipt and to make sure your payroll systems are correctly reporting income.

The IRS issued proposed regulations under Code Section 457 in June of 2016 regarding, in part, non-qualified deferred compensation plans of not-for-profit (NFP) organizations. Those regulations contain guidance regarding the cash-out of sick and vacation time and the possibility that certain cash-out provisions may create a plan of deferred compensation and not a bona fide sick leave or vacation leave plan. As noted above, such a determination would be disastrous as all amounts accrued would become immediately taxable. NFP organizations and their advisors should keep a close eye on the proposed Section 457 regulations to see how they develop in final form. Once the regulations are finalized, NFP organizations may need to make changes to their cash-out provisions.

Please note that the above information is general in nature and is not meant to provide guidance on any particular case. If you have any questions about your PTO plan, please contact Bill Enck.

When it comes to offering non-qualified deferred compensation to executives of not-for-profit organizations, there aren’t many options. Your organization must follow the rules and related guidance outlined in Internal Revenue Code Sections 457 and 409A. There are two types of non-qualified deferred compensation plans: Eligible (457(b) plans) and ineligible (457(f) plans)

• 457(b) plans operate very similarly to 403(b) or 401(k) plans and have an annual benefit limit.

• 457(f) plans have no annual benefit limit but the participants must include the benefits in taxable income when the substantial risk of forfeiture lapses.

Changes are on the table
And that's largely a good thing.The proposed regulations provide guidance in several key areas used to determine whether a substantial risk of forfeiture exists or not. For the most part, the proposed guidance is welcome news and provides an employer with more flexibility than originally expected.

Earlier this year, the IRS issued proposed regulations which describe just what constitutes a substantial risk of forfeiture under an ineligible 457(f) plan and what types of benefits are not considered to be ineligible 457(f) plans. Because of the tax implications to the executive, this is important for your organization to understand and communicate.

What the proposed regulations cover:

1. Non-compete agreements
2. Rolling risks of forfeiture (e.g., rolling vesting schedules)
3. Determining the present value of accrued benefits
4. Plans that are not considered 457(f) plans, including bona fide severance pay plans

In each of these areas, the proposed regulations provide employers with specific rules to follow in order to design and operate a plan, whether it's an existing plan or one adopted before or after the rules are finalized. Current plans will not have grandfathered status. 

What you need to do
For existing deferred compensation arrangements or employment contracts that provide for severance pay for deferred compensation arrangements,you must:

• Take inventory of the types of benefits you provide (e.g., severance pay, 457(b), 457(f) plans)
• Review plan provisions and determine the changes you need to make in order for them to be in compliance with the guidelines. 
• Make the appropriate changes to the plan or employment contract provisions before the final regulations are effective.
• The final regulations generally will not be effective until 90 days after they've been published. You may rely on them in the interim.

If you have questions or concerns
We've helped many not-for-profit organizations design and develop executive compensation packages, including deferred compensation plans. Our Benefits Compensation experts are well versed in the rules that apply to deferred compensation and severance pay plans and can help guide you through the process to:

1. Create a plan that meets the needs of your executive and your organization
2. Determine if any changes must be made to the benefits you’re currently offering

Contact Bill Enck if you have questions or need help.

Executive compensation, bonuses, and other cost structure items, such as rent, are often contentious issues in business valuations, as business valuations are often valued by reference to the income they produce. If the business being valued pays its employees an above-market rate, for example, its income will be depressed. Accordingly, if no adjustments are made, the value of the business will also be diminished.

When valuing controlling ownership interests, valuation analysts often restate above- or below-market items (compensation, bonuses, rent, etc.) to a fair market level to reflect what a hypothetical buyer would pay. In the valuation of companies with ESOPs, the issue gets more complicated. The following hypothetical example illustrates why.

Glamorous Grocery is a company that is 100% owned by an ESOP. A valuation analyst is retained to estimate the fair market value of each ESOP share. Glamorous Grocery generates very little income, in part because several executives are overcompensated. The valuation analyst normalizes executive compensation to a market level. This increases Glamorous Grocery’s income, and by extension the fair market value of Glamorous Grocery, ultimately resulting in a higher ESOP share value.

Glamorous Grocery’s trustee then uses this valuation to establish the market price of ESOP shares for the following year. When employees retire, Glamorous Grocery buys employees out at the established share price. The problem? As mentioned before, Glamorous Grocery generates very little income and as a result has difficulty obtaining the liquidity to buy out employees.

This simple example illustrates the concerns about normalizing executive compensation in ESOP valuations. If you reduce executive compensation for valuation purposes, the share price increases, putting a heavier burden on the company when you redeem shares. The company, which already has reduced income from paying above-market executive compensation, may struggle to redeem shares at the established price.

While control-level adjustments may be common, it is worth considering whether they are appropriate in an ESOP valuation. It is important that the benefit stream reflect the underlying economic reality of the company to ensure longevity of the company and the company’s ESOP.

Questions? Our valuation team will be happy to help. 

BerryDunn’s Business Valuation Group partners with clients to bring clarity to the complexities of business valuation, while adhering to strict development and reporting standards. We render an independent, objective opinion of your company’s value in a reporting format tailored to meet your needs. We thoroughly analyze the financial and operational performance of your company to understand the story behind the numbers. We assess current and forecasted market conditions as they impact present and future cash flows, which in turn drives value.

Do you know what would happen to your company if your CEO suddenly had to resign immediately for personal reasons? Or got seriously ill? Or worse, died? These scenarios, while rare, do happen, and many companies are not prepared. In fact, 45% of US companies do not have a contingency plan for CEO succession, according to a 2020 Harvard Business Review study.  

Do you have a plan for CEO succession? As a business owner, you may have an exit strategy in place for your company, but do you have a plan to bridge the leadership gap for you and each member of your leadership team? Does the plan include the kind of crises listed above? What would you do if your next-in-line left suddenly? 

Whether yours is a family-owned business, a company of equity partners, or a private company with a governing body, here are things to consider when you’re faced with a situation where your CEO has abruptly departed or has decided to step down.  

1. Get a plan in place. First, assess the situation and figure out your priorities. If there is already a plan for these types of circumstances, evaluate how much of it is applicable to this particular circumstance. For example, if the plan is for the stepping down or announced retirement of your CEO, but some other catastrophic event occurs, you may need to adjust key components and focus on immediate messaging rather than future positioning. If there is no plan, assign a small team to create one immediately. 

Make sure management, team leaders, and employees are aware and informed of your progress; this will help keep you organized and streamline communications. Management needs to take the lead and select a point person to document the process. Management also needs to take the lead in demeanor. Model your actions so employees can see the situation is being handled with care. Once a strategy is identified based on your priorities, draft a plan that includes what happens now, in the immediate future, and beyond. Include timetables so people know when decisions will be made.  

2. Communicate clearly, and often. In times of uncertainty, your employees will need as much specific information as you can give them. Knowing when they will hear from you, even if it is “we have nothing new to report” builds trust and keeps them vested and involved. By letting them know what your plan is, when they’ll receive another update, what to tell clients, and even what specifics you can give them (e.g., who will take over which CEO responsibility and for how long), you make them feel that they are important stakeholders, and not just bystanders. Stakeholders are more likely to be strong supporters during and after any transition that needs to take place. 

3. Pull in professional help. Depending on your resources, we recommend bringing in a professional to help you handle the situation at hand. At the very least, call in an objective opinion. You’ll need someone who can help you make decisions when emotions are running high. Bringing someone on board that can help you decipher what you have to work with and what your legal and other obligations may be, help rally your team, deal with the media, and manage emotions can be invaluable during a challenging time. Even if it’s temporary. 

4. Develop a timeline. Figure out how much time you have for the transition. For example, if your CEO is ill and will be stepping down in six months, you have time to update any existing exit strategy or succession plan you have in place. Things to include in the timeline: 

• Who is taking over what responsibilities? 
• How and what will be communicated to your company and stakeholders? 
• How and what will be communicated to the market? 
• How will you bring in the CEO's replacement, while helping the current CEO transition out of the organization? 

If you are in a crisis situation (e.g., your CEO has been suddenly forced out or asked to leave without a public explanation), you won’t have the luxury of time.  

Find out what other arrangements have been made in the past and update them as needed. Work with your PR firm to help with your change management and do the right things for all involved to salvage the company’s reputation. When handled correctly, crises don’t have to have a lasting negative impact on your business.   

5. Manage change effectively. When you’re under the gun to quickly make significant changes at the top, you need to understand how the changes may affect various parts of your company. While instinct may tell you to focus externally, don’t neglect your employees. Be as transparent as you possibly can be, present an action plan, ask for support, and get them involved in keeping the environment positive. Whether you bring in professionals or not, make sure you allow for questions, feedback, and even discord if challenging information is being revealed.  

6. Handle the media. Crisis rule #1 is making it clear who can, and who cannot, speak to the media. Assign a point person for all external inquiries and instruct employees to refer all reporter requests for comment to that point person. You absolutely do not want employees leaking sensitive information to the media. 
 
With your employees on board with the change management action plan, you can now focus on external communications and how you will present what is happening to the media. This is not completely under your control. Technology and social media changed the game in terms of speed and access to information to the public and transparency when it comes to corporate leadership. Present a message to the media quickly that coincides with your values as a company. If you are dealing with a scandal where public trust is involved and your CEO is stepping down, handling this effectively will take tact and most likely a team of professionals to help. 

Exit strategies are planning tools. Uncontrollable events occur and we don’t always get to follow our plan as we would have liked. Your organization can still be prepared and know what to do in an emergency situation or sudden crisis.  Executives move out of their roles every day, but how companies respond to these changes is reflective of the strategy in place to handle unexpected situations. Be as prepared as possible. Own your challenges. Stay accountable. 

BerryDunn can help whether you need extra assistance in your office during peak times or interim leadership support during periods of transition. We offer the expertise of a fully staffed accounting department for short-term assignments or long-term engagements―so you can focus on your business. Meet our interim assistance experts.

Read this if your CFO has recently departed, or if you're looking for a replacement.

With the post-Covid labor shortage, “the Great Resignation,” an aging workforce, and ongoing staffing concerns, almost every industry is facing challenges in hiring talented staff. To address these challenges, many organizations are hiring temporary or interim help—even for C-suite positions such as Chief Financial Officers (CFOs).

You may be thinking, “The CFO is a key business partner in advising and collaborating with the CEO and developing a long-term strategy for the organization; why would I hire a contractor to fill this most-important role?” Hiring an interim CFO may be a good option to consider in certain circumstances. Here are three situations where temporary help might be the best solution for your organization.

Your organization has grown

If your company has grown since you created your finance department, or your controller isn’t ready or suited for a promotion, bringing on an interim CFO can be a natural next step in your company’s evolution, without having to make a long-term commitment. It can allow you to take the time and fully understand what you need from the role — and what kind of person is the best fit for your company’s future.

BerryDunn's Kathy Parker, leader of the Boston-based Outsourced Accounting group, has worked with many companies to help them through periods of transition. "As companies grow, many need team members at various skill levels, which requires more money to pay for multiple full-time roles," she shared. "Obtaining interim CFO services allows a company to access different skill levels while paying a fraction of the cost. As the company grows, they can always scale its resources; the beauty of this model is the flexibility."

If your company is looking for greater financial skill or advice to expand into a new market, or turn around an underperforming division, you may want to bring on an outsourced CFO with a specific set of objectives and timeline in mind. You can bring someone on board to develop growth strategies, make course corrections, bring in new financing, and update operational processes, without necessarily needing to keep those skills in the organization once they finish their assignment. Your company benefits from this very specific skill set without the expense of having a talented but expensive resource on your permanent payroll.

Your CFO has resigned

The best-laid succession plans often go astray. If that’s the case when your CFO departs, your organization may need to outsource the CFO function to fill the gap. When your company loses the leader of company-wide financial functions, you may need to find someone who can come in with those skills and get right to work. While they may need guidance and support on specifics to your company, they should be able to adapt quickly and keep financial operations running smoothly. Articulating short-term goals and setting deadlines for naming a new CFO can help lay the foundation for a successful engagement.

You don’t have the budget for a full-time CFO

If your company is the right size to have a part-time CFO, outsourcing CFO functions can be less expensive than bringing on a full-time in-house CFO. Depending on your operational and financial rhythms, you may need the CFO role full-time in parts of the year, and not in others. Initially, an interim CFO can bring a new perspective from a professional who is coming in with fresh eyes and experience outside of your company.

After the immediate need or initial crisis passes, you can review your options. Once the temporary CFO’s agreement expires, you can bring someone new in depending on your needs, or keep the contract CFO in place by extending their assignment.

Considerations for hiring an interim CFO

Making the decision between hiring someone full-time or bringing in temporary contract help can be difficult. Although it oversimplifies the decision a bit, a good rule of thumb is: the more strategic the role will be, the more important it is that you have a long-term person in the job. CFOs can have a wide range of duties, including, but not limited to:

• Financial risk management, including planning and record-keeping
• Management of compliance and regulatory requirements
• Creating and monitoring reliable control systems
• Debt and equity financing
• Financial reporting to the Board of Directors

If the focus is primarily overseeing the financial functions of the organization and/or developing a skilled finance department, you can rely — at least initially — on a CFO for hire.

Regardless of what you choose to do, your decision will have an impact on the financial health of your organization — from avoiding finance department dissatisfaction or turnover to capitalizing on new market opportunities. Getting outside advice or a more objective view may be an important part of making the right choice for your company.

BerryDunn can help whether you need extra assistance in your office during peak times or interim leadership support during periods of transition. We offer the expertise of a fully staffed accounting department for short-term assignments or long-term engagements―so you can focus on your business. Meet our interim assistance experts.

A common pitfall for inbound sellers is applying the same concepts used to adopt “no tax” positions made for federal income tax purposes to determinations concerning sales and use tax compliance. Although similar conceptually, separate analyses are required for each determination.

For federal income tax purposes, inbound sellers that are selling goods to customers in the U.S. and do not have a fixed place of business or dependent agent in the U.S. have, traditionally, been able to rely on their country’s income tax treaty with the U.S. for “no tax” positions. Provided that the non-U.S. entity did not have a “permanent establishment” in the U.S., it was shielded from federal income tax and would have a limited federal income tax compliance obligation.

States, however, are generally not bound by comprehensive income tax treaties made with the U.S. Thus, non-U.S. entities can find themselves unwittingly subject to state and local sales and use tax compliance obligations even though they are protected from a federal income tax perspective. With recent changes in U.S. tax law, the burden of complying with sales and use tax filing and collection requirements has increased significantly.

Does your company have a process in place to deal with these new state and local tax compliance obligations?

What has changed? Wayfair—it’s got what a state needs

As a result of the Supreme Court’s ruling in South Dakota v. Wayfair, Inc., non-U.S. entities that have sales to customers in the U.S. may have unexpected sales and use tax filing obligations on a go-forward basis. Historically, non-U.S. entities did not have a sales and use tax compliance obligation when they did not have a physical presence in states where the sales occurred.

In Wayfair, the U.S. Supreme Court ruled that a state is no longer bound by the physical presence standard in order for it to impose its sales and use tax regime on entities making sales within the state. The prior physical presence standard was set forth in precedent established by the Supreme Court and was used to determine if an entity had sufficient connection with a state (i.e., nexus) to necessitate a tax filing and collection requirement.

Before the Wayfair ruling, an entity had to have a physical presence (generally either through employees or property located in a state) in order to be deemed to have nexus with the state. The Wayfair ruling overturned this precedent, eliminating the physical presence requirement. Now, a state can deem an entity to have nexus with the state merely for exceeding a certain level of sales or transactions with in-state customers. This is a concept referred to as “economic nexus.”

The Court in Wayfair determined that the state law in South Dakota providing a threshold of $100,000 in sales or more than 200 sale transactions occurring within the state is sufficient for economic nexus to exist with the state. This is good news for hard-pressed states and municipalities in search of more revenue. Since this ruling, there has been a flurry of new state legislation across the country. Like South Dakota, states are actively passing tax laws with similar bright-line tests to determine when entities have economic nexus and, therefore, a sales and use tax collection and filing requirement.

How this impacts non-U.S. entities

This can be a trap for non-U.S. entities making sales to customers in the U.S. Historically, non-U.S. entities lacking a U.S. physical presence generally only needed to navigate federal income tax rules.

Inbound sellers without a physical presence in the U.S. may have very limited experience with state and local tax compliance obligations. When considering all of the state and local tax jurisdictions that exist in the U.S. (according to the Tax Foundation there are more than 10,000 sales tax jurisdictions), the number of sales and use tax filing obligations can be significant. Depending on the level of sales activity within the U.S., a non-U.S. entity can quickly become inundated with the time and cost of sales and use tax compliance.

Next steps

Going forward, non-U.S. entities selling to customers in the U.S. should be aware of those states that have economic nexus thresholds and adopt procedures so they are prepared for their sales and use tax compliance obligations in real time. These tax compliance obligations will generally require an entity to register to do business in the state, collect sales tax from customers, and file regular tax returns, usually monthly or quarterly.

It is important to note when an entity has an obligation to collect sales tax, it will be liable for any sales tax due to a state, regardless of whether the sales tax is actually collected from the customer. It is imperative to stay abreast of these complex legislative changes in order to be compliant.

At BerryDunn, our tax professionals work with a number of non-U.S. companies that face international, state, and local tax issues. If you would like to discuss your particular circumstances, contact one of the experienced professionals in our state and local tax (“SALT”) practice.

It’s that time of year. Kids have gone back to school, the leaves are changing color, the air is getting crisp and… year-end tax planning strategies are front of mind! It’s time to revisit or start tax planning for the coming year-end, and year-end purchase of capital equipment and the associated depreciation expense are often an integral part of that planning.

The Tax Cuts and Jobs Act (TCJA) expanded two prevailing types of accelerated expensing of capital improvements: bonus depreciation and section 179 depreciation. They each have different applications and require planning to determine which is most advantageous for each business situation.

100% expensing of selected capital improvements—bonus depreciation

Originating in 2001, bonus depreciation rules allowed for immediate expensing at varying percentages in addition to the “regular” accelerated depreciation expensed over the useful life of a capital improvement. The TCJA allows for 100% expensing of certain capital improvements during 2018. Starting in 2023, the percentage drops to 80% and continues to decrease after 2023. In addition to the increased percentage, used property now qualifies for bonus depreciation. Most new and used construction equipment, office and warehouse equipment, fixtures, and vehicles qualify for 100% bonus depreciation along with certain other longer lived capital improvement assets. Now is the time to take advantage of immediate write-offs on crucial business assets. 

TCJA did not change the no dollar limitations or thresholds, so there isn’t a dollar limitation or threshold on taking bonus depreciation. Additionally, you can use bonus depreciation to create taxable losses. Bonus depreciation is automatic, and a taxpayer may elect out of the bonus depreciation rules.

However, a taxpayer can’t pick and choose bonus depreciation on an asset-by-asset basis because the election out is made by useful life. Another potential drawback is that many states do not allow bonus depreciation. This will generally result in higher state taxable income in the early years that reverses in subsequent years.

Section 179 expensing

Similar to bonus depreciation, section 179 depreciation allows for immediate expensing of certain capital improvements. The TCJA doubled the allowable section 179 deduction from $500,000 to $1,000,000. The overall capital improvement limits also increased from $2,000,000 to $2,500,000. These higher thresholds allow for even higher tax deductions for business that tend to put a lot of money in a given year on capital improvements.

In addition to these limits, section 179 cannot create a loss. Because of these constraints, section 179 is not as flexible as bonus depreciation but can be very useful if the timing purchases are planned to maximize the deduction. Many states allow section 179 expense, which may be an advantage over bonus depreciation.

Both section 179 and bonus depreciation are crucial tools for all businesses. They can reduce taxable income and defer tax expense by accelerating depreciation deductions. Please contact your tax advisor to determine if your business qualifies for bonus depreciation or section 179 and how to maximize each deduction for 2018.

Section 179 and bonus depreciation: where to go from here

Both section 179 and bonus depreciation are crucial tools for all businesses. They can reduce taxable income and defer tax expense by accelerating depreciation deductions. Please contact your tax advisor to determine if your business qualifies for bonus depreciation or section 179 and how to maximize each deduction for 2018.

IRS Notice 2018-67 Hits the Charts
Last week, in addition to The Eagles Greatest Hits (1971-1975) album becoming the highest selling album of all time, overtaking Michael Jackson’s Thriller, the IRS issued Notice 2018-67—its first formal guidance on Internal Revenue Code Section 512(a)(6), one of two major code sections added by the Tax Cuts and Jobs Act of 2017 that directly impacts tax-exempt organizations. Will it too, be a big hit? It remains to be seen.

Section 512(a)(6) specifically deals with the reporting requirements for not-for-profit organizations carrying on multiple unrelated business income (UBI) activities. Here, we will summarize the notice and help you to gain an understanding of the IRS’s thoughts and anticipated approaches to implementing §512(a)(6).

While there have been some (not so quiet) grumblings from the not-for-profit sector about guidance on Code Section 512(a)(7) (aka the parking lot tax), unfortunately we still have not seen anything yet. With Notice 2018-67’s release last week, we’re optimistic that guidance may be on the way and will let you know as soon as we see anything from the IRS.

Before we dive in, it’s important to note last week’s notice is just that—a notice, not a Revenue Procedure or some other substantive legislation. While the notice can, and should be relied upon until we receive further guidance, everything in the notice is open to public comment and/or subject to change. With that, here are some highlights:

No More Netting
512(a)(6) requires the organization to calculate unrelated business taxable income (UBTI), including for purposes of determining any net operating loss (NOL) deduction, separately with respect to each such trade or business. The notice requires this separate reporting (or silo-ing) of activities in order to determine activities with net income from those with net losses.

Under the old rules, if an organization had two UBI activities in a given year, (e.g., one with $1,000 of net income and another with $1,000 net loss, you could simply net the two together on Form 990-T and report $0 UBTI for the year. That is no longer the case. From now on, you can effectively ignore activities with a current year loss, prompting the organization to report $1,000 as taxable UBI, and pay associated federal and state income taxes, while the activity with the $1,000 loss will get “hung-up” as an NOL specific to that activity and carried forward until said activity generates a net income.

Separate Trade or Business
So, how does one distinguish (or silo) a separate trade or business from another? The Treasury Department and IRS intend to propose some regulations in the near future, but for now recommend that organizations use a “reasonable good-faith interpretation”, which for now includes using the North American Industry Classification System (NAICS) in order to determine different UBI activities.

For those not familiar, the NAICS categorizes different lines of business with a six-digit code. For example, the NAICS code for renting* out a residential building or dwelling is 531110, while the code for operating a potato farm is 111211. While distinguishing residential rental activities from potato farming activities might be rather straight forward, the waters become muddier if an organization rents both a residential property and a nonresidential property (NAICS code 531120). Does this mean the organization has two separate UBI rental activities, or can both be grouped together as rental activities? The notice does not provide anything definitive, but rather is requesting public comments?we expect to see something more concrete once the public comment period is over.

*In the above example, we’re assuming the rental properties are debt-financed, prompting a portion of the rental activity to be treated as UBI.

UBI from Partnership Investments (Schedule K-1)
Notice 2018-67 does address how to categorize/group unrelated business income for organizations that receive more than one partnership K-1 with UBI reported. In short, if the Schedule K-1s the organization receives can meet either of the tests below, the organization may treat the partnership investments as a single activity/silo for UBI reporting purposes. The notice offers the following:

De Minimis Test
You can aggregate UBI from multiple K-1s together as long as the exempt organization holds directly no more than 2% of the profits interest and no more that 2% of the capital interest. These percentages can be found on the face of the Schedule K-1 from the Partnership and the notice states those percentages as shown can be used for this determination. Additionally, the notice allows organizations to use an average of beginning of year and end of year percentages for this determination.

Ex: If an organization receives a K-1 with UBI reported, and the beginning of year profit & capital percentages are 3%, and the end of year percentages are 1%, the average for the year is 2% (3% + 1% = 4%/2 = 2%). In this example, the K-1 meets the de minimis test.

There is a bit of a caveat here—when determining an exempt organization's partnership interest, the interest of a disqualified person (i.e. officers, directors, trustees, substantial contributors, and family members of any of those listed here), a supporting organization, or a controlled entity in the same partnership will be taken into account. Organizations need to review all K-1s received and inquire with the appropriate person(s) to determine if they meet the terms of the de minimis test.

Control Test
If an organization is not able to pass the de minimis test, you may instead use the control test. An organization meets the requirements of the control test if the exempt organization (i) directly holds no more than 20 percent of the capital interest; and (ii) does not have control or influence over the partnership.

When determining control or influence over the partnership, you need to apply all relevant facts and circumstances. The notice states:

“An exempt organization has control or influence if the exempt organization may require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operations of the partnership. An exempt organization also has control or influence over a partnership if any of the exempt organization's officers, directors, trustees, or employees have rights to participate in the management of the partnership or conduct the partnership's business at any time, or if the exempt organization has the power to appoint or remove any of the partnership's officers, directors, trustees, or employees.”

As noted above, we recommend your organization review any K-1s you currently receive. It’s important to take a look at Line I1 and make sure your organization is listed here as “Exempt Organization”. All too often we see not-for-profit organizations listed as “Corporations”, which while usually technically correct, this designation is really for a for-profit corporation and could result in the organization not receiving the necessary information in order to determine what portion, if any, of income/loss is attributable to UBI.

Net Operating Losses
The notice also provides some guidance regarding the use of NOLs. The good news is that any pre-2018 NOLs are grandfathered under the old rules and can be used to offset total UBTI on Form 990-T.

Conversely, any NOLs generated post-2018 are going to be considered silo-specific, with the intent being that the NOL will only be applicable to the activity which gave rise to the loss. There is also a limitation on post-2018 NOLs, allowing you to use only 80% of the NOL for a given activity. Said another way, an activity that has net UBTI in a given year, even with post-2017 NOLs, will still potentially have an associated tax liability for the year.

Obviously, Notice 2018-67 provides a good baseline for general information, but the details will be forthcoming, and we will know then if they have a hit. Hopefully the IRS will not Take It To The Limit in terms of issuing formal guidance in regards to 512(a)(6) & (7). Until they receive further IRS guidance,  folks in the not-for-profit sector will not be able to Take It Easy or have any semblance of a Peaceful Easy Feeling. Stay tuned.