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Tax-exempt
organizations: The wait is over, sort of

08.29.18

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 2018-67its 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.

Related Services

Of all the changes that came with the sweeping Tax Cuts and Jobs Act (TCJA) in late 2017, none has prompted as big a response from our clients as the changes TCJA makes to the qualified parking deduction. Then, last month, the IRS issued its long-waited guidance on this code section in the form of Notice 2018-99

We've taken a look at both the the original provisions, and the new guidance, and have collected the salient points and things we think you need to consider this tax season. For not-for-profit organizations, visit my article here. And for-profit companies can read here.  

Blog
IRS guidance on qualified parking: Our take

Not-for-profit board members need to wear many hats for the organization they serve. Every board member begins their term with a different set of skills, often chosen specifically for those unique abilities. As board members, we often assist the organization in raising money and as such, it is important for all members of the board to be fluent in the language of fundraising. Here are some basic definitions you need to know, and the differences between them.

Gifts with donor restriction

While many organizations can use all donations for their operating costs, many donors prefer to specify how―or when―they can use the donation. Gift restrictions come in several forms:

1.    Purpose-restricted gifts are, as their name implies, for a specific use. These can be in response to a request from your organization for that specific purpose or the donor can indicate its purpose when they make the gift. Consider how you solicit gifts from donors to be sure you don’t inadvertently apply restrictions. Not all gifts need to (or even should) be accepted by an organization, so take care in considering if specific restrictions are in line with your mission. 

2.    Time-restricted gifts can come with or without a restricted purpose. You can treat gifts for future periods as revenue today, though the funds would be considered restricted for use until the time restrictions have lapsed. These are often in the form of pledges of gifts for the future, but can also be actual donations provided today for use in coming years.

3.    Some donors prefer the earnings of their gift be available for use, while their actual donation be held in perpetuity. These are often in the form of endowments and specific restrictions may or may not be placed by the donor on the endowment’s earnings. Laws can differ from state-to-state for the treatment of those earnings, but your investment policy should govern the spending from these earnings.

The bottom line? Restricted-purpose gifts must be used for that restricted purpose.

Gifts without restriction are always welcome by organizations. The board has the ability to direct the spending of these gifts, and may designate funds for a future purpose, but unlike gifts with donor restrictions, the board does have the discretion to change their own designations.

Whether raising money or reviewing financial information, understanding fundraising language is key for board members to make the most out of donations. See A CPA’s guide to starting a capital campaign and Accounting 101 for development directors blogs for more information. Have questions or want to learn more? Please contact Emily Parker or Sarah Belliveau.

Blog
The language of fundraising: A primer for NFP board members

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.

Blog
Sales & Use Tax: A potential trap for Non-U.S. entities

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 improvementsbonus 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.

Bonus Depreciation Section 179
Deduction maximum N/A $1,000,000 for 2018
Total addition phase out N/A $2,500,000 for 2018


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.

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Tax planning strategies for year-end

As 2018 is about to come to a close, organizations with fiscal year ends after December 15, 2018, are poised to start implementing the new not-for-profit reporting standard. Here are three areas to address before the close of the fiscal year to set your organization up for a smooth and successful transition, and keep in compliance:

  1. Update and approve policies—organizations need to both change certain disclosures and add new ones. The policies in place at the end of the year will be pivotal in creating the framework within which to draft these new disclosures (for example, treatment of board designations, underwater endowments, and liquidity).
  2. Functional expense reporting—if you have not historically reported expenses by natural and functional classification, develop the methodology for cost allocation. If you already have a framework in place, revisit it to determine if this still fits your organization. Finally, determine where you will present this information in the financial statements.
  3. Internal investment costs—be sure you have a methodology to segregate the organization’s internal investment costs such as internal staff time (remember, this is the cost to generate the income, not account for it) and consider the overall disclosure.

While the implementation of the new reporting standard will not be without cost (both internal costs and audit costs), if your organization considers this an opportunity to better tell your story, the end result will be a much more useful financial narrative. Don’t forget to include the BerryDunn implementation whitepaper in your implementation strategy.

We at BerryDunn are helping organizations gain momentum with a personal touch, through our not-for-profit reporting checkup. This checkup includes initial recast of the prior financial statements to the new format, a personalized review of the checklist to identify opportunities for success, and consideration of the footnotes to be updated. Contact me and find out how you can join the list of organizations getting ahead of the new standard.

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Three steps to ace the new not-for-profit reporting standard

Over the course of its day-to-day operations, every organization acquires, stores, and transmits Protected Health Information (PHI), including names, email addresses, phone numbers, account numbers, and social security numbers.

Yet the security of each organization’s PHI varies dramatically, as does its need for compliance with the Health Insurance Portability and Accountability Act of 1996 (HIPAA). Organizations that meet the definition of a covered entity or business associate under HIPAA must comply with requirements to protect the privacy and security of health information.

Noncompliance can have devastating consequences for an organization, including:

  • Civil violations, with fines ranging from $100 to $50,000 per violation
  • Criminal penalties, with fines ranging from around $50,000 to $250,000, plus imprisonment

All it takes is just one security or privacy breach. As breaches of all kinds continue to rise, this may be the perfect time to evaluate the health of your organization’s HIPAA compliance. To keep in compliance and minimize your risk of a breach, your organization should have:

  • An up-to-date and comprehensive HIPAA security and privacy plan
  • Comprehensive HIPAA training for employees
  • Staff who are aware of all PHI categories
  • Sufficiently encrypted devices and strong password policies

HIPAA Health Check: A Thorough Diagnosis

If your organization doesn’t have these safeguards in place, it’s time to start preparing for the worst — and undergo a HIPAA health check.

Organizations need to understand what they have in place, and where they need to bolster their practice. Here are a variety of fact-finding methods and tools we recommend, including (but not limited to):

  • Administrative, technical, and physical risk analyses
  • Policy, procedure, and business documentation reviews
  • Staff surveys and interviews
  • IT audits and testing of data security

Once you have diagnosed your organization’s “as-is” status, you need to move your organization toward the “to-be” status — that is, toward HIPAA compliance — by:

  • Prioritizing your HIPAA security and privacy risks
  • Developing tactics to mitigate those risks
  • Providing tools and tactics for security and privacy breach prevention and minimization
  • Creating or updating policies, procedures, and business documents, including a HIPAA security and privacy plan

As each organization is different, there are many factors to consider as you go through these processes, and customize your approach to the HIPAA-compliance needs of your organization.

The Road to Wellness

An ounce of prevention is worth a pound of cure. Don’t let a security or privacy breach jump-start the compliance process. Reach out to us for a HIPAA health check. Contact us if you have any questions on how to get your organization on the road to wellness.

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How healthy is your organization's HIPAA compliance?

As we begin the second year of Uniform Guidance, here’s what we’ve learned from year one, and some strategies you can use to approach various challenges, all told from a runner's point of view.

A Runner’s Perspective

As I began writing this article, the parallels between strategies that I use when competing in road races — and the strategies that we have used in navigating the Uniform Guidance — started to emerge. I’ve been running competitively for six years, and one of the biggest lessons I’ve learned is that implementing real-time adjustments to various challenges that pop up during a race makes all the difference between crossing — or falling short of — the finish line. This lesson also applies to implementing Uniform Guidance. On your mark, get set, go!

Challenge #1: Unclear Documentation

Federal awarding agencies have been unclear in the documentation within original awards, or funding increments, making it hard to know which standards to follow: the previous cost circulars, or the Uniform Guidance?

Racing Strategy: Navigate Decision Points

Take the time to ask for directions. In a long race, if you’re apprehensive about what’s ahead, stop and ask a volunteer at the water station, or anywhere else along the route.

If there is a question about the route you need to take in order to remain compliant with the Uniform Guidance, it’s your responsibility to reach out to the respective agency single audit coordinators or program officials. Unlike in a race, where you have to ask questions on the fly, it’s best to document your Uniform Guidance questions and answers via email, and make sure to retain your documentation.  Taking the time to make sure you’re headed in the right direction will save you energy, and lost time, in the long run.    

Challenge #2: Subrecipient Monitoring

The responsibilities of pass-through entities (PTEs) have significantly increased under the Uniform Guidance with respect to subaward requirements. Under OMB Circular A-133, the guidance was not very explicit on what monitoring procedures needed to be completed with regard to subrecipients. However, it was clear that monitoring to some extent was a requirement.

Racing Strategy: Keep a Healthy Pace

Take the role of “pacer” in your relationships with subrecipients. In a long-distance race, pacers ensure a fast time and avoid excessive tactical racing. By taking on this role, you can more efficiently fulfill your responsibilities under the Uniform Guidance.

Under the Uniform Guidance, a PTE must:

  • Perform risk assessments on its subrecipients to determine where to devote the most time with its monitoring procedures.
  • Provide ongoing monitoring, which includes site visits, provide technical assistance and training as necessary, and arrange for agreed-upon procedures to the extent needed.
  • Verify subrecipients have been audited under Subpart F of the Uniform Guidance, if they meet the threshold.
  • Report and follow up on any noncompliance at the subrecipient level.
  • The time you spend determining the energy you need to expend, and the support you need to lend to your subrecipients will help your team perform at a healthy pace, and reach the finish line together.

Challenge #3: Procurement Standards

The procurement standards within the Uniform Guidance are similar to those under OMB Circular A-102, which applied to state and local governments. They are likely to have a bigger impact on those entities that were subject to OMB Circular A-110, which applied to higher education institutions, hospitals, and other not-for-profit organizations.

Racing Strategy: Choose the Right Equipment

Do your research before procuring goods and services. In the past, serious runners had limited options when it came to buying new shoes and food to boost energy. With the rise of e-commerce, we can now purchase everything faster and cheaper online than we can at our local running store. But is this really an improvement?

Under A-110, we were guided to make prudent decisions, but the requirements were less stringent. Now, under Uniform Guidance, we must follow prescribed guidelines.

Summarized below are some of the differences between A-110 and the Uniform Guidance:

A-110 UNIFORM GUIDANCE
Competition
Procurement transaction shall be conducted in a manner to provide, to the maximum extent practical, open and free competition.
Competition
Procurement transaction must be conducted in a manner providing full and open competition consistent with the standards of this section.
 
Procurement
Organizations must establish written procurement procedures, which avoid purchasing unnecessary items, determine whether lease or purchase is most economical and practical, and in solicitation provide requirements for awards.
Procurement
Organizations must use one of the methods provided in this section:
  1. Procurement by Micro Purchase (<$3,000)
  2. Procurement by Small Purchase Procedures (<$150,000)
  3. Procurement by Sealed Bids
  4. Procurement by Competitive Proposal
  5. Procurement by Noncompetitive Proposal

While the process is more stringent under the Uniform Guidance, you still have the opportunity to choose the vendor or product best suited to the job. Just make sure you have the documentation to back up your decision.

A Final Thought
Obviously, this article is not an all-inclusive list of the changes reflected in the Uniform Guidance. Yet we hope that it does provide direction as you look for new grant awards and revisit internal policies and procedures.

And here’s one last tip: Do you know the most striking parallel that I see between running a race and implementing the Uniform Guidance? The value of knowing yourself.

It’s important to know what your challenges are, and to have the self-awareness to see when and where you will need help. And if you ever need someone to help you navigate, set the pace, or provide an objective perspective on purchasing equipment, let us know. We’re with you all the way to the finish line.

Grant Running.jpg

Blog
A runner's guide to uniform guidance, year two

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