The Tax Cuts and Jobs Act (The “Act”) amended the unrelated business income provisions by adding a Section 512(a)(7) to the Internal Revenue Code (IRC), which imposes tax on exempt entities with respect to qualified transportation benefits.
The provision treats the funds used to pay for these fringe benefits as unrelated business taxable income (“UBIT”), provided the amounts are not deductible under IRC Section 274 (Disallowance of Deductions for Certain Expenses for Entertainment, Amusement, Recreation, or Travel).
In effect, this subjects the cost of these fringe benefits to tax at the corporate tax rate. The provision is intended to replicate the effect of a similar provision for taxable entities, which makes certain benefits non-deductible.
However, it is important to note that the effects of this provision will have a different effect on fiscal year taxpayers vs. calendar year ones.
According to the Act, the provision to tax fringe benefits as UBIT says it applies to “amounts paid or incurred after December 31, 2017.” Based on this, all amounts of this type of “income” from January 1, 2018 forward must be included as taxable income to the organization, whether or not this timeframe falls into their actual “2018” tax year.
Furthermore, in addition to having to include these amounts from its 2017 tax year as UBIT, a fiscal year filer will not get the complete benefit of the reduced corporate tax rate afforded by the Act, as under Section 15 of the Internal Revenue Code organizations will be required to use a blended rate based on the number of days prior to January 1, 2018 at the old tax rate and the number of days since January 1, 2018 at the new rate.
For fiscal-year companies whose fiscal years end June 30, for example, half their total taxable income is subject to the 35% rate, and half will be subject to the 21% rate as part of its subsequent fiscal year’s reporting. This essentially amounts to a 28% blended tax rate for fiscal year filers.
Additionally, while most states have not specifically provided guidance on this issue, many follow the federal income tax laws by statute, and these amounts would be considered taxable at the state level as well.
This provision of the Act introduces an additional tax burden and other complexities for tax-exempt entities, particularly for those that have specifically avoided engaging in activities which would subject them to unrelated business income tax (UBIT), but have been providing employees with transportation fringe benefits or access to gyms and other athletic facilities.
In addition, several jurisdictions such as New York City and Washington, D.C. require employers with 20 or more full-time employees to provide this benefit to employees. As such, for organizations operating in these jurisdictions, it is virtually impossible to avoid this tax.
Fiscal year filers are at a disadvantage in comparison to calendar year tax filers, as they are required to report and pay tax on “income” from their 2017 fiscal tax year, without receiving the benefit of the reduced corporate tax rate afforded to calendar year taxpayers.
Fiscal year organizations making estimated payments generally should take into account the change in rates for quarterly due dates that fall in 2018 and should consider tax accruals as they close their books to reflect the tax they will need to pay for the period of their 2017 tax year which falls in calendar 2018.
It should be noted that presently it appears that small organizations with prior year tax liabilities can rely on 100% of the prior year safe harbor (6655(d)(1)(B)(ii), governing underpayment of estimated taxes was unchanged by the Act) in estimating their overall annual federal tax liability for tax years 2017 and 2018.
Please contact your Mazars USA LLP professional for additional information.