On December 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) into law. The TCJA represents one of the most significant revisions to the Internal Revenue Code (IRC) in more than 30 years. Many provisions took effect January 1, 2018, and the TCJA will affect virtually all U.S. taxpayers. Tax-exempt health care providers are no exception.
In this article, we’ll spotlight what we believe are the top five tax reform provisions that will affect a significant number of tax-exempt health care providers. You’ll find a brief overview of each provision and see a consistent theme that additional guidance is needed in several areas. The American Institute of CPAs recently formally requested immediate guidance on 39 different TCJA provisions to allow taxpayers to appropriately comply with 2017 tax obligations and make informed business and tax planning decisions for the future. In future BKD insights, we’ll dive deeper into each of the provisions, highlight ongoing developments and discuss planning opportunities.
1. Separate Tracking of Unrelated Trade or Business Activities
Under IRC Section 512, unrelated business taxable income (UBTI) will be computed separately with respect to each trade or business activity for organizations with more than one unrelated trade or business. Therefore, losses from one unrelated activity won’t be allowed to offset profits from another. This is a revenue-raising provision with an estimated budget effect of $3.5 billion over the next 10 years.
Additional clarity around the definition of an “activity” will be helpful for this particular provision. It seems fairly clear that a hospital with UBTI from a lab and a pharmacy would constitute activities that must be separately tracked. However, the decision becomes less clear when an organization has multiple similar activities. For instance, if the hospital operates a lab that generates UBTI and also owns an interest in a joint venture that operates a lab in a separate location and generates UBTI, will the IRS consider this one lab activity or multiple activities?
In response to this provision, some tax-exempt health care organizations may consider forming wholly owned C corporations to hold unrelated trades or businesses. Careful planning and important nontax considerations must be evaluated prior to restructuring. Watch for future insights on this topic as additional guidance becomes available.
2. UBTI Increased by the Amount of Certain Fringe Benefits
Under this provision, UBTI includes any expenses paid or incurred by a tax-exempt organization for qualified transportation fringe benefits, a parking facility used in connection with qualified parking or any on-premises athletic facility, provided such amounts aren’t deductible under IRC §274.
This is one of the most overlooked TCJA provisions, as it could affect nearly all tax-exempt health care organizations that provide parking to employees. Many organizations could be required to file Form 990-T, Exempt Organization Business Income Tax Return, for the first time. In addition, with the separate tracking of unrelated activities and the net operating loss (NOL) changes discussed below, organizations may not have losses available to offset this income.
Questions remain about whether UBTI is increased by employee salary reduction elections made through a §125 cafeteria plan. If an employer owns a parking garage but doesn’t charge patients or employees for parking, does this create UBTI for the employee parking? If so, how is the amount determined? If a tax-exempt organization includes an otherwise excludable transportation fringe in an employee’s gross income, will it avoid UBTI treatment? These are all questions we’ll be monitoring and discussing in more detail in future insights as additional guidance becomes available.
This is another revenue-raising provision, but its estimated budget effect wasn’t separately stated from a related provision, which disallows for-profit organizations’ deduction for the fringe benefits listed above. The total estimated budget effect for the loss of the for-profit deduction and increase in UBTI is $17.7 billion over the next 10 years.
3. Excise Tax on Excess Tax-Exempt Organization Executive Compensation
Under IRC §4960, an excise tax will be imposed on excess tax-exempt organization executive compensation, effective for tax years beginning after December 31, 2017. The excise tax will be 21 percent of the remuneration paid by an applicable tax-exempt organization—and all related organizations—to any covered employee in excess of $1 million plus any excess parachute payment paid by the organization to any covered employee. Covered employees include the organization’s five highest-compensated employees for the taxable year and any employee who was a covered employee of the organization for any preceding taxable year beginning after December 31, 2016. For tax-exempt health care providers, the term remuneration doesn’t include any remuneration paid to a licensed medical professional for the performance of medical services by the professional.
While the excise tax on compensation exceeding $1 million should be relatively straightforward to monitor, the excess parachute payment may be less clear. This provision applies without regard to the $1 million threshold when a parachute payment exceeds three times the average annualized compensation to the employee for the five taxable years ending before the date of separation. There are other nuances to this provision that we’ll explore further in future insights. If your organization is entering into a separation agreement with a highly compensated employee, this is a provision you should study further to understand its potential implication.
Organizations also should consider the effect of this excise tax on nonqualified deferred compensation arrangements. The excise tax can apply to the value of this remuneration when the deferred amounts are no longer subject to a substantial risk of forfeiture. Covered employees normally under the excise tax threshold may be pushed over in years with significant amounts vesting. Careful planning may be necessary to manage this new tax.
You might have noticed a trend of revenue-raising provisions directed at tax-exempt organizations, and this is no exception. The estimated budget effect of this provision over the next 10 years is $1.8 billion.
4. Modification of NOL Deduction
This provision limits the NOL deduction to 80 percent of taxable income for losses arising in taxable years beginning after December 31, 2017. It also repeals the two-year carryback of NOLs and 20-year carryforward and instead allows indefinite carryovers.
For organizations that report NOLs on Form 990-T, tracking NOLs will become more complicated, as losses incurred prior to December 31, 2017, will be tracked separately from losses incurred after that date. The requirement to separately report unrelated trade or business activities also will complicate the application of NOLs.
This provision is one of the most significant revenue generators in the TCJA. It has widespread applicability with an estimated budget effect of $201.1 billion over the next 10 years. Tax-exempt health care providers will be a small part of this overall budget effect.
5. Reduction in the Corporate Tax Rate
This provision replaces the graduated corporate rate structure with a flat 21 percent corporate rate, effective for taxable years beginning after December 31, 2017. Special blended rate rules apply to the 2017 tax return for fiscal year corporations with years ending in 2018.
For organizations that typically reported UBTI of more than $335,000, this change represents a 13 percent rate reduction (14 percent if more than $18.3 million). For organizations reporting a lesser amount of UBTI, the change could actually represent a rate increase. For example, organizations with $50,000 of UBTI previously would have paid tax at a 15 percent rate, so they will see a 6 percent rate increase.
This provision represents the single largest cut under the TCJA with an estimated revenue loss of $1.3 trillion over the next 10 years. Tax-exempt health care providers represent a small part of this estimated effect.
While we attempted to identify the five tax reform provisions most relevant to tax-exempt health care providers, there may be other provisions important to your organization. Other tax reform topics you may be interested in include, but are not limited to:
- Effect of individual, estate and business tax changes on charitable giving
- Repeal of the exclusion from gross income for interest on advance refunding bonds
- Effect of net interest expense limitations on UBTI calculations
- Effect of pass-through deduction on charitable trusts holding UBTI investments
- Effect of other corporate tax changes on UBTI
If you have questions about tax reform, please contact Brian or your trusted BKD advisor. Also, stay tuned for future insights and be sure to visit BKD’s Tax Reform Resource Center.