Top Five Tax Reminders for Nonprofits Beyond PPP Loans
The Paycheck Protection Program (PPP) and the related loan forgiveness is, without a doubt, extremely important. However, the headlines with updates and changes to the program have dominated the news for months, potentially overshadowing other significant information that nonprofits need to be aware of. Below are the top five reminders for nonprofits as they continue to navigate this unprecedented time.
1. Excise Tax on Compensation
On June 5, the IRS issued proposed regulations under Section 4960 of the Internal Revenue Code amending part 53 of the excise tax regulations. The IRS previously issued Notice 2019-09 on December 31, 2018, which imposes an excise tax equal to the corporate tax rate (currently 21 percent) on excess remuneration above $1 million and certain types of parachute payments. Although the proposed regulations retain many of the key concepts from Notice 2019-09, they also include significant new guidance and clarifications. The proposed regulations include several exceptions intended to ensure that related organizations are treated fairly when compensation is aggregated to apply the excise tax.
A special timing rule for end-of-year wages was established within the proposed regulations. Regular wages are treated as paid when actually paid and not when vested. For example, if salary in December isn’t paid until January 2, 2021, the salary is treated as paid in 2021. Alternatively, if a bonus was vested in December and paid in January, the bonus is treated as paid in 2020.
The proposed regulations also clarify the present value determination. This is calculated on the date the covered employee vests in the right to payment of the remuneration.
Lastly, excess parachute payments are now included in the application of the tax if paid by the applicable tax-exempt organization, not if a related organization pays the parachute payment. Excess parachute payments include payments related to separation such as severance if the payments are more than three times the employee’s average annual compensation.
2. Unrelated Business Income (UBI) “Siloing”
The Tax Cuts and Jobs Act, under the new §512(a)(6), modified the process in which tax-exempt organizations compute their UBI if they have more than one unrelated trade or business. The most notable change in the proposed regulations is trades or businesses should be separated using the NAICS code system, applying only the first two digits. This is welcome guidance that reduces hundreds of potential “silos” for UBI to 20 broader sections. See our recent BKD Thoughtware® alert for more information.
3. Schedule B Reporting Requirements
Final regulations were issued in 2020 regarding annual reporting requirements for tax-exempt organizations not described in §501(c)(3) or §527. The regulations remove the requirement to report names and addresses of donors who contribute more than $5,000. Organizations described in §501(c)(7), (8), and (10) also are no longer required to disclose the names and addresses of donors who contribute more than $1,000 for a specific charitable purpose. However, these organizations will still be required to file Schedule B with their annual Form 990 series return and include the contribution amounts. In addition, organizations should maintain internal records that contain donor names and addresses in case of an examination.
4. Temporary Increase of Charitable Contribution Limitations
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) added a provision for taxpayers who don’t otherwise elect to itemize deductions. For 2020, there’s an above-the-line deduction for up to $300. For individuals who do itemize, the previous 60 percent of adjusted gross income limitation on deductions has been temporarily suspended for 2020. Both incentives apply only to cash contributions made to qualifying 501(c)(3) organizations, excluding donor-advised funds.
In addition, for corporations, the CARES Act temporarily increased the 10 percent limitation on charitable contribution deductions to 25 percent of taxable income. Therefore, incorporated tax-exempt organizations with net positive unrelated business taxable income (UBTI) can take advantage of this increased deduction to reduce the UBTI and pay lower tax. See this Thoughtware alert for more information.
5. Potential for More IRS Examination Activity
The IRS continues to use data-driven decision making to choose organizations that will receive examination notices. In fiscal year 2019, there were approximately 3,700 examinations closed—and of those, approximately 2,000 were chosen with data-driven analytics. The change rate of the exams closed was 85 percent (much higher than the rate prior to using data-driven decision making), and there were 70 tax exemptions revoked due to the examination of the organization.
In February 2020, the IRS announced it had hired 40 additional revenue agents, with plans to hire more later in the year. At the time, approximately 300 employees were dedicated to exempt organization examinations. With an increased workforce, the IRS can perform additional exams each year. However, it’s unclear if COVID-19 affected the hiring plan. Although the pandemic might have slowed the process, tax-exempt organizations should be on alert for increases in exam activity. The IRS will continue to focus its effort to find the riskiest taxpayers. It’s important for exempt organizations to stay diligent with their tax filing requirements now and in the future.
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