Tax News of Note for Nonprofits
It’s critical for nonprofits to stay abreast of proposed and updated regulations from the Internal Revenue Service (IRS). Here are a couple of recent announcements they should keep in mind:
As of Feb. 1, 2020, organizations filling out Form 1023 (Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code) to apply for tax exempt status must submit the form online at Pay.gov. The IRS introduced this new procedure in the hopes that electronic filing will reduce errors and offer a more seamless application process for those seeking tax exemption.
While the electronic Form 1023 is similar to its paper counterpart, a few questions are new and have been reordered. When filling out the online form, it will be helpful for nonprofits to have all necessary information available and ready to be entered, as organizations must complete each section of the form before moving onto the next. Additionally, the required user fee for Form 1023 remains $600 for 2020. Applicants must pay the fee through Pay.gov when submitting the form, either directly from a bank account or by credit or debit card.
Form 1023 should be submitted within 15 months after an organization is established. The IRS generally reviews applications for exemption in the order they receive them and typically contacts applicants within 180 days. However, some circumstances may warrant expedited review so long as a compelling written explanation is provided. Examples of such situations include:
- A grant to the applicant is pending and the failure to secure the grant may have an adverse impact on the organization’s ability to continue operations.
- The purpose of the newly created organization is to provide disaster relief to victims of emergencies such as floods and hurricanes.
- An IRS error has caused delays in review of the application.
Calculating Unrelated Business Taxable Income
On April 24, 2020, the U.S. Treasury Department and IRS published proposed regulations under IRC Section 512(a)(6) in the Federal Register, which was added to the tax law as part of the 2017 Tax Cuts and Jobs Act (TCJA). The provision requires tax-exempt organizations with more than one unrelated trade or business to calculate unrelated business taxable income (UBTI) separately with respect to each unrelated trade or business. The provision’s aim is to prevent a net loss from one activity from reducing the net income from a profitable activity. As a result of having to treat each unrelated activity separately, Section 512(a)(6) has become known as the “Silo” provision. The provision is effective for tax years beginning on Jan. 1, 2018 and thereafter.
The principal issue for organizations seeking to comply with Section 512(a)(6) has been determining how many unrelated trade or business activities they have. This is because Congress did not provide explicit criteria for determining whether an exempt organization has “more than one unrelated trade or business” or how to identify “separate” unrelated trades or businesses for purposes of computing UBTI.
The proposed regulations seek to clarify these issues by establishing a method for determining whether an organization has more than one unrelated trade or business and by identifying separate unrelated trades or businesses. Most business activities will use the North American Industry Classification System (NAICS) business codes, and separate guidance is provided for investment activities. In each of these instances, the proposed regulations start with the approach utilized in Notice 2018-67
(which includes interim rules for calculating UBTI) but make some additional changes to this guidance based on the comments received.
Still, some questions have yet to be answered. For example:
- The IRS is requesting comments regarding circumstances in which an organization should be permitted to change its selected two-digit business code
- The IRS and Treasury are still considering what would be a recommended method of allocating expenses between separate unrelated trades or businesses
Even so, the proposed regulations should provide organizations some comfort in the potential aggregation of activities, which may help the determination of how many unrelated trades or businesses they have. However, this may not ease the inevitable result of increasing their unrelated business income tax liability exposure from a provision that tilts the proverbial “level playing field” toward their taxable entity competitors. To learn more, read our recent article “How Many Unrelated Trades or Businesses Do You Have?
In these challenging times, it’s especially important for nonprofits to stay informed about tax changes. As organizations strive to manage today’s challenges, the last thing they need is to accidentally fail to comply with a regulatory update affecting their organization.
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