New unrelated business income rules: Go beyond the surface
The “basketing” provision in the 2017 Tax Act has caused a stir among tax-exempt organizations for a number of reasons. The Tax Act now requires organizations to “basket” unrelated business activities. There are also new limitations on net operating losses, and a new, flat 21 percent tax rate for corporate taxpayers. While there’s still uncertainty about the new provisions, there are also significant opportunities for organizations to mitigate the costs of these changes through prudent tax planning.
Moving an activity into a for-profit entity is much easier than moving that same activity out of one, which can trigger tax.
Consider the following three-step process when beginning to plan:
- Assess your current situation.
Does your organization project to have multiple unrelated activities in one entity? Do any of these activities project to have a profit from time to time? Maybe your organization has multiple unrelated activities in many different entities. Does your organization have significant net operating losses (NOLs) carrying forward prior to 2018? Does your organization currently pay tax and possibly stand to pay less tax going forward?
Completing a detailed assessment of how the new rules might affect your organization will help you identify strengths and weaknesses in your tax position under the new rules.
- Consider changes to strengthen your future situation.
Armed with the knowledge of your current situation, consider whether it makes sense to shift activities among entities. An organization might shift multiple activities into a for-profit subsidiary, because for-profit subsidiaries aren’t subject to the loss basketing limitations in the new tax law. As a result, multiple activities could exist with gains and losses netted to come to one bottom line.
In multi-entity organizations, another possibility is to concentrate multiple activities, previously resident in multiple entities, in one entity with significant pre-tax reform NOLs. While the basketing provisions would accelerate any income, the “old” NOL would offset the additional unrelated income because it isn’t subject to the new 80 percent of income NOL limitation. A creative tax planner might be able to design other strategies, as well.
- Assess advantages and disadvantages of any change.
Advantages to any change should be obvious and to some extent measurable. But, with every modification through planning also comes potential disadvantages. For instance, moving an activity into a for-profit entity is much easier than moving that same activity out of one, which can trigger tax. In addition, organizations should be aware of any legal ramifications of shifting activities between organizations. The movement of some activities may be a simple bookkeeping entry or small contractual modification, while other activities may have various assets and liabilities attached to them, making an entity shift more challenging. Finally, organizations should consider the transaction costs involved in any planning, such as legal fees, filing fees, and new regulatory compliance like tax returns.
This is just a snapshot of what the planning process might look like. Involving tax professionals and legal counsel in analysis will be critical to ensure that the decisions made regarding the Tax Act changes are best for your organization’s long-term strategy.