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Editorial 9 MIN READ

The nonprofit corporation, revisited: what TCJA did to the exempt sector

UBIT silos, a parking tax, and a 21% excise on big compensation, all landing on organizations that never thought of themselves as taxpayers

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 5 sections
  1. The state charter still works the same way
  2. The IRS side, as of January 2019
  3. What the Tax Cuts and Jobs Act did to exempt organizations
  4. What a 2019 board should actually do
  5. Sources

he nonprofit corporation walked into 2019 with three new tax bills and one cleaner path to recognition. Form 1023 still costs $600 and Form 1023-EZ still costs $275, both reaffirmed by Rev. Proc. 2019-5, the annual Exempt Organizations determination-letter procedure. What changed is what happens to the organization after the determination letter arrives, once the Tax Cuts and Jobs Act reached past the business sector and began taxing activities the exempt world had never thought of as taxable.

Twenty months after the original nonprofit corporation guide, the state-level mechanics are largely the same. The federal surface has moved.

The state charter still works the same way

Chartering is boring and that is a compliment. California still codifies its Nonprofit Corporation Law at Corporations Code §§ 5000–9927, still split into public benefit (§ 5110), mutual benefit (§ 7110), and religious (§ 9110) tracks. Texas still governs nonprofit corporations under Chapter 22 of the Business Organizations Code, and the Form 202 certificate of formation still costs $25. Delaware still declines to have a separate nonprofit statute and runs its nonstock corporations through 8 Del. C. § 114. New York's Not-for-Profit Corporation Law, rewritten under the Nonprofit Revitalization Act of 2013, still sorts entities into "charitable" and "non-charitable" rather than the old Type A / B / C / D scheme.

The drafting hygiene that matters for federal recognition also has not moved. Articles still need an exempt-purposes clause that tracks § 501(c)(3), and a dissolution clause committing the assets to another exempt organization or to a government. The IRS still publishes suggested language in the Form 1023 instructions, and state SOS templates still do not. The amendment fee, paid twice by organizations that file the state articles without this language, is still the most common avoidable expense in the first year.

The IRS side, as of January 2019

The $600 user fee for Form 1023 and the $275 user fee for Form 1023-EZ are set by Rev. Proc. 2019-5, 2019-1 I.R.B. 230, the January annual procedure for exempt-organization determinations. Rev. Proc. 2019-5 replaces Rev. Proc. 2018-5 the way Rev. Proc. 2018-5 replaced 2017-5 and 2016-5: an annual reissue that rolls forward the ruling and determination procedures with whatever year's updates Treasury wants to fold in. The fees themselves have not moved since the IRS dropped the 1023-EZ fee to $275 in 2017.

The 1023-EZ remains a three-page online filing through Pay.gov, capped at applicants with annual gross receipts of $50,000 or less in each of the past three years (and projected for the next three) and total assets under $250,000. Churches, schools, hospitals, supporting organizations, and private foundations are still ineligible for the EZ. Approval timing is still roughly two to four weeks for the EZ and three to six months for the full 1023.

One operational change worth flagging for 2019 filers: the IRS updated Form 1023-EZ effective January 2018 to require applicants to provide a brief description of the organization's mission or activities, in response to Taxpayer Advocate criticism that the EZ was approving applicants whose papers did not disclose what they actually did. Still three pages. Still cheaper. Just slightly less of a checkbox exercise.

The 27-month retroactivity window under Treasury Regulation § 1.508-1(a)(2) has not moved either. File Form 1023 within 27 months after the end of the month of incorporation and the exemption runs from formation. Miss it and exemption runs from the postmark, with a gap during which donors' deductions are void.

What the Tax Cuts and Jobs Act did to exempt organizations

The TCJA, signed December 22, 2017, and effective for tax years beginning after December 31, 2017, included three provisions that imposed tax directly on § 501(c)(3) organizations. For boards that had spent years thinking of their organization as a non-taxpayer, 2018 was the first year that stopped being true. Forms 990-T for tax years beginning in 2018 are being prepared now, and the fact patterns are surprising a lot of treasurers.

§ 512(a)(6): unrelated business income, now in silos

Before TCJA, an exempt organization with more than one unrelated trade or business aggregated the whole set. Income from a profitable advertising operation could be offset by losses from an unprofitable rental or merchandising activity. Net operating losses from one unrelated business could shelter net income from another.

Section 13702 of TCJA added IRC § 512(a)(6), which requires an organization with more than one unrelated trade or business to calculate UBTI separately "with respect to each such trade or business." Losses from one silo can no longer offset income from another. Post-2017 NOLs carry forward only within the same silo; pre-2018 NOLs retain the old aggregate treatment. The practical effect is that a university with a profitable licensing arm and a loss-making bookstore now owes UBIT on the licensing arm gross, instead of netting the two.

The statute did not tell anyone how to decide what counts as a "separate" trade or business. Notice 2018-67, 2018-36 I.R.B. 409, published August 21, 2018, provided interim guidance. Pending proposed regulations, organizations may rely on a "reasonable, good-faith interpretation" of §§ 511 through 514. The Notice identifies the six-digit North American Industry Classification System code as one such reasonable approach. Investment-partnership interests get a narrower transition rule: income from a qualifying partnership interest (the de minimis test or the control test in the Notice) can be aggregated with other investment partnership income and treated as a single silo.

Good-faith reliance is doing a lot of work here. Proposed regulations have not issued as of this writing. Organizations filing the first post- TCJA 990-T are categorizing activities using NAICS codes, disclosing the method on the return, and hoping the final rule does not force re-siloing after the fact.

§ 512(a)(7): the parking tax

Section 13703 of TCJA added IRC § 512(a)(7), which increases an exempt organization's UBTI by "any amount for which a deduction is not allowable under section 274" on account of qualified transportation fringes, any parking facility used in connection with qualified parking, or any on-premises athletic facility. In plain terms: the amount a for-profit employer can no longer deduct for employee parking and transit benefits, an exempt employer must now add to UBTI and pay tax on at the corporate rate.

The corporate rate is 21% under new IRC § 11(b), which means the first dollar of parking-benefit UBTI is a twenty-one-cent tax. There is no threshold. A church that provides five reserved parking spaces for its staff is, on the statute's terms, a UBIT filer.

Notice 2018-99, 2018-52 I.R.B. 1067, published December 10, 2018, gave organizations a methodology and a safe harbor. For parking provided in a facility the employer owns or leases, the nondeductible amount is computed in a four-step process: (1) calculate the expenses allocable to reserved employee spots (entirely nondeductible); (2) determine the primary use of the remaining spots, and if more than 50% is for the general public, stop and deduct the rest; (3) allocate remaining expenses to reserved non-employee spots; (4) allocate the balance based on actual or estimated usage. Notice 2018-99 also gave organizations until March 31, 2019 to retroactively reduce or eliminate reserved employee spots, effective as of January 1, 2018, which would allow them to avoid most of the parking liability for 2018.

The political environment around § 512(a)(7) is unusually open for a tax provision 13 months old. Senators Lankford and Coons introduced legislation in late 2018 to repeal it; the American Institute of CPAs and a broad coalition of national charities have been public in urging repeal. For now the statute is on the books and the Notice 2018-99 methodology is the operative guidance. Organizations should assume they owe the tax and file accordingly; whether Congress unwinds it later is a separate question.

§ 4960: the excise tax on excess compensation

Section 13602 of TCJA added IRC § 4960, which imposes a 21% excise tax on two buckets of compensation paid by an "applicable tax-exempt organization" to its covered employees. The first bucket is remuneration in excess of $1 million paid to any covered employee. The second is excess parachute payments (essentially, separation pay exceeding 3x a base amount tied to the employee's historic pay).

"Covered employee" means one of the five highest-compensated employees in the current tax year, or anyone who was a covered employee for any preceding tax year beginning after December 31, 2016. The covered- employee group only grows over time; once in, an employee counts forever, even at lower pay in later years.

The $1 million threshold sounds narrow. In practice it bites at a wider range of organizations than boards expect. Large hospital systems, research universities, private foundations with investment staff, and certain arts organizations pay above $1 million to at least one executive. The tax is 21% of the excess, paid by the organization, not the employee. Notice 2019-9, 2019-4 I.R.B. 403, published December 31, 2018 and out in the January 22, 2019 Bulletin, is 90-plus pages of interim guidance on definitions, related-organization aggregation, medical-services exclusions, and the timing of remuneration. Proposed regulations will follow.

The medical-services exclusion deserves its own sentence. Remuneration for medical services performed by a licensed medical professional (doctors, nurses, veterinarians) is carved out of § 4960. That matters enormously for hospital systems, where a well-compensated physician's clinical pay is exempt but their administrative or research pay is not. The allocation will be contested.

What a 2019 board should actually do

Read the last post-close 990 and flag every activity that might be an unrelated trade or business. For each one, write down the six-digit NAICS code you would assign. That is your 512(a)(6) silo map, on paper, dated before you file the 990-T. Good-faith reliance is easier to defend with contemporaneous records.

Count reserved employee parking spots. If any are labeled and there is time before March 31, 2019, unlabel them and document the change. Notice 2018-99 treats the unreserving as effective January 1, 2018, and the reduction flows through the parking-UBTI calculation.

Check the compensation of the top five. If anyone is above $1 million including deferred amounts vesting in the year, the § 4960 return (on Form 4720) is in your filing set for 2018, due by the 15th day of the 5th month after year-end.

None of this replaces the older failure modes. The 27-month Form 1023 window is still the first year's most expensive trap. The § 509(a) public-support test still catches founder-funded charities at year five. The state-level charitable-solicitation registrations (40 states plus D.C., each with its own form) still trigger when fundraising goes online, not when the mail hits an in-state donor. The new federal taxes are added to the old compliance stack, not substituted for it.

The through-line from 2017 to 2019 is that "tax-exempt" got narrower as a term of art. An organization with a § 501(c)(3) determination letter is exempt from tax on its exempt-purpose activities. It is not exempt from UBIT on unrelated business, from UBIT on fringes it provides to its own employees, or from an excise on how much it pays its people. The letter still matters. It just covers less of the ground than it used to.

Sources

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