Year-End Tax Considerations for Exempt Organizations: CLA (CliftonLarsonAllen LLP)

Key insights

The IRS recently indicated that it is auditing exempt organizations at an increasing rate.
Exempt organizations should consider a slew of new IRS treasury regulations and related guidance and act accordingly.
CLA’s national exempt tax professionals can help exempt organizations navigate this tax maze as we approach year end.

Need clarity on new tax regulations?

Between COVID-19 and the elections, many headlines have occupied our attention throughout 2020. However, it was also an active year on the tax front — the Internal Revenue Service (IRS) issued many new announcements on key tax issues and opportunities facing all exempt organizations.

In case you missed them, take a moment to review key 2020 developments so you can begin to assess their impact on your organization.

The IRS in 2020 — working friendlier, faster, and smarter

Recently, the IRS’s Exempt Organization (EO) Division gave its fiscal year (FY) update to the public. The EO Division continues to learn from the IRS scandal back in 2013. In particular, the IRS is focused on processing applications for exemptions (Forms 1023 and 1024) quicker (on average 70 to 146 days), while still maintaining its quality of review.

The IRS also provided interesting commentary on its examination of exempt organizations. That commentary indicates that the IRS is auditing exempt organizations at an increased rate (over 3,200 examinations of exempt organizations in FY 2020). In addition, it revealed the IRS’ approach to auditing exempt organizations. In conducting over 3,200 examinations, the IRS used the following strategic audit approaches:

Compliance strategy examinations represented 12% of its examinations
Data-driven examinations represented 47% of its examinations
Referrals and claims examinations represented 41% of its examinations

The main takeaway? The IRS is working smarter with a focus on ascertaining an exempt organization’s compliance with the ever-changing tax laws, related regulations, and pronouncements. Now, more than ever, you must be vigilant when it comes to tax planning and compliance. To reduce your chances of being subjected to an IRS examination, we recommend you:

Give focused time and attention to advanced tax planning to deal with the changing and complex tax issues confronting your organizations.
Use a proactive approach to Form 990 and Form 990-T preparation to clearly demonstrate compliance with IRS rules and to advance your organization’s mission accomplishments.

New tax developments that could impact your organization

Significant new IRS treasury regulations and related guidance issued this year could impact your organization.

Repeal of the qualified transportation fringe benefit UBTI provision

Most exempt organizations remember the troubles generated by the taxation—as unrelated business taxable income (UBTI)—of qualified transportation fringe benefits provided to employees following the enactment of the 2017 Tax Cuts and Jobs Act (TCJA). That provision was effective for tax years beginning after December 31, 2017. However, in December of 2019, Congress repealed the qualified transportation fringe benefit UBTI provision retroactively to its inception.

Key takeaway — This repeal has created UBTI refund or net operating loss (NOL) restoration opportunities for many exempt organizations. If your organization has not yet reviewed this opportunity, do so as soon as possible.

Final Treasury regulations related to the new UBTI “siloing” rules and the CARES Act NOL carryback opportunity

As a result of the TCJA, the UBTI rules were changed prospectively to prevent exempt organizations from netting two or more UBTI activities to compute the organization’s unrelated business income tax. Accordingly, if an exempt organization conducts two unrelated business activities, with one activity having a net loss and the other having net income, the new UBTI “siloing” rules prevent the exempt organization from netting the two unrelated activities to arrive at the total UBTI.

Key takeaway — If your organization has two or more UBTI activities, review the impact of the above final regulations and implement sound tax planning to mitigate tax exposure moving forward.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was enacted earlier this year, changed the NOL rules to allow corporations, including exempt organizations with losses from UBTI activities, to carryback NOLs. The carryback is to the fifth previous year first, and then to the fourth previous year, etc. The carryback is available for NOLs incurred in tax years beginning after December 31, 2017, and before January 1, 2021. In addition, this NOL provision removes the 80% of taxable income limitation on the use of those NOLs for taxable years beginning before 2021.

Key takeaway — Consider pursuing this tax opportunity if your exempt organization has incurred NOLs from UBTI activities in tax years beginning after 2017 and has paid tax on those UBTI activities in the prior five tax years.

Final Treasury regulations related to new excise tax on investment income of private colleges and universities

The TCJA also established a new 1.4% excise tax on the net investment income of certain private colleges and universities with at least 500 students and significant endowments.

Key takeaway — Higher education institutions affected by this tax issue need to understand its application and develop a tax plan to mitigate their exposure to this tax.

Proposed Treasury regulations related to new excise tax on exempt organization’s executive compensation

The TCJA also introduced a new 21% excise tax on executive compensation over $1,000,000 and on certain executive severance arrangements paid by an exempt organization. This is a tax on the exempt organization and not the executive employee. These new proposed regulations provide guidance on the application and the computational requirements under this new law.

Key takeaway — These proposed regulations provide insight on viable tax planning that could be deployed to mitigate the tax’s impact if it is applicable to your organization.

Guidance for COVID-related tax items

Finally, the IRS has also issued guidance on the tax treatment and reporting of the following government COVID-19 initiatives:

Treatment of Paycheck Protection Program (PPP) loans and reporting for Form 990 purposes
Requirements and application of the Employee Retention Credit
Coverage of employee expenses under the IRS’s “Qualified Disaster Relief” rules
Employer paid sick leave and paid family leave payroll credits
CARES Act deferral of the employer share of Social Security tax

How we can help

The exempt organization tax area experienced many changes in 2020. Many of these new IRS developments are complex but, with careful tax planning, can result in tax opportunities and reduced tax burdens for your organization.

CLA’s national exempt tax professionals are here to help you navigate this tax maze. Please contact us for additional information.