While most of the publicized focus is on the impact of new tax rates for individuals and corporations, the ability of many individuals to itemize fewer deductions going forward and the termination of the individual mandate for health insurance under The Affordable Care Act, other changes in the Internal Revenue Code (“IRC”) will directly affect both unions and their members’ collectively bargained pension plans and, to a lesser extent, multiemployer health and welfare plans that are tax-exempt Voluntary Employee Beneficiary Associations (“VEBAs”). The most significant costs to our union and plan clients will occur with respect to the Unrelated Business Income Tax (“UBIT”).
Unions and all benefit trusts currently paying UBIT pay tax at different rates. Labor unions whether incorporated or not, are taxed as corporations. Employee retirement trusts, including multiemployer pension plans, pay UBIT at trust rates. Collectively bargained VEBAs, if subject to tax on investment income, pay tax at trust rates.
For tax years beginning after December 31, 2017, the maximum tax rate for corporations under the TCJA will be lowered from 35% to 21%, while the maximum tax rate for trusts will be lowered from 39.6% to 37%. Many international and national unions are currently paying UBIT on debt-financed rents from real property, income resulting from associate membership revenues and advertising income, income from personal property rentals, income from certain affinity relationships and advertising. Other types of tax-exempt organizations frequently pay UBIT on income from “alternative investments” as well. Many collectively bargained pension plans are also currently paying UBIT on income received from “alternative investments” in partnerships and limited liability companies, the taxable income resulting from debt-financed investments in other than real property investments in extractive industries and income received from direct operations of business entities.
Other types of tax-exempt organizations such as hospitals, colleges and universities, private foundations and trade associations frequently pay UBIT on income from unrelated business activities including “alternative investments.” A substantial majority of those organizations, however, pay UBIT at corporate tax rates and will benefit from the decrease in the maximum corporate tax rate from 35% to 21%, as will unions while, multiemployer pension trusts will be paying UBIT at a top rate of 37%. This represents a large difference in tax rates based upon structure alone; for income from the same activities.
Under Internal Revenue Code (“IRC”) Section 15, a fiscal year taxpayer may obtain the benefit of the reduced corporate rate beginning on January 1, 2018 by computing a tentative tax under both the old and new rates, and then prorating the tentative tax based on the number of days with and without the rate change to arrive at a blended tax rate.
Furthermore, under the TCJA, the alternative minimum tax, which currently applies to both organizations taxable as corporations and to trusts, will only apply to trusts prospectively.
Effective for amounts paid or incurred after December 31, 2017, under new IRC Section 512(a)(7), certain employee fringe benefit payments are treated as unrelated business income unless they would be deductible under IRC Section 274. These fringe benefit expenses include:
To be deductible under IRC Section 274 and, thus, for unrelated business income purposes, these fringe benefit expenses must be “directly connected” or “associated” with the taxpayer’s trade or business.
This provision was introduced as part of the TCJA to make the deductibility of these fringe benefit expenses for tax-exempt organizations that report unrelated business income consistent with that of for-profit taxpayers which, under the TCJA, are now not permitted to deduct these benefits unless “directly connected” or “associated” with the taxpayer’s trade or business. While the Joint Committee on Taxation Explanation of The TCJA new IRC Section 512(a) (7) provision supports the notion that organizations have unrelated business taxable income, if they pay or incur costs for these benefits, the language of TCJA Section 3308, itself, is unclear. In the absence of additional interpretations or the issuance of other guidance with respect to this provision, unions and plans are advised to treat amounts paid for or incurred for the benefits listed above as includible in unrelated business taxable income.
Effective for tax years beginning after December 31, 2017, organizations carrying on more than one unrelated trade or business must separately calculate unrelated trade or business income for each trade or business. This forecloses an organization’s ability to use losses from one unrelated business income generating activity to offset income from another activity. For example, a union would not be able to offset losses incurred through the debt financed rental of real property against income from the sale of associate memberships under the new tax regime. It is possible that losses from different types of “alternative investment” activities may not be used to offset income from other types of “alternative investment” activities, however, that is not clear in the new Internal Revenue Code provisions and must be addressed in ensuing Treasury regulations.
Net operating loss deductions of organizations paying tax as corporations, such as unions and those paying tax as trusts, such as pensions and VEBAs, may be carried forward but would be limited to 80% of taxable income and amounts carried forward to other years must be adjusted to account for the limitation of losses in tax years beginning after December 31, 2017. The alternative minimum tax remains applicable for trusts. As discussed above, losses will have to be separately computed and tracked for each business activity and may only offset current year income from that activity.
Under current law, publicly traded C corporations can deduct up to $1 million for compensation paid to “covered employees”. A covered employee is defined under IRC Section 4960(c)(2) as any current or former employee of an “applicable tax-exempt organization” that (1) is one of the five highest compensated employees of the organization for the tax year; or (2) was a covered employee of the organization or any predecessor organization for any tax year after December 31, 2016.
Current law also limits the deductibility of certain severance-pay (“parachute payments”). There is no excise tax or other limitation on the executive compensation or severance payments made by tax-exempt organizations. Under current law, there are reasonableness requirements and a prohibition against private inurement for executive compensation for tax-exempt entities. There is not, however, an excise tax under current law tied to the amount of compensation. The provision imposes an excise tax of 21% on compensation in excess of $1 million paid to any of the five highest-paid employees of a tax-exempt organization which includes labor unions, VEBAs and multiemployer pension plans. The tax would apply to the value of all remuneration paid for services, including cash and the cash-value of most benefits, including plans under IRC Section 457(f), however, excluding payments under qualified plans or plans described in IRC Section 457(b). The excise tax would also apply to excess “parachute payments,” or payments in the nature of compensation that are contingent on an employee’s separation and, in present value, are at least three times the employee’s base compensation. This excise tax applies to tax years beginning after December 31, 2017.
Clearly, there is a lot to talk about in the TCJA and as we noted in an earlier communication on the impact of the separate House and Senate versions of TCJA, there were House and Senate provisions impacting unions and multiemployer plans which were not included in the final legislation which is something for which we should all be grateful. We are happy to address the impact of the provisions discussed above on your union’s or plan’s current activities, as well as, the impact of any of the TCJA provisions on your members, plan participants and employees.
|Richard Ruvelson, Principal, JD