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It’s the Most Wonderful Time of the Year…To Repeal and Simplify Unpopular Tax Laws for Tax-Exempt Organizations!

Tax-Exempt Organizations Alert Patricia S. Marx and Jodi Patt

The Taxpayer Certainty and Disaster Tax Relief Act of 2019 (the “Act”), found in Division Q of the Further Consolidated Appropriations Act, 2020 (H.R. 1865) that was signed into law on December 20, 2019, is sure to spread holiday cheer throughout the tax-exempt sector. Among other things, the Act eliminates one tax for most tax-exempt organizations and simplifies another for private foundations. Happy holidays, one and all!

Of importance for most tax-exempt organizations, the Act retroactively repeals Section 512(a)(7) of the Internal Revenue Code of 1986, as amended (the “Code”), an extremely unpopular provision that expanded the definition of unrelated business taxable income (“UBTI”) to include certain transportation and parking fringe benefits provided to employees (see repeal on page 715 here). Section 512(a)(7) of the Code, a component of the Tax Cuts and Jobs Act, was signed into law approximately two years ago on December 22, 2017, and was made effective for amounts paid or incurred after December 31, 2017. In short, pursuant to the Tax Cuts and Jobs Act, Section 512(a)(7) has generally subjected tax-exempt organizations to a 21% tax on amounts paid or incurred for any qualified transportation fringe benefits or for parking facilities used in connection with qualified parking. (Additional information about Section 512(a)(7) of the Code may be found in our prior Tax-Exempt Organizations Alert.) As a result, many organizations have had UBTI (and a corresponding Form 990-T filing obligation) for the first time or a significant increase in their taxable income, and considerable administrative expenses have been expended in efforts to understand and comply with the provision.

The repeal of Section 512(a)(7) of the Code is retroactive to Section 512(a)(7)’s original effective date. In other words, it essentially is as though Section 512(a)(7) of the Code never existed…and the tax on a tax-exempt organization’s transportation and parking fringe benefits provided to employees is no more! It is unclear how the retroactive repeal will impact the Forms 990-T or unrelated business income taxes that have been submitted since Section 512(a)(7) of the Code was enacted. We are hopeful that binding guidance will be issued in the new year regarding steps organizations may take to modify their returns in light of the repeal and to obtain a refund of taxes paid as a result of Section 512(a)(7) of the Code.

Private foundations also will be pleased to learn that the Act simplifies the private foundation net investment income tax rules under Section 4940 of the Code. Before the Act, Section 4940(a) of the Code imposed on each tax-exempt private foundation a tax equal to 2% of the foundation’s net investment income for the tax year. This 2% tax could have been reduced to 1% if the foundation satisfied certain distribution requirements. This two-tier system has been difficult for private foundations to administer, resulting in increased accounting and legal fees. It also has created the unintended consequence of penalizing private foundations with the higher tier tax when they maintain or increase giving during times of extraordinary need. The Act gives private foundations relief on both fronts by replacing the two-tiered tax regime with a single net investment income tax at a rate of 1.39% (see previsions on page 713 here).

With gifts like these for the tax-exempt sector, one can only imagine what 2020 may bring!

This update is intended as a general summary of legal matters and not as specific advice to any particular client. If you have any questions concerning the subject matter of this update, please contact: