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Nonprofits Face Headaches Under Income Reporting Rules (1)

Feb. 4, 2020, 6:56 PMUpdated: Feb. 4, 2020, 7:52 PM

Nonprofits could soon get long-awaited guidance on the tax law’s change to reporting requirements for income they make from business unrelated to their core mission.

The 2017 overhaul said that nonprofits can no longer report unrelated business income—which is taxable—in one chunk. Instead, they have to separate out each flow of income, calculating and reporting things like ticket sales for football games, income on rental property, and profit from franchise agreements separately.

Nonprofits have been awaiting instructions on how to do that for years. On Monday the White House review office began studying the IRS proposed rules, one of the last steps before they can be released.

“I think there had been some sense that maybe there were tax shelters happening within the unrelated business income world,” said Phil Hackney, a law professor at the University of Pittsburgh. Hackney previously litigated nonprofit issues in the IRS Office of the Chief Counsel.

The Section 512(a)(6) change—often referred to as siloing or basketing—brings complexity for all nonprofits. It’s aimed primarily at large organizations, such as universities, that could have many income streams.

It could create a giant headache for nonprofits, especially when accounting for employees that work in multiple areas of unrelated business and or business related to the nonprofit’s core mission, according to Kathleen Adcock, an analyst for Bloomberg Tax.

“This can be a lot of work for nonprofits where one person may work in fulfilling the exempt function and several unrelated businesses,” Adcock said. “How do you allocate the time? The same is true for other resources, such as supplies and space.”

The National Association of College and University Business Officers, which represents more than 1,900 colleges and universities, urged the IRS to clarify if certain deductions made under one area of unrelated business could still be used to offset a separate area of unrelated business.

As the law is currently written “you can’t do that anymore,” Adcock said.

Smaller nonprofits may also struggle with the change.

For the run-of-the-mill nonprofit making around $500,000 a year the guidance will “either be a greater headache and they won’t comply or they will comply and it’ll be very costly,” Hackney said. “Most likely won’t comply with the change because they don’t understand, or because they don’t have the resources.”

The American Institute of CPAs in November 2019 asked the IRS to exclude small tax-exempt organizations from the measure, saying those entities don’t have the tools that their larger counterparts have to easily track separate unrelated activities.

David Thompson, vice president of public policy at the National Council of Nonprofits, which represents primarily small nonprofits, said his organization “will be very interested in the final product.”

The organization submitted comments in 2018, saying that the change “will only add costs, conflicts, and unnecessary complexity for years to come.”

(Updated with additional comments starting in the fourth paragraph. )

To contact the reporter on this story: Sam McQuillan in Washington at smcquillan@bloomberglaw.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com

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