Over the past several months, regulators have released new guidance that will affect not-for-profit accounting and taxes. The following highlights some of the major developments from the end of 2017 and the beginning of 2018.
FASB Releases Guidance to Address Stranded Tax Effect
If your not-for-profit organization was subject to the previous corporate tax rate (up to a top rate of 35 percent) for its unrelated business taxable income or other activities that generated significant deferred tax assets and deferred tax liabilities, it may encounter a stranded tax effect as a result of the change to a flat 21 percent corporate tax rate. Entities account for the change as a component of their current period income tax expense or benefit, retaining the difference between the historical rate and the newly enacted rate in accumulated other comprehensive income (AOCI) as a stranded amount.
In Accounting Standards Update 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), entities can elect to reclassify the stranded amount from AOCI to retained earnings. Items that can be reclassified include anything directly affected by the Tax Cuts & Jobs Act (TCJA) as well as indirect effects of the TCJA, such as the effect of state income taxes. The standard is effective for annual periods beginning after Dec. 15, 2018, but may be early adopted for any financial statements not yet available for issuance. If not elected, the stranded amount would be released only when the underlying item is disposed, liquidated, or terminated. For more information, see our in-depth analysis of accounting issues in the new tax law.
IRS Updates Form 1023-EZ
The IRS recently updated the Form 1023-EZ, the streamlined application for tax-exempt status, to address quality concerns. During reviews of 2016 1023-EZ applications, the Taxpayer Advocate Service found that roughly 1 in 4 organizations (26 percent) that had used the Form 1023-EZ failed the organizational test to become a 501(c)(3).
In creating the Form 1023-EZ, the IRS walked a fine line between simplifying the process of becoming a tax-exempt organization and requesting enough information from applicants to verify they met the 501(c)(3) requirements. The revised Form 1023-EZ asks for more information from applicants. It creates a text box for organizations to provide a brief description of their mission and/or significant activities. The new Form 1023-EZ also adds questions about annual gross receipts, total assets, and public charity classification. The IRS clarifies that foundations that have had their tax-exempt status automatically revoked (for example, if they missed filing their Form 990 three years in a row) can use the Form 1023-EZ so long as they apply for the same foundation classification. If changing the foundation classification, foundations will need to file the full-length Form 1023.
Updated Guidance May Be Coming for Donor-Advised Funds
With the increased threshold for cash contributions to charitable organizations in the new tax law, it is widely believed that donor-advised funds (DAFs) will become more popular. Donors use DAFs to provide guidance on how public charities can use the donor’s contributions. Distributions from the DAF to the charity are tax-free in most cases, but some arrangements result in an excise tax. A taxable distribution could arise when the distribution leads to a donor receiving more than an incidental benefit from his or her contribution to the sponsoring organization. Distributions are also taxable if they are considered to be excess benefit transactions.
Several taxable distribution issues were recently addressed by IRS Notice 2017-73, Request for Comments on Application of Excise Taxes With Respect to Donor Advised Funds in Certain Situations.
One issue involved whether a DAF contribution used to pay for the cost of a charity-sponsored event would be considered taxable. The proposed regulations suggest that if a DAF distribution is used to pay for a charitable event, the distribution from the DAF would be considered taxable.
Another issue involved using a DAF to fulfill charitable pledges. The IRS proposes that DAF distributions could be used to fulfill a pledge without paying the excise tax if the following conditions are met:
- The sponsoring organization makes no reference to the existence of a charitable pledge when making the DAF distribution;
- No Donor/Advisor receives, directly or indirectly, any other benefit that is more than incidental on account of the DAF distribution; and
- A Donor/Advisor does not attempt to claim a charitable contribution deduction under § 170(a) with respect to the DAF distribution, even if the distributee charity erroneously sends the Donor/Advisor a written acknowledgment in accordance with § 170(f)(8) with respect to the DAF distribution.
On a similar note, the IRS proposes that DAFs also not be used to pay a deductible portion of a membership fee charged by the charity.
IRS Notice 2017-73 addresses a separate issue as well—the practice of using a DAF to avoid the 2 percent public support limitations placed on organizations that receive a substantial portion of their support from governmental units or public contributions. The proposed regulations would consider any DAF contribution made to a publicly supported organization as a donor’s indirect contribution to the publicly supported organization and therefore subject to the public support limitations rule. Publicly supported organizations would also have to treat all anonymous contributions as public support from one person (therefore subject to the public support limitation rule).
Comments are requested on the proposed changes by March 5, 2018. Learn More.
IRS Clarifies When New Determination Letter Needed
In Rev. Proc 2018-15, the IRS clarifies that a 501(c)(3) will not need to file a new exemption application if the organization changes its form or location. The latest ruling supersedes Rev. Rul. 67-390 and Rev. Rul. 77-429. Learn More.
For More Information
If you have any questions or comments about the regulations and requirements outlined, please contact us.
Brenda Booth is a Director in the Not-For-Profit & Education Tax Practice. She can be reached at 617.761.0729 or firstname.lastname@example.org.
Mark Winiarski is a Director and can be reached at 816.945.5614 or email@example.com.
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