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Slide1
Health care topics
August 16, 2018
Slide2Disclaimer
EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.
This presentation is ©
2018
Ernst & Young LLP. All
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Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.
Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP.
This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.
These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice
.
Slide3Presenters
Laura KielczewskiExempt Organization Tax ServicesNew York, NY laura.kielczewski@ey.com+1 212 773 1525Jim ZiescheExempt Organization Tax Services Pittsburgh, PAjames.ziesche@ey.com+1 412 644 0659Ryan MayorExempt Organization Tax Services San Diego, CAryan.mayor@ey.com+1 858 535 7267
Slide4Agenda
Tax-exempt health care organizations
Unrelated business income specific to health care organizations
Health care consolidation and integration
IRS activity and tax reform guidance
State and local tax matters
Slide5Objectives
Upon completion of this program, you should be able to:
Describe the basics of tax exemption for health care organizations
Identify unrelated business income related to health care organizations
Identify tax considerations associated with health care consolidation and integration
Identify IRS activity related to 501(r) audits and tax reform guidance affecting health care organizations
Identify recent state and local tax matters affecting health care organizations
Slide6Tax-exempt health care organizations
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Slide7Section 501(c)(3)
Corporations and any community chest, fund or foundation organized and operated exclusively for: Religious, charitable, scientific reasonsTesting for public safetyLiterary or educational purposesTo foster national or international amateur sports competitionFor the prevention of cruelty to children or animals
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Slide8Scope of “charitable”
Treas. Reg. 1.501(c)(3)-1(d)(2) definition:Generally accepted legal senseIncludes, but not limited to:Relief of the poor, distressed and underprivilegedAdvancement of religion, education or scienceLessening the burden of governmentPromotion of social welfare
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Slide9Organizational and operational tests
In order to be exempt as an organization described in Section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt (Treas. Reg. 1.501(c)(3)-1(a)).
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Organizational test relates to the purposes of the organization as described in its organizational charter, articles of incorporation, or other governing institute.
Operational test
relates to the actual activities conducted by the organization.
Slide10“Public charities” defined
Section 509 divides Section 501(c)(3) organizations into two general categories:Section 509(a) provides for four broad types of public charities, each with its own qualification criteria.Any Section 501(c)(3) organization not described as a public charity is a private foundation.
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Public charities
Private foundations
Slide11Hospitals
Form 1023 definition of the term “hospital”:Principal purpose or function is providing medical or hospital care or medical education or research.Medical care includes treatment of any physical or mental disability or condition, on an inpatient or outpatient basis. If an organization is a rehabilitation institution, outpatient clinic, or community mental health or drug treatment center, it is a hospital if its principal function is providing treatment services as described above.
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Slide12Community benefit standard
To qualify as organizations described in Section 501(c)(3), nonprofit hospitals must meet the “community benefit standard” set forth in Rev. Rul. 69-545.From Rev. Rul. 69-545: “The promotion of health is one of the purposes in the general law of charity that is deemed beneficial to the community as a whole even though the class of beneficiaries eligible to receive a direct benefit from its activities does not include all members of the community, such as indigent members of the community, provided that the class is not so small that relief is not of benefit to the community.”
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Slide13Community benefit standard
Rev. Rul. 69-545 criteria:Maintains an emergency room open to all persons requiring emergency care, without regard to ability to payProvides hospital care for all persons in the community otherwise able to pay the cost of medical services either directly or through third-party reimbursementMaintains a board of directors drawn from the communityUses surplus receipts over disbursements to improve the quality of patient care, expand hospital facilities and advance medical training, education, and research programsMaintains an open medical staffRev. Rul. 69-645: Does not require any minimum level of charity care to qualify for federal income tax exemption Expressly mentions Medicare participation and participation in public aid programs as a requirement for exemption
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Slide14Hospitals as public charities
Section170(b)(1)(A)(iii):“…an organization the principal purpose or functions of which are the providing of medical or hospital care or medical education or medical research, if the organization is a hospital, or if the organization is a medical research organization directly engaged in the continuous active conduct of medical research in conjunction with a hospital…”
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Slide15Polling question
Which of the following requirements must a hospital satisfy in order to be considered furthering charitable purposes?Maintain an emergency room open to all persons requiring emergency care, without regard to ability to payProvide hospital care for all persons in the community otherwise able to pay the cost of medical services either directly or through third party reimbursementMeet a minimum level of charity careA and B
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Slide16Section 501(r)
Effective for taxable years beginning after March 23, 2010, hospital organizations are required to satisfy Section 501(r), which was implemented as part of the Affordable Care Act (ACA), in order to qualify as an organization described in Section 501(c)(3). General Section 501(r) requirements:Community health needs assessment (CHNA) requirementsFinancial assistance policy (FAP) requirementsRequirements on chargesBilling and collection requirementsUnder Section 9007, the IRS is required to: Review the community benefit activities of each charitable hospital at least once every three years Submit reports to Congress, with the U.S. Department of Health and Human Services, comparing community benefit provided by taxable, tax-exempt and government hospitals
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Slide17Other tax-exempt health care organizations
Physician practices and clinicsHomes for the agedEducational organizationsResearch organizationsAccountable care organizations (ACOs)Health maintenance organizations (HMOs)
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Slide18Other tax-exempt health care organizations
For other health care organizations to qualify as organizations described in Section 501(c)(3), similar to hospitals, the organizational and operational tests must be met.Other health care organizations may also qualify under other Section 501(c) sections such as Section 501(c)(4).
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Slide19Other tax-exempt health care organizations
Public charity statusSection 170(b)(1)(A)(iii) – organizations providing medical careSections 170(b)(1)(A)(vi) and 509(a)(2) – publicly supported organizationsSection 509(a)(3) – supporting organizationsType IType IIType III
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Slide20Polling question
Which of the following identifies a “Type II” relationship between a supporting organization described in Section 509(a)(3) and its supported organization(s)? A. Operated in connection with the supported organization(s) B. Supervised or controlled in connection with the supported organization(s) C. Operated, supervised or controlled by the supported organization(s) D. None of the above
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Slide21Physician practices and clinics
General criteria (e.g., General Counsel Memoranda (GCM) 38394)Provide medical education and trainingConduct medical education and researchProvide charity careConduct community serviceEnsure reasonable physician compensationPotential private inurement and private benefit are an IRS focal pointCommunity boardRecruiting incentivesCorporate practice of medicine considerations
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Slide22Homes for the aged
Rev. Rul. 61-72Furnishes care and housing to aged individuals who would otherwise be unable to provide for themselves without hardshipServices are rendered to all, or a reasonable proportion of its residents, at substantially below the actual cost thereof, to the extent of the organization's financial abilityServices are of the type that address the needs and the relief of hardship or distress of aged individualsRev. Rul. 72-124: three primary needs of aged personsNeed for housingNeed for health care Need for financial securityRev. Rul. 79-18: facility must be “accessible to the community” by setting its fees at levels that are financially affordable to a significant segment of the community's elderly population
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Slide23Research organizations
Treas. Reg. Section 1.501(d)(5): research carried on for scientific purposes in the public interestResults of research (e.g., patents, copyrights) made available to the public on a nondiscriminatory basisResearch is performed for the United States, or any of its agencies or instrumentalities, or for a state or political subdivision thereofResearch is directed toward benefiting the public“Applied” vs. “fundamental” researchMedical research organizations – Treas. Reg. Section 1.170A-9(d)(2)Principal purpose or function is to engage primarily in the conduct of medical researchPrimarily engaged directly in the continuous active conduct of medical research in conjunction with a hospital which is described in Section 501(c)(3), a federal hospital or an instrumentality of a government unitSection 170(b)(1)(A)(iii)
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Slide24Educational organizations
Treas. Reg. Section 1.501(d)(3)The instruction or training of the individual for the purpose of improving or developing his or her capabilitiesThe instruction of the public on subjects useful to the individual and beneficial to the community Medical school faculty group practiceUniversity of Massachusetts Medical School Group Practice v. Commissioner, 74 T.C. 1299 (1980)B.H.W. Anesthesia Found., Inc. v. Commissioner, 72 T.C. 681 (1979)
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Slide25Accountable care organizations
IRS Notice 2011-20ACA created Medicare Shared Savings Program (MSSP) Under Section 1899 of Social Security Act, groups of health care service providers and suppliers that have established a mechanism for shared governance and that meet criteria specified by HHS are eligible to participate as ACOs under the MSSP An exempt organization’s (EO’s) participation in the MSSP through an ACO should not result in inurement or impermissible private benefit to any private-party ACO participants where: ACO terms set forth in advance written agreement negotiated at arm’s length Economic benefits derived from, ownership interest in, returns of capital, distributions, allocations and share of losses from ACO are proportional to the benefit provided to ACOAll contracts and transactions with ACO, ACO participants and other parties are fair-market valueEO’s share of MSSP payment should not be treated as unrelated business income (UBI) PLR 201615022 (April 8, 2016)ACO with non-MSSP activities denied Section 501(c)(3) recognitionIRS found that more than an insubstantial part of the ACO’s activities served private interests
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Slide26Health maintenance organizations
“Managed care” generally involves systems comprised of physicians and secondary health care service providers organized to manage costs directly affecting the delivery of health care services.Section 501(c)(3) recognition GCM 39828 (August 30, 1990) provides criteria for a “staff model” HMO to satisfy the community benefit standard under Rev. Rul. 69-545.HMO’s may be able to qualify as Section 501(c)(3) organizations as an “integral part” of a Section 501(c)(3) health system. See Geisinger Health Plan v. Commissioner, 985, F.2d 1210 (3rd Cir. 1993).Section 501(c)(4) social welfare organization statusGCM 39828 community benefit analysisMembership is open to individuals and small groupsHMO serves low-income, high-risk, medically underserved or elderly personsPremiums are established on a community-rated basisRecent cases/rulings:Vision Service Plan v. U.S., 265 Fed. Appx. 650 (9th Cir. 2008)IHC Health Plans, Inc. v. Commissioner, 325 F.3d 1188 (10th Cir. 2003)PLR 201443020 (July 12, 2012)
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Slide27Taxable affiliates
The IRS has held that a tax-exempt organization can organize, capitalize, own, and provide services and assets to a taxable corporate entity without violating the requirements of Section 501(c)(3), e.g., PLR 199938041.Under general corporate principles, a taxable corporate subsidiary’s activities will generally not be attributed to its tax-exempt parent. ConsiderationsPrivate inurement and private benefitTransfer pricing (Section 482)UBI (Section 512(b)(13))
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Slide28Unrelated business income
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Slide29UBI tax
Section 511: imposes a tax on unrelated business taxable income (UBTI) of organizations described in Sections 401(a) and 501(c), and of state colleges and universitiesSection 512: UBTI definedGross income from unrelated trade or business activities reduced by allowable deductions directly connected to such trade or business activitiesSection 513: unrelated trade or business defined Any trade or business That is regularly carried on, and The conduct of which is not substantially related to the exercise of performance by such organization of its charitable, educational or other purpose or function constituting the basis for its exemption under Section 501
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Slide30Common UBI categories in health care
Laboratory servicesPharmacy salesCafeteriasParking facilitiesFitness facilities/health clubsHospital gift shopsSale of durable medical equipment (DME)TelemedicineJoint ventures with for-profit partnersDebt-financed incomeIncome from controlled organizationsCaptive insurance
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Slide31Laboratory services and pharmacy sales
The IRS has generally adopted a patient/non-patient approach to determining the UBI treatment of laboratory services and pharmacy sales. Patients – generally not treated as UBI. Rev. Rul. 68-376 defines a “patient”:A person admitted to the hospital as an inpatientA person receiving general or emergency diagnostic, therapeutic or preventive health services from outpatient facilities of the hospitalA person directly referred to the hospital’s outpatient facilities by his or her private physician for specific diagnostic or treatment procedures A person refilling a prescription written during the course of his or her treatment as a patient of the hospitalA person receiving medical services as part of a hospital-administered home care programA person receiving medical care and services in a hospital-affiliated extended care facilityNon-patients – generally treated as UBIPrivate patients of hospital staff physicians are not patients of the hospital for this purpose
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Slide32Laboratory services and pharmacy sales
There are exceptions to non-patient UBI ruleLaboratory servicesProvision of lab services to patients of affiliated entities under common controlHospital personnel draw samples (“hands-on” exception)Training/educationIsolated rural area not adequately served by commercial laboratoriesSpecialized facilities/capabilitiesPharmacy salesSale to patients of affiliated entities under common controlSales to the general public where the sales are not promoted by the hospital, do not occur with frequency and represent only an insignificant portion of the pharmacy’s salesConvenience exception: pharmacy sales to employees not UBI under Section 513(a)(2)
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Slide33Cafeteria
Section 513(a)(2) convenience exceptionRev. Rul. 69-268: Section 513(a)(2) convenience exception applied to a hospital’s operation of a cafeteria or coffee shopPrimarily for employees and medical staffUsed by visitors to the hospitalGeneral public was not encouraged to use the cafeteriaCatering services can often generate UBI
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Slide34Parking facilities
Section 513(a)(2) convenience exceptionRev. Rul. 69-269: Section 513(a)(2) convenience exception applied to hospital’s operation of a parking facility where used by patients, visitors and staffA parking facility open to the general public will likely generate UBI
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Slide35Polling question
Which of the following scenarios will likely generate unrelated business income for a tax-exempt hospital?Hospital owns its parking facility and permits employees and the public to park in the facility for no cost.Hospital owns its parking facility. It charges the public a fee to park in the facility, but employees park there for free.Hospital owns its parking facility. It charges the public a fee to park in the facility and it imputes in employees’ income an amount equal to that fee charged to the public.All three of the above scenarios will likely generate unrelated business income for a tax-exempt hospital.
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Slide36Fitness facilities
Rev. Rul. 79-360: The operation of a fitness facility in a manner similar to a commercial business (a fee structure that restricts membership to a small community segment) can generate UBI.The IRS has consistently ruled (e.g., PLR 9110042) that the operation of a fitness facility can further Section 501(c)(3) purposes. Criteria for related treatment include:Facility equipped for the special needs of the handicappedFacility open to the general public without discriminationAlthough different rates may be charged to users of the facility, fees low enough that a significant segment of the community can afford to participateThe rates charged substantially lower than rates charged by commercial fitness centers in the areaUse of the facilities and programs promoted the well-being of the organization's employees, thereby affording the employees a better opportunity to serve the health care needs of the organization's patients
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Slide37Hospital gift shops
Can be treated as substantially related to exempt purposesPromotes welfare of patients Improves the physical comfort and mental well-being of patients by encouraging recovery Section 513(a)(2) convenience exception can apply if operated for the convenience of employees and visitors to the hospitalMay generate UBI if determined to be competing with for-profit businesses. For example:Gift shops located in medical office buildingsAdvertised to the publicInternet sales to the public
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Slide38Sale of durable medical equipment
Sale by a hospital of DME to patients will generally not generate UBISection 513(a)(2) convenience exceptionSee Rev. Rul. 78-435; PLR 8736046Sale by a hospital of DME to non-patients will generally generate UBIException: DME sales to non-patients may not generate UBI where related health care services (i.e., teaching, demonstrating and supervising patient use of equipment, performing physical assessments of purchaser and evaluating home needs of purchaser) are provided in conjunction with the DME sales. See PLR 9801058
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Slide39Telemedicine
Generally, the use of medical information exchanged from one site to another via electronic communications to improve a patient’s clinical health statusCommon delivery modelsReal-time interactions between a patient and a providerProvider remotely monitors the patientProvider reviews images, test results, samples, etc. (“store and forward”)Provider-to-provider consultUBI treatmentTo date, there has not been any IRS guidance or rulings on pointPresumably, the IRS will apply existing principles when analyzing telemedicine servicesPatient vs. non-patientSection 513(a)(2)Special circumstances
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Slide40Joint ventures with for-profit partners
Section 512(c): If a pass-through entity in which an EO is a member carries on a trade or business that is an unrelated trade or business with respect to the organization, the organization must include in UBTI the organization’s share of the gross income of the partnership from the unrelated trade or business and the organization’s share of the partnership deductions directly connected with the included income.An EO’s tax exemption can be jeopardized if the partnership’s unrelated activities are substantial in relation to the organization’s overall activities.Rev. Rul. 2004-51: UBI and exemption guidelines where joint venture activities are insubstantial compared to EO partner’s overall activitiesRev. Rul. 98-15: UBI and exemption guidelines where joint venture activities are substantial compared to EO partner’s overall activities
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Slide41Debt-financed income
Section 512(a)(4): In the case of debt-financed property, there shall be included, as an item of gross income derived from an unrelated trade or business, the amount ascertained under Section 514(a)(1), and there shall be allowed, as a deduction, the amount ascertained under Section 514(a)(2) Can include income generated by property and dispositions of the propertySection 514Debt-financed propertyProperty held to produce incomeAcquisition indebtedness Any point during year“But for” testExamples of exceptionsSubstantially related use of property – generally 85%Certain federal financingReal property financing by “qualified organizations” (e.g., pensions, universities)
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Slide42Income from controlled organizations
Generally, passive-type income is excluded from UBI treatment under Section 512(b). Exception under Section 512(b)(13) for certain payments from controlled organizations Interest, annuities, royalties and rentsTreated as UBI to recipient to the extent the payment reduces the net unrelated income of the controlled entity (or increases net unrelated loss)For a non-EO controlled entity, this includes the portion of its taxable income that would be UBI if the taxable entity were exempt and had the same purposes as the controlling organization.“Control” generally means greater than 50% and the constructive ownership rules of Section 318 applySpecial rule for payments made pursuant to a written binding contract in effect on August 17, 2006
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Slide43Captive insurance
Under Subpart F of the Code, certain insurance-related income of controlled foreign corporations is required to be included in the gross income of their US shareholders. Such Subpart F income is generally treated as a dividend, which is excluded from UBI treatment under Section 512(b)(1).Section 512(b)(17) Subpart F income is treated as UBI to the extent it is attributable to insurance income that, if derived directly by the EO, would be treated as gross income from an unrelated trade or business.This generally includes insurance coverage for for-profit organizations and unrelated EOs.
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Slide44Health care consolidation and integration
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Slide45What is the trend?
Generally involves mergers, acquisitions, joint ventures and other affiliations, and entry into new lines of business. For example:Hospital mergers and acquisitionsPhysician practice acquisitionsPayer/provider integration networksAcquisition or development of health care technologyCost management and the creation of efficiencies are the primary drivers. For example:IT infrastructurePhysician infrastructureNegotiating powerVertical integrationHealth industry disruption
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Slide46Tax considerations
Tax-exemption and UBI, as discussed above. For example:Conversion from taxable to tax-exempt (and vice versa)Private inurement and benefit considerationsTransaction tax. For example:Character of transaction (e.g., asset purchase vs. stock purchase)Legal entity structureTransfer pricingPartnership taxInternational taxOther
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Slide47Polling question
True or false: If a Section 501(c)(3) organization purchases the stock of a federally taxable corporation, the federally taxable corporation will be able to qualify as a Section 501(c)(3) organization following the transaction by virtue of it now having a Section 501(c)(3) parent organization. A. True B. False
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Slide48IRS activity
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Slide49IRS Section 501(r) examination activity
The IRS has identified Section 501(r) compliance as an “emerging issue” for exam focus.The IRS has trained agents to conduct Section 501(r) reviews, compliance checks and field exams.As of April 2017, the IRS had initiated over 400 Section 501(r) field exams of tax-exempt hospitals.IRS exam selection methodologyACA review group conducts community benefit and Section 501(r) reviews of publicly available data (e.g., Form 990 Schedule H, websites), refers hospitals for field exams Form 990 data search query
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Slide50IRS Section 501(r) examination activityAudit techniques
IRS Section 501(r) audit techniques training module: a guide and basic road map, not a comprehensive audit manual for agentsRequest policies, billing statements, board/committee meeting minutesReview websites to determine if federal assistance policy (FAP), FAP application and plain language summary are postedUse answers provided on hospital’s Schedule H as starting point for asking information document request questionsMake arrangements for an on-site tour of all FAP-related signage and publications in the hospital facility
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Slide51IRS Section 501(r) examination activityAudit techniques
Interview persons who were responsible for content of CHNA and implementation strategy, and who are familiar with FAP, billing and collection practices, and computation of amounts generally billed (AGB)Request assistance, if needed, from IRS Tax Exempt and Government Entities (TE/GE) Division counsel and IRS intranet sites (e.g., Knowledge Network)If 501(r) violation is detected, determine whether error is minorIf not minor, was it corrected and disclosed properly so as to avoid noncompliant facility income tax?If not disclosed and corrected, the IRS can impose tax and/or revoke exemption
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Slide52IRS Section 501(r) examination activityPenalty Chart
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Issue
501(c)(3)
revocation?
4959
excise tax?
Noncompliant
facility income tax?
Subject to correction?
Subject to disclosure?
Tax-exempt bonds revoked?
Minor errors
and omissions
(
non-failures)
N
N
N
Y
N
N
Failures
that
are neither
willful nor
egregious (excused failures)
N
Y
N (if corrected and disclosed)
Y
Y
N
All other failures (willful
or
egregious)
Maybe
Y
Maybe
N
N
Maybe
Slide53IRS Section 501(r) examination activity
Agents have been trained and are currently conducting examinations, asking for:Copies of policies and reportsCHNA reportImplementation strategyFAPFAP applicationEmergency medical care policyBilling and collections policyDocumentation of board approval (minutes) Documentation that policies/reports are posted on websitePersons knowledgeable about soliciting community input for CHNAs
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Slide54IRS Section 501(r) examination activity
Agents have been trained and are currently conducting examinations, asking for:Description of how the hospital informs and notifies its patients of availability of financial assistanceTranslations of FAP, FAP application and plain language summary into limited English proficiency (LEP) languages and methodology used to determine required translationsAGB workpapers and basis for calculating amounts charged to FAP-eligible patientsRecords of charges to FAP-eligible individualsVerification of information reported on Form 990, Part V, Section B
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Slide55IRS Section 501(r) examination activity
Agents have been trained and are currently conducting examinations, asking for:Copies of representative billing statements Description of extraordinary collection actions (ECAs) taken by hospitalCopies of notices sent to patients who were subject to ECAsContracts with collection agenciesComplaints the hospital has received regarding collection actions or failure to comply with FAPOn-site facility tours and interviews
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Slide56Fiscal year 2018 compliance focus
A look at the fiscal year 2018 work plan of the IRS TE/GE shows that exempt organizations are being scrutinized in several areas including worker classification and fringe benefits. The TE/GE fiscal year work plan includes the following compliance checks:Combined Annual Wage Reporting (CAWR) employment taxCAWR Federal Unemployment Tax Act (FUTA)The work plan also calls for the following compliance strategies:Early retirement incentive plansForm W-2/1099 matchesFederal unemployment insurance (FUTA) taxNotice CP 2100, backup withholding Models
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Slide57Tax reform guidance: several provisions impacting health care organizations
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Slide58UBTI to be separately computed for each trade or business
New provision: Section 512(a)(6), effective for tax years starting after December 31, 2017, requires determining UBTI separately for each business. Thus, an unrelated trade or business’ income can only be offset using deductions directly connected with that particular trade or business.Net operating losses (NOLs) of a particular business could offset future income from that business, but not from other businesses.However, NOLs arising in a tax year beginning before January 1, 2018 that are carried forward to a tax year beginning after such date are not subject to provision and can be applied to UBTI generally.
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Slide59UBTI increased by amount of certain fringe benefit expenses
Provision summary: New Section 512(a)(7) provides that, effective for amounts paid after December 31, 2017, organizations subject to the UBI tax rules must increase their UBTI by their expenses of providing certain fringe benefits that would be nondeductible for a taxable entity under Section 274.Fringe benefits subject to the rule:Expenses for commuter highway vehicle transportation, transit passes and qualified parking increase UBTI if the benefits are excludable from employee income under 132(f).On-premises athletic facility expenses increase UBTI if the facility is primarily for the benefit of highly-compensated employees.Expense considerations:Employee pretax salary reductions (excludable under 132(f)) are likely to be treated as UBTI.Post-tax reimbursements of commuting expenses that do not qualify for exclusion under 132(f) should not generate UBTI.Other considerations:Many organizations may be subject to state or local laws requiring employers to provide some form of transportation subsidy.
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Slide60Excise tax on excess tax-exempt organization executive compensation
Provision summary: New Section 4960 provides that, effective for taxable years beginning after December 31, 2017, an “applicable tax-exempt organization” is subject to a 21% excise tax on the following:Remuneration over $1m paid to a covered employee (other than an excess parachute payment)Excess parachute payments paid to a covered employeeAn applicable tax-exempt organization is one that is exempt from tax under Section 501(a), a farmers’ cooperative described in Section 521(b)(1), has income excluded from tax under Section 115, or is a political organization described in Section 527.A covered employee is an employee who:Was one of the five highest-compensated employees of the organization for the tax year Or Was a covered employee of the organization (or predecessor) for any preceding tax year beginning after December 31, 2016Excess parachute payment is: Compensation paid on account of separation from service if the present value of the aggregate amount exceeds three times the base amount, which is the five-year averageExcise tax is imposed on full amount above the base amount if present value exceeds three times the base amount
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Slide61Excise tax on excess tax-exempt organization executive compensation
Applicable tax-exempt organization considerations:Are state colleges and universities and similar entities included? Covered employee considerations:Once a covered employee, always a covered employee, even if no longer one of the five highest-compensated employeesCovered employee determination made beginning with taxable years after December 31, 2016Applies to any employee, not just officersCompensation paid to licensed medical professionals in performance of professional service is not included in the definition of “remuneration”No controlled group rule applies to determining a covered employee, which means that determination may need to be made on an employer-by-employer basisUnclear whether the compensation calculated based on the calendar year (i.e., Form W-2 wages) or based on the organization’s fiscal yearExcess parachute payment considerations:Compensation paid to non-highly compensated employees within the meaning of Section 414(q) is exempt
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Slide62Excise tax on excess tax-exempt organization executive compensation
Remuneration paid to a covered employee includes amounts paid with respect to employment by a related person. A related person includes any person that:Controls, or is controlled by, the organizationIs controlled by one or more persons who also control the organizationIs a supporting or supported organization of the organizationFor a voluntary employees’ beneficiary association (VEBA) described in Section 501(c)(9), is an entity establishing, maintaining or making contributions to the VEBAConsiderations for determining amount of remuneration:Deciding what constitutes controlInteraction with joint ventures where the institution asserts sufficient control to ensure charitable operations (and avoid UBTI from pass-through income)Multiple supporting organizations, but with only a tangential connection to the organizationRemuneration is allocated between tax-exempt and related taxable entity
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Slide63Excise tax on excess tax-exempt organization executive compensation
Possibilities to mitigate impact of the excise tax:Avoid spikes in compensation payments; gradual payment of deferred compensationIncrease tax-qualified retirement benefits Allocate compensation between tax-exempt and taxable entitiesRetain present value of separation from service payments below three times the five-year average “base compensation” amountOrganizations will need to consider other rules, including benefit plan restrictions, the inurement prohibition and the excess benefit transaction excise tax.
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Slide64Repeal of exempt status of advance-refunding bond issuances
Prior law: Section 103 excludes from gross income the interest on any state or local bond, which is classified generally as either a governmental or private activity bond. This includes refunding bonds, but with limits on advance refundings. Summary of new provision: The Tax Cuts and Jobs Act (TCJA) removes the income exclusion for bonds issued after December 31, 2017 that were issued to advance-refund another bond.
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Slide65Polling question
Which of the following statements is true regarding covered employees under the new Section 4960 excise tax on excess executive compensation?Covered employee determination is made for taxable years beginning January 1, 2018.A covered employee is one of the five highest compensated employees, other than current officers, directors, trustees, or key employees.Once a covered employee, always a covered employee, even if no longer one of the five highest compensated employees.Covered employees will be subject to an excise tax on excess executive compensation.
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Slide66State and local matters
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Slide67State tax exemption
State-specific tax exemption is generally applicable to property taxes and state and local sales and use taxes.State tax-exemption criteria can differ from federal tax-exemption criteria.State and local governments have challenged nonprofit hospitals’ tax exemption in recent years. For example:New JerseyIllinois
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Slide68Tax reform: impact on state and local taxation
39 states and DC impose an income or similar tax on UBI.Will states conform to any federal tax law changes related to UBI?It depends …States typically use the Internal Revenue Code (IRC) as the starting point for determining state taxable income:If the IRC changes (e.g., base expansion, elimination of deductions, modifications of credits), the state tax base may change as well. States differ on federal conformity:Keys are in the state conformity dates:“Fixed” (or “static”) conformity states = conformity not automatic (consider whether and when to conform)“Rolling” conformity states = conformity automatic (consider whether to decouple)“Selective” conformity states = conformity depends (consider whether and when to conform)
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Slide69Polling question
Which of the following is true regarding state and local sales and use and property tax exemption? A. An organization that the IRS recognizes as a Section 501(c)(3) organization will automatically qualify for the state exemption B. Exemption criteria is uniform across the 50 states and DC C. All of the above D. None of the above
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Slide70South Dakota v. Wayfair, Inc.
Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) provides that a tax on interstate commerce is valid if:Applied to an activity having a substantial nexus with the taxing stateIs fairly apportionedDoes not discriminate against interstate commerce, andIs fairly related to the services provided by the stateQuill Corp. v. North Dakota generally provided that for the substantial nexus prong of Complete Auto Transit to be met for state sales and use tax purposes, the taxpayer must have a physical presence in the state.The Supreme Court of the United States’ June 21, 2018 ruling overturns the Quill physical presence standard, thus opening the door to states requiring taxpayers without a physical presence (e.g., online retailers) to collect sales tax.Broader implications?
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Slide71Questions?
Slide72EY
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