Exempt

Article Dean Dorton

By Allison Carter, CPA

The current bill for the Tax Cuts and Jobs Act, which was signed by President Trump on Friday, has several provisions impacting tax-exempt organizations. Below is a brief overview of the highlights of those provisions.

Highlights of the Provisions

  • Require tax-exempt organizations to calculate unrelated business taxable income (UBTI) separately for each trade or business carried on — in effect prohibiting deductions relating to one business from offsetting income derived from another business. This provision is effective for tax years beginning after December 31, 2017. This could be a big deal for exempt organizations that have been using losses from one activity to offset income from another. Importantly, net operating losses from prior years will continue to be available to offset net income, regardless of the source of the loss.
  • Require tax-exempt organizations to increase UBTI by the amount of certain fringe benefits, such as qualified transportation and on-premise athletic facilities, provided to their employees, effective for amounts paid or incurred after December 31, 2017.
  • Repeal the exclusion from gross income for interest on a bond issued to advance refund another bond for bonds issued after December 31, 2017.
  • Repeal the authority to issue tax credit bonds and direct-pay bonds issued after December 31, 2017.
  • Private activity bonds, which were on the chopping block in the House version of the bill, remain intact, for now – there is continuing discussion in Congress on returning private activity bonds to the purposes for which they were originally intended.
  • Impose a 1.4% excise tax on net investment income on private colleges and universities (and their related organizations) that: (1) have at least 500 students; (2) have at least 50% of their students located within the United States; and (2) have assets (other than assets used directly in carrying out the institution’s educational purpose) with an aggregate fair market value of at least $500,000 per full-time student at the end of the preceding year. The assets and net investment income of related organizations would be included in determining the applicability and amount of the tax if the assets and income are available to the educational institution. The tax will be effective for tax years beginning after December 31, 2017. Harvard has estimated that, had this provision been in place last year, its tax bill would have been $43 million.
  • Impose an excise tax of 21% on compensation, plus any parachute payment in excess of $1,000,000, paid to any of a tax-exempt organization’s five highest compensated employees for the year and any employee who was one of the organization’s five highest paid employees in any tax year beginning after 2016. The tax would apply to W-2 wages, not including designated Roth contributions, but including amounts included under 457(f). In addition, payments to medical professionals for providing medical or veterinary services would be exempted from the definition of “compensation” for purposes of the tax. The tax would be effective for tax years beginning after 2017. This provision applies to both public and private organizations and includes compensation from any related or governmental entity. So, paying a senior executive or coach $6mm will cost the organization an additional $1,050,000.

While the itemized deduction for charitable donations was not repealed, the Act does disallow certain other itemized deductions and increase the standard deduction for individuals, thus removing the benefit of a charitable deduction for many. A 2017 study by the Indiana University Lilly Family School of Philanthropy suggests that charitable giving may drop by up to $13 billion annually. For fundraisers, we’re suggesting focusing more on the good you do and less on deductibility, at least for smaller donors.

Also keep in mind that while the increased standard deduction and lowering of itemized deductions is expected to result in only 5% of taxpayers itemizing deductions, before the change only about 30% itemized — so even before this change, 70% of taxpayers got no benefit from charitable contributions and yet, many contributed anyway.

Disclaimer

The information presented is not intended to be a full and exhaustive explanation of the tax bills referenced. Please consult your tax advisor regarding the policies that might be applicable to your specific situation.

Article Dean Dorton

By: Jen Shah, Dean Dorton Equine Industry Team Leader

As the December 1, 2016 implementation deadline rapidly approaches, we thought it would be useful to farms to provide some reminders on these new regulations and to illustrate their effect on certain farm managerial, executive, administrative and professional positions. Farms, professionals (myself included!) and even local Department of Labor agents have been confused about interpreting the new rules and applying them to farms.

Earlier this year, we issued an article regarding the potential applicability to farms under the final regulations issued by the US Department of Labor to Part 541, which governs certain executive, administrative and professional positions under the Fair Labor Standards Act (FLSA). A link to that article may be found here:

Federal Overtime Regulations for Thoroughbred Businesses

This article takes a closer look at how the updated Part 541 regulations may impact farms, specifically regarding certain manager-level, executive, administrative or professional farm employees who fall below the new $47,476 salary threshold.

FLSA provides for two categories of employees:

  1. Exempt – Salaried
  2. Non-Exempt – Hourly or Salaried

“Exempt” in this context means “exempt from overtime pay.” In order to be “exempt,” an employee must meet the salary basis test (fixed salary not subject to reduction based on the quality or quantity of work performed), the duties test (refer to our prior article for a more in-depth discussion), AND the salary level test. If any one of these tests is not met, then an employee is “non-exempt.” A non-exempt employee must be paid based on hours worked in the pay period plus overtime at a rate of time and one-half for hours that exceed 40/week. The prior statement ignores the general agricultural exemption under Part 780, which is specifically addressed later in this article.

The salary basis and duties tests did not change upon issuance of the final regulations, but the minimum salary level was increased to $913 per week ($47,476 per year) from $455 per week ($23,660 per year). Therefore, if a person meets the duties test but is paid less than the minimum salary threshold, this employee is treated as “non-exempt” effective December 1, 2016.

By converting a prior exempt-salaried employee to a non-exempt employee, the farm is now required to track actual hours the employee works and to pay at the calculated hourly rate based on these actual hours. This creates issues for both the farm and these farm employees.

So how does the above change from “exempt” to “non-exempt” status interact with the agricultural exemption under Part 780, which is available to qualifying employees who perform duties on the farm? As a reminder, the agricultural exemption was not changed by the updated regulations. Under Part 780, employees who are engaged in agriculture continue to be exempt from overtime pay at time and one-half (although KY law requires overtime to be paid to employees who have worked seven days in any given work week for all hours worked on the seventh day).

The updated regulations merely convert certain previously “exempt” employees to “non-exempt” status, requiring that these employees now be paid based on actual hours worked versus a salary. However, the hours worked in excess of 40 hours/week are only required to be paid based on the calculated hourly rate, not time and one-half, under the agricultural exemption available to qualifying employees under Part 780.

Let’s walk through an example of a broodmare manager who makes $40,000 per year, is paid weekly and works an average of 45 hours per week. Under Part 541, the manager meets the duties test of an executive and, as of November 2016, his salary exceeds the $23,660/year threshold. He currently is treated as an exempt-salaried employee and paid about $760/week ($40,000 per year/52 weeks).

Effective December 1, 2016, the manager does not meet the salary test since his $40,000 salary is less than the newly-established minimum of $47,476. Therefore, this broodmare manager is converted from an exempt-salaried employee to a non-exempt employee.

What does the change in status on December 1, 2016 mean for the farm and the broodmare manager? The farm may address this situation in a variety of ways:

  1. Increase the broodmare manager’s salary to the $47,476 threshold.
    1. Pro – Less administrative burden because tracking hours is not required.
    2. Con – Increased expense for the farm.
  1. Convert to an hourly wage using a 40 hour/work week.
    1. The broodmare manager’s $40,000 salary could be converted to an hourly wage, and the manager would be paid by the farm for the actual hours worked in a week. Conversion to an hourly wage per hour is calculated below for this example:
    2. Salary ($40,000) / (40 hours per week * 52 weeks) = $40,000/2,080 hours = about $19/hour.
    3. Therefore, if the broodmare manager works a 40 hour week, he would be paid about $760 ($19/hour * 40) for that week. If he works 60 hours in one week, he would be paid about $1,140 ($19/hour * 60) for that week.
    4. Pro – Keeps base weekly wage the same for the broodmare manager (with increased pay for weeks where greater than 40 hours are worked).
    5. Con – Increased salary expense for the farm and increased administrative burden for both the manager and the farm to track hours.
  1. Convert to an hourly wage using the average number of hours worked/work week.
    1. The broodmare manager’s $40,000 salary could be converted to an hourly wage, and the manager would be paid by the farm for the actual hours worked in a week. Conversion to an hourly wage per hour is calculated below for this example:
    2. Salary ($40,000) / (45 hours per week * 52 weeks) = $40,000/2,340 hours = about $17/hour
    3. Therefore, if the broodmare manager works a 40 hour week, the pay would be $680 ($17/hour * 40) for that week. If he works 60 hours in one week, he should be paid about $1,020 ($17/hour * 60) for that week.
    4. Pro – Attempts to maintain current salary expense consistent for farm.
    5. Con – Broodmare manager will receive less weekly pay in weeks where 40 hours are worked versus what he received previously (farm may consider a bonus to “true-up” the manager’s salary at intervals throughout the year). Increased administrative burden for both the manager and the farm to track hours.

In short, if you are converting a managerial, executive, administrative or professional farm employee from “exempt” to “non-exempt” status, you are required to pay for actual hours worked in a work week, but are not required to pay at time and one-half rates for hours in excess of 40 as long as the employee qualifies for the general agricultural exemption under Part 780.

Note that a ruling regarding a preliminary injunction to implement these FLSA updates is expected to be issued on November 22, 2016 by a U.S. District Court. Another hearing trial could be set for November 28th if the motion is denied. Stay tuned for news on this ruling; however, in the meantime, it is wise to prepare the farm for the December 1, 2016 implementation of these updated regulations.

Please contact me at jshah@deandorton.com or your Dean Dorton advisor with any questions regarding the above.

Jen Shah, Equine Industry Team Leader

Article Dean Dorton

The Kentucky General Assembly recently passed legislation, in effect August 1, 2016, to exempt disregarded single-member limited liability companies wholly-owned by IRC 501(c)(3) organizations from Kentucky sales and use tax on their purchases.

Prior to this legislation, issues arose as Kentucky required these disregarded entities to establish their own IRC 501(c)(3) exemption separate from their sole owner, which is not required, nor allowed, under Federal income tax law.

Kentucky now requires disregarded single-member limited liability companies wholly-owned by IRC 501(c)(3) organizations to apply for exempt status with Kentucky using Form 51A125 and attach documentation supporting the organization as a disregarded entity of the parent organization, along with the parent organization’s exempt status determination letter from the IRS or other proof of its exemption. These LLCs will obtain their own Kentucky exemption number separate from their sole owner.

It is becoming more frequent for tax exempt entities to use wholly owned LLCs to hold either property or separate operations from the parent organization.

This can be beneficial in providing liability protection for the parent organization. If you have any questions regarding sales tax exemption for nonprofit LLCs, please contact your Dean Dorton advisor or Allison Carter at 859-425-7645 or alcarter@deandorton.com.

Article Dean Dorton

Many tax exempts face the difficult task of trying to raise enough capital to fund programs, without the risk of losing exempt status, when traditional lending opportunities are increasingly less available. Joint venturing with for-profit corporations has been one strategy used. However, such partnerships could put exempt status at risk if too much control is retained by the for-profit co-venturer.

IRS has upheld that a joint venture with a 50/50 allocation of control between the exempt and for-profit partners, with other safeguards, could be a valid arrangement. These safeguards are: a partnership document that contains a charitable purpose, effective control over day-to-day operations and major decisions retained by the non-profit, a charitable override for a deadlocked board, absence of profit maximization as a primary motive, and the governing documents containing written commitment to fulfilling the charitable purpose if there is a conflict with profit maximization. The problem lies in whether the for-profit corporation will agree to these terms.

Another solution would be for the exempt organization to form a partnership with a Benefit Corporation (B-corp) or a low profit limited liability company (L3C), which are for-profit entities whose missions include promotion of social good. Those tasked with governance of these types of entities make decisions based on profitability and impact on other stakeholders, including the community at large and the social good. These entities’ interests are more closely aligned with the non-profit organization’s mission than that of a for-profit corporation. If designed correctly, a partnership with the B-corp or L3C is a way to effectively structure a joint venture that will benefit both organizations and help preserve the exempt status of the non-profit. While B-corps and L3Cs cannot currently be formed in Kentucky, they may be formed elsewhere and operated in Kentucky.

If you have questions about structuring your joint ventures, please contact Allison Carter at alcarter@deandorton.com or 859-425-7645.