State and local tax implications of federal tax reform for tax-exempt organizations
In the rush to understand the changes made by the 2017 federal tax reform law, known as the Tax Cuts and Jobs Act (TCJA), tax-exempt organizations may not yet have had time to consider how the federal changes may affect state taxes. Similarly, state taxing authorities and state tax practitioners may be so wrapped up in the state and local tax (SALT) implications of the TCJA for individuals or regular C corporations (especially changes affecting the 2017 tax year) that they may not yet have had time to consider the SALT implications of tax reform for tax-exempt organizations.
Significant changes to federal unrelated business income under TCJA
A tax-exempt organization is generally subject to federal income tax only on unrelated business income (UBI) — generally, income that is unrelated to the organization's tax-exempt purpose. The TCJA made several significant changes to the definition and structure of federal UBI, effective for tax years beginning after Dec. 31, 2017. One such change is the new "siloing" rule, under which a tax-exempt organization must track its income and expenses from each separate unrelated trade or business, and losses derived from one unrelated trade or business may not offset the income from another unrelated trade or business.
As of this writing, federal guidance defining what constitutes a separate unrelated trade or business had not yet been issued. The TCJA provides a transition rule for net operating losses (NOLs) incurred prior to tax year 2018, which allows these losses to still be used to reduce aggregate UBI. However, losses incurred in tax years beginning on or after Jan. 1, 2018, must be separately tracked and may reduce UBI only from that separate trade or business.