The Parking Lot Tax

Last year’s Tax Cuts and Jobs Act created a 21% tax on transportation-related fringe benefits provided by nonprofits.

That does not sound so bad until you consider that qualified transportation fringe benefits include:

1.    Transit passes or reimbursement for the same

2.    Use of a commuter highway vehicle or reimbursement for the same

3.    Qualified bicycle commuting reimbursement

4.    Qualified parking expenses or reimbursement for the same

That last one proved to be a shocker.

What started the issue was the new deduction disallowance for qualified transportation fringe benefits paid by taxable employers. For example, if the employer pays for employee parking, up to $260 per month can be excluded from the employee’s 2018 W-2. In the past the employer could deduct that $260 on its tax return. Now it could not. Congress felt that – if taxable employers were to be affected – then nonprofit employers should also be affected.

But how does a nonprofit even pay tax?

It can happen, and it is called unrelated business income. In general, it means that the nonprofit is veering away from its charitable mission and is conducting an activity that is virtually indistinguishable from a for-profit business next door.

The nonprofit has to separately account for this activity. The IRS then spots it a $1,000 exemption. If it has more than a $1,000 in profit then it has to pay tax at the corporate rate – which is now 21%.

This change entered the tax Code in December, 2017 via Code Section 512(a)(7):

      (7)  Increase in unrelated business taxable income by disallowed fringe.

Unrelated business taxable income of an organization shall be increased by any amount for which a deduction is not allowable under this chapter by reason of section 274 and which is paid or incurred by such organization for any qualified transportation fringe (as defined in section 132(f) ), any parking facility used in connection with qualified parking (as defined in section 132(f)(5)(C) ), or any on-premises athletic facility (as defined in section 132(j)(4)(B) ).

There are three things to note here:

(1)  Congress is treating these disallowed deductions as if they were income to the nonprofit.

(2)  We have to track down the meaning of “qualified parking,” and

(3)  The phrase “deduction is not allowable” has a meaning that is not immediately apparent.

Let’s start with qualified parking, defined as:

… parking provided to an employee on or near the business premises of the employer or on or near a location from which the employee commutes to work …. 

Qualified parking does not include parking provided near the employee’s residence. 

Employer-provided parking includes parking on property an employer owns or leases, parking for which the employer pays, or parking for which an employer reimburses an employee.

So we know that qualified parking is provided near the employer and the employer pays for, reimburses, leases or owns the parking facility.

This makes sense if there is a public garage across the street and the employer pays the garage directly or reimburses an employee who paid the garage. However, how does this work if the employer owns the parking lot?  More specifically, how does this work if the parking lot is available to employees, customers – that is, to everyone and for free?

There is (what appears to be) a Congressional mistake when drafting Code Section 512(a)(7).

In 1994 the IRS published a rule in Notice 94-3, conveniently titled “IRS Explains Rules For Qualified Transportation Fringe Benefits.” Here is Question 10 and its example:

EXAMPLE. Employer Z operates an industrial plant in a rural area in which no commercial parking is available. Z furnishes ample parking for its employees on the business premises, free of charge. The parking provided by Z has a fair market value of $0 because an individual other than an employee ordinarily would not pay to park there.

The answer makes sense. Anyone can park on that lot for free. If an employee parks there, it seems reasonable that the value of the parking would be zero (-0-).

That is not what Code Section 512(a)(7) did:

Unrelated business taxable income of an organization shall be increased by any amount for which a deduction is not allowable ….

There is no reference here to value. To the contrary, the reference is to a deduction – which to an accountant means cost. Parking may be free to the user, but it will cost something to maintain that parking facility. The cost may be a lot or a little, but there is a cost.

The Notice 94-3 rule that tax practitioners had gotten used to was overturned.

Needless to say, there were many questions on what the new rules meant and how to apply them. Consider that a nonprofit is supposed to make quarterly estimated tax payments against any expected unrelated-business-income tax, and guidance was needed sooner rather than later. On December 10, 2018 the IRS published interim guidance (Notice 2018-99) on qualified transportation fringe benefits. 

It started with the easiest example:

A taxable employer pays a garage $12,000 annually so that its employees can park. None of this exceeds the $260 monthly threshold per employee for 2018. The entire $12,000 is non-deductible by the employer.

Introduce any complexity and there are steps to the calculation:   

(1)  Calculate the cost for reserved employee spots.

a.     These costs are disallowed.

(2)  Calculate the primary use of the remaining spots.

a.     If more than 50% is for customers, clients and the general public, the calculation ends.

                                                             i.     Any remaining cost is fully deductible.

b.    If more than 50% is for employees, there is math:

                                                             i.     Calculate the cost for reserved nonemployee parking; these costs are allowed.

                                                           ii.     Calculate the cost for nonreserved employee parking; these costs are disallowed.

Let’s go through an example from the Notice.

An accounting firm leases a parking lot for $10,000 next to its office. The lot has 100 spaces, used by clients and employees. The firm has 60 employees.

(1)  There are no reserved employee parking spaces

a.     We have zero (-0-) from this step.

(2)  The primary use is for employees (60/100).

a.     We have math.

(3)  There are no reserved nonemployee parking spaces (think visitor parking).

a.     We have zero (-0-) from this step.

(4)  One must use a reasonable allocation method. The accounting firm determines that employee use constitutes 60% (60/100) of parking lot use during business days, with no adjustment for evenings, weekends or holidays. The disallowance is $6,000 ($10,000 times 60%).

An accounting firm is a taxable entity, so the $6,000 is not deductible on its return.

What if we were talking about a nonprofit? Then the $6,000 magically “transforms” into unrelated business taxable income. The IRS spots $1,000 exemption, so the taxable amount is $5,000. Apply a 21% tax rate and the tax on the parking lot is $1,050.

What if the employer owns the parking lot? What costs could there be to a parking lot?

The IRS thought of this:

For purposes of this notice, “total parking expenses” include, but are not limited to, repairs, maintenance, utility costs, insurance, property taxes, interest, snow and ice removal, leaf removal, trash removal, cleaning, landscape costs, parking lot attendant expenses, security, and rent or lease payments or a portion of a rent or lease payment (if not broken out separately). A deduction for an allowance for depreciation on a parking structure owned by a taxpayer and used for parking by the taxpayer’s employees is an allowance for the exhaustion, wear and tear, and obsolescence of property, and not a parking expense for purposes of this notice.

At a minimum, I anticipate that one is allocating insurance and taxes.

So a nonprofit can have tax because it provides parking to its employees. You may have heard this referred to as the “church parking lot tax.” Yes, churches are 501(c)(3)s, meaning they are nonprofits just like the March of Dimes. Granted, there are additional tax breaks to being a church, such as not having to file a Form 990. The unrelated business income tax is not filed on a Form 990, however; it is filed on a Form 990-T. They both have “990” in their name, but they are separate tax forms. Who knows how many churches will have to file a Form 990-T for the first time for 2018, even though their board has never filed – or even seen - a Form 990.

How can a church have income from its parking lot?

If it charges for parking, obviously. That however is a low probability event.

Another way would be to have reserved employee parking spaces. Those are allocated cost (which morphs into income) immediately.

A third way is the employee:nonemployee calculation. That calculation would be tricky because of the uneven use of a church over an average week. One would somehow weight the use of the parking lot. Church employees are there Monday through Friday. The congregation is there on Sunday and (maybe) one night during the week. Perhaps employee parking is weighted using a factor of eight (hours) and congregational use is weighted using a factor of 2.5 (hours). Hopefully the result is to get congregational use above 50%. Why?

Remember: if nonemployee use at step (2) is more than 50%, the calculation ends. All the church would have to pay tax on is income from reserved employee parking. If that is below $1,000, there is no tax.

There is an effort to include a repeal of Code Section 512(a)(7) on any extender or other bill that Congress may pass, but that would require Congress to be able to pass a bill – any bill – in the near future.

The Notice also has one of the more unusual “make-up” provisions I have seen. Say that you want to do away reserved employee parking (that is, step (1)) because the tax gets expensive. It is way too late to do anything for 2018, as the guidance came out in December. The Notice allows you to make the change by March 31, 2019 and consider it retroactive to January 1, 2018.

Our church would have no step (1) income as long as it did away with reserved employee parking by March 31, 2019. That would mean taking down the sign saying “Pastor Parking Only,” but that may be the best alternative until Congress can correct this mess.

Should I Have A Separate Bank Account For …?

One of the accountants recently told me that a client had asked whether he/she should set-up a separate bank account for their business.

The short answer is: yes.

It is not always about taxes. An attorney might recommend that your corporation have annual meetings and written minutes – or that you memorialize in the minutes deferring a bonus for better cash flow.  It may seem silly when the company is just you and your brother. Fast forward to an IRS audit or unexpected litigation and you will realize (likely belatedly) why the recommendation was made.

I am skimming a case where the taxpayer:

·      Had three jobs

·      Was self-employed providing landscaping and janitorial services (Bass & Co)

·      Owned and operated a nonprofit that collected and distributed clothing and school supplies for disadvantaged individuals (Lend-A-Hand).

The fellow is Duncan Bass, and he sounds like an overachiever.

Since 2013, petitioner, Bass & Co …, and Lend-A-Hand have maintained a single bank account….”

That’s different. I cannot readily remember a nonprofit sharing a bank account in this manner. I anticipated that he blew up his 501(c)(3).

Nope. The Court was looking at his self-employment income.

He claimed over $8 thousand in revenues.

He deducted almost $29 thousand in expenses.

Over $19 thousand was for

·      truck expenses

·      payment to Lend-A-Hand for advertising and rental of a storage unit

He handed the Court invoices from a couple of auto repair shops and a receipt from a vehicle emissions test.

Let’s give him the benefit of the doubt. Maybe he was trying to show mileage near the beginning and end of the year, so as to establish total mileage for the year.

Seems to me he next has to show the business portion of the total mileage.

Maybe he could go through his calendar and deposits and reconstruct where he was on certain days. He would still be at the mercy of the Court, as one is to keep these records contemporaneously.  At least he would field an argument, and the Court might give him the benefit of the doubt.

He gave the Court nothing.

His argument was: I reported income; you know I had to drive to the job to earn the income; spot me something.

True enough, but mileage is one of those deductions where you have to provide some documentation. This happened because people for years abused vehicle expenses. To give the IRS more firepower, Congress tightened-up Code Section 274 to require some level of substantiation in order to claim any vehicle expenses.

And then we get to the $9,360 payment to Lend-A-Hand.

Let’s not dwell on the advertising and storage unit thing.

I have a bigger question:

How do you prove that his business paid the nonprofit anything?

Think about it: there is one checking account. Do you write a check on the account and deposit it back in?

It borders on the unbelievable.

And the Tax Court did not believe him.

I am not saying that the Court would have sustained the deduction had he separated the bank accounts. I am saying that he could at least show a check on one account and a deposit to another.  The IRS could still challenge how much “advertising” a small charity could realistically provide.

As it was, he never got past whether money moved in the first place.

Can A Coffee Shop Be Tax-Exempt?

I have been spending quite a bit of time over the last few days working on or reviewing not-for-profit returns.

It may surprise you, but – with a few exceptions – not-for-profit organizations are required to file paperwork annually with the IRS.

There is a reason for this: the tax Code recognizes some organizations as “per se” not-for-profit – churches are the classic example. Churches do not need to be told by the IRS that they are tax-exempt; they simply are. A large part of this is church:state separation, although church programs that begin to look uncannily similar to for-profit businesses are supposed to file an income tax return (known as Form 990-T) and pay tax.

Then we have the next tier: the education, charitable, scientific, etc. entities that also comprise not-for-profits. These are not “per se” and have to apply with the IRS to have their exempt status recognized. The application is done via either Form 1023 or Form 1024, depending upon the type of exempt status desired.

We talking about the March of Dimes, Doctors Without Borders or your local high school boosters club.

One thing this tier has in common is that they have to explain to the IRS what their exempt purpose is.

And there are tax subtleties at play. For example, can your exempt purpose be less than 50% of what you do? What if it is more than 50% but you have a significant (but less than 50%) non-exempt purpose? What if you start out at a more-than-50% exempt purpose but – over time – your non-exempt purpose goes over 50%?

This becomes its own field of specialization. I have met practitioners over the years whose only practice is tax exempts.

I am looking at the IRS response to a recent exempt application. I will give you a few facts and flavor, and let’s see if you can anticipate the IRS decision on the matter.

(1)  A minister had an idea for a coffee shop. The shop would be separate from the church (hence the exempt application). Being separate however would allow (and maybe encourage) other churches and religious groups to participate.

(2)  The coffee shop would allow believers and non-believers to interact. There would be religious activities, but the activities would not be organized by the shop. They would instead be organized by the patrons. By the way, the shop could also be used for non-religious activities. One could leave a donation for the use of the space.

(3)  There are no similar businesses where the shop is located, hence it is not taking commercial opportunity from a profit-seeking business.

(4)  The shop affords a gathering space that is open late, as well as provide safe space for residents to gather.

(5)  The shop takes part in a job-skills training program to help underserved youth by placing them in an actual job for a six-week internship.

(6)  The shop participates in a project for the children of incarcerated parents. Patrons can share gifts with the kids, such as for their birthdays and Christmas.

(7)  The shop does not want to turn away anyone for inability to pay. There is a program where a customer can pay for a certain amount of coffee in advance. When a not-able-to-pay patron enters, he/she is served from those advance payments.

(8)  The shop sells coffee, teas, smoothies and so forth. There are also baked goods, as well as salads and desserts.

(9)  The shop roasts its own coffee, which is sourced directly from coffee farmers. This allows the farmers to earn more than other conventional means of distribution. The coffee is also available for sale, and there are plans to sell the coffee online in the future

(10)        The shop uses some volunteers, but its largest expense is (understandably) wages and related payroll costs.

(11)        The shop intends to give away its profits - that is, when it finally becomes profitable.

What do you think? Would you give this shop exempt status?

Here goes the IRS:

(1)  To be exempt, an organization must be both organized and operated exclusively for an exempt purpose. The test has two parts: the paperwork and what is actually going on.

(2)  The IRS has defined the word “exclusively” to mean “primarily.”

(3)  Hot on the heels of that definition, the IRS has also said that non-exempt activities must not be “more than an insubstantial part” of activities.

OBSERVATION: You can see the evolution of law here. A non-tax specialist would anticipate that an activity is exempt if the exempt activity is 51% or more of all activities. The flip side is that a non-exempt activity should be as much as 49%.

The IRS however states that a non-exempt activity cannot be “more than an insubstantial part” of all activities.

Does “insubstantial” mean as much as 49%?

If not, then the IRS is changing definitions all over the place.

(4)  The IRS has previously decided that the operation of a grocery store to provide on-the-job training to hardcore unemployed represented two purposes, not one. Each purpose has to be reviewed to determine whether it is exempt or not.

(a)  And now it gets tricky. If the store is staffed principally by a target group (or volunteers) AND the store is no larger than reasonably necessary for achieving the exempt purpose, the IRS has said that the store is exempt.

(b)  Conversely, if the store is not staffed by the target group (or volunteers) or larger than necessary, the IRS has said that the store is non-exempt.

(5)  While the coffee shop intends to donate its profits, its main activity is the operation of a coffee shop in a commercial manner.

(6)  And that activity is “more than insubstantial.”

The IRS rejected the application. The coffee shop will have to pay taxes.

Doesn’t it matter that they are giving away all profits? Isn’t there a vow-of-poverty-thing that one can point to?

And there is a key point about tax law in the world of exempts. Giving away money will not transform a for-profit activity into a not-for-profit activity. Granted, you may get a charitable deduction, but you will be taxable. The IRS has been steadfast on this point for many years. The activity itself has to be exempt, not just the monies derived from said activity. To phrase it differently, gigantic donations will not make Microsoft a tax-exempt entity.

The IRS decided the shop was too similar to a Starbucks or Caribou.    

And giving away any profits wasn’t enough to change the answer.

Does the shop do great work?

Yes.

Is it tax exempt?

Nope.

When A Good Cause Is Not Enough

Let’s talk about the tax issues of tax-exempt entities. It sounds like a contradiction, doesn’t it?

It actually is its own area of practice. Several years ago I was elbow-deep working with nonprofits, and I attended a seminar presented by a specialist from Washington, D.C. All he did was nonprofits. At least he was in the right town for it.

There are the big-picture tax-exempt issues. For example, a 501(c)(3) has to be publicly-supported. You know there is a tractor-trailer load of rules as to what “publicly supported” means.

Then there are more specialized issues. One of them is the unrelated business income tax. The concept here is that a nonprofit cannot conduct an ongoing business and avoid tax because of its exemption. A museum may be a great charitable cause, for example, but one cannot avoid tax on a chain of chili restaurants by having the museum own them.

That is not what museums do. It is unrelated to “museum-ness,” and as such the chili restaurants will be taxed as unrelated business income.

Sometimes it can get tricky. Say that you have a culinary program at a community college. As part of the program, culinary students prepare meals, which are in turn sold on premises to the students, faculty and visitors. A very good argument can be made that this activity should not be taxed.  

What is the difference? In the community college’s case, the activity represents an expansion of the underlying (and exempt) culinary education program. The museum cannot make this argument with its chili restaurants.

However, what if the museum charges admission to view its collection of blue baby boots from Botswana? We are now closer to the example of culinary students preparing meals for sale. Exhibiting collections is what museums do.

I am looking a technical advice memorandum (TAM) on unrelated business income. This is internal IRS paperwork, and it means that an IRS high-level presented an issue to the National Office for review.

Let’s set it up.

There is a community college.

The community college has an alumni association. The association has one voting member, which is a political subdivision of the state.

The alumni association has a weekly farmers market, with arts and crafts and music and food vendors. It sounds like quite the event. It uses the parking areas of the community college, as well as campus rest rooms and utilities. Sometimes the college charges the alumni association; sometimes it does not.

The alumni association in turn rents parking lot space to vendors at the market.

All the money from the event goes to the college. Monies are used to fund scholarships and maintain facilities, such as purchasing a computer room for the library and maintaining the football field.

OBSERVATION: The tax Code does not care that any monies raised are to be used for a charitable purpose. The Code instead focuses on the activity itself. Get too close to a day-in-and-day-out business and you will be taxed as a business. Granted, you may get a charitable deduction for giving it away, but that is a different issue.

From surveys, the majority of visitors to the farmers market are age 55 and above.

There was an IRS audit. The revenue agent thought he spotted an unrelated business activity. The file moved up a notch or two at the IRS and a bigwig requested a TAM.

The association immediately conceded that the event was a trade or business regularly carried on. It had to: it was a highly-organized weekly activity.

The association argued instead that the event was its version of “museum-ness,” meaning the event furthered the association’s exempt purpose. It presented three arguments:

(1) The farmers market contributed to the exempt purpose of the college by drawing potential students and donors to campus, helping to develop civic support.

(2) The farmers market lessened the burden of government (that is, the college).

(3) The farmers market relieved the distress of the elderly.

The IRS saw these arguments differently:

(1) Can you provide any evidence to back that up? A mere assertion is neither persuasive nor dispositive.

COMMENT: The association should have taken active steps – year-after-year – to obtain and accumulate supporting data. It may have been worth hiring someone who does these things. Not doing so made it easy for the IRS to dismiss the argument as self-serving.

(2) At no time did the community college take on the responsibility for a farmers market, and the college is the closest thing to a government in this conversation. Granted, the college benefited from the proceeds, but that is not the test. The test is whether the association is (1) taking on a governmental burden and (2) actually lessening the burden on the government thereby.  As the government (that is, the college) never took on the burden, there can be no lessening of said burden.

COMMENT: This argument is interesting, as perhaps – with planning – something could have been arranged. For example, what if the college sponsored the weekly event, but contracted out event planning, organization and execution to the alumni association? 

(3) While the market did provide a venue for the elderly to gather and socialize, that is not the same as showing that the market was organized and worked with the intent of addressing the special needs of the elderly. 

COMMENT: Perhaps if the association had done things specifically for the elderly – transportation to/from retirement homes or free drink or meal tickets, for example – there would have been an argument. As it was, the high percentage of elderly was a happenstance and not a goal of the event.

There was no “museum-ness” there.

And then the association presented what I consider to be its best argument:

(4) We charged rent. Rent is specifically excluded as unrelated business income, unless special circumstances are present – which are not.

Generally speaking, rent is not taxable as unrelated business income unless there is debt on the property. The question is whether the payments the association received were rent or were something else.

What do I mean?

We would probably agree that leasing space at a strip mall is a textbook definition of rent. Let’s move the needle a bit. What would you call payment received for a hospital room? That doesn’t feel like rent, does it? What has changed? Your principal objective while in a hospital is medical attention; provision of the room is ancillary. The provision of space went from being the principal purpose of the transaction to being incidental.

The IRS saw the farmers’ market/arts and craft/et cetera as something more than a parking lot. The vendors were not so much interested in renting space as they were in participating (and profiting) from a well-organized destination and entertainment event. Landlords provide space. Landlords do not provide events. 

The IRS decided this was not rent.  

You ask why I thought this was the association’s best argument? Be fair, I did not say it was a winning argument, only that it was the best available.

The alumni association still has alternatives. Examination requested the TAM, so there will be no mercy there. That leaves Appeals and then possibly going to Court. A Court may view things differently.

And I am unhappy with the alumni association. I suspect that the farmers’ market went from humble origins to a well-organized, varied and profitable event. As a practitioner, however, I have to question whether they ever sought professional advice when this thing started generating pallet-loads of cash. Granted, the activity may have evolved to the point that no tax planning could save it, but we do not know that. What we do know is that little – if any – planning occurred.