In the draft 2016 Instructions for Form 990-T, Exempt Organization Business Income Tax Return (and proxy tax under Section 6033(e)), the IRS explains changes made to the draft 2016 Form 990-T, and how to complete the form accurately.

Background

Form 990-T is being amended for the 2016 tax year to reflect changes in the law, including the final regulations under Section 501(r) for tax-exempt hospital organizations and hospital facilities, released in December 2014 (see Tax Alert 2015-29). The final regulations address the requirements for community health needs assessments (CHNAs), financial assistance policies (FAPs), billing and collections policies and practices, emergency medical care policies, and limitations on charges that tax-exempt hospital organizations and facilities must meet to preserve their tax exemption and avoid excise and noncompliant facility income tax. The final regulations generally are effective for tax years beginning on or after December 29, 2015 — e.g., tax years beginning January 1, 2016, for calendar-year filers.

Draft instructions

The most significant changes in the draft instructions are:

— A new Line 39 (Part III, Tax Computation) has been added to Form 990-T to report liability for tax on noncompliant hospital facility income.¹ Under certain circumstances, the IRS may tax the income of a noncompliant hospital facility if the entity fails to meet Section 501(r) requirements. The draft instructions note that this "tax is an income tax and is separate from the excise on a failure to meet the community health needs assessments requirements of 501(r)(3) that is reported on Form 4720."

— The exclusion from unrelated business taxable income (UBTI) for certain qualifying specified payments under Section 512(b)(13)(E) is now permanent (see "What's New," page 1).

— Discussing automatic extensions for corporations to file Form 990-T, the draft instructions omit the modifier "six months," stating simply that corporations "may request an automatic extension of time to file Form 990-T by using Form 8868, Application for Extension of Time to File an Exempt Organization Return."

— A paragraph discussing automatic three-month extensions available for trusts has been omitted from the draft instructions.

Other changes include:

— Line 28 (Part II, Deductions Not Taken Elsewhere) is provided for claiming a Section 179D   deduction for costs related to energy efficient commercial building property, which may be claimed for property placed in service on or before December 31, 2016.

— The qualified plug-in electric vehicle credit is not available for vehicles acquired after 2011, and Treas. Reg. Section 1.30-1(b)(2) requires recapture for events within three full years of the being-placed-in-service date (see "Line 41B," page 20).

— The minimum penalty amount for late filing of a return has been increased from $135 to $205 (see "Interest and Penalties," page 4).

— An exempt organization must file Form 5884-C, Work Opportunity Credit for Qualified Tax-Exempt Organizations Hiring Qualified Veterans, to claim the credit for qualified first-year wages paid to qualified veterans working for the organization between November 22, 2011 and December 31, 2019 (see "Other Forms That May Be Required," page 6).

— DHL Express has been added to the private delivery service list, in addition to UPS and FedEx (see "Where to File," page 4).

Noncompliant hospital facility income

A hospital organization that operates a noncompliant hospital facility and has not properly corrected and reported the noncompliance will be subject to tax on its "noncompliant facility income."² The liability for this tax applies to hospitals that fail to meet one or more of the Section 501(r) requirements during a tax year, except when failures have resulted from minor omissions or errors that have been corrected, or when failures have been corrected and disclosed on Form 990, Schedule H.³ "Noncompliant facility income" is the gross income derived from a hospital facility that fails to meet one or more of the Section 501(r) requirements during the tax year, less allowable income tax deductions that are directly connected to the operation of that hospital facility during the tax year, excluding any gross income and deductions taken into account in computing any UBTI that is derived from the facility during the tax year.⁴

To compute a hospital facility's noncompliant facility income for reporting purposes, the gross income and allowable deductions for the hospital facility may not be aggregated with the gross income and allowable deductions for the hospital organization's other noncompliant hospital facilities or its unrelated trade or business activities under Section 513.⁵

Qualified specified payments

In general, Section 512(b)(13) evidences congressional intent to strip any exemption from the exempt organization's receipt of certain income from business entities it controls.

The provision applies if a tax-exempt entity receives or accrues a "specified payment" from an entity that it "controls."⁶ A "specified payment" is defined as "any interest, annuity, royalty, or rent."⁷ A recipient controls an entity if it owns more than 50% of the stock (by vote or by value) of a corporation, more than 50% of the interests in the profits or capital of a partnership, or more than 50% of the beneficial interests of an entity organized in some other form.⁸ The constructive ownership rules of Section 318 apply in determining the ownership of stock and other interests.⁹

When Section 512(b)(13) applies, the controlling tax-exempt organization must treat specified payments from its controlled entity as unrelated business gross income to the extent they reduce the controlled entity's "net unrelated income" or increase its "net unrelated loss."¹⁰ If the controlled entity is not tax-exempt, net unrelated income is the portion of its taxable income that would be UBTI if it were exempt and had the same exempt purposes as the controlling tax-exempt organization.¹¹ If the controlled entity is tax-exempt, its net unrelated income is its UBTI. Net unrelated loss is an NOL from activities that would be unrelated trades or businesses.¹²

Section 512(b)(13)(E) provides a special modification to the determination of what portion of a specified payment is considered UBTI. For payments meeting the terms of that subsection, the taxable amount of the specified payment is only that portion of the item received or accrued by the controlling tax-exempt organization that exceeds the amount that would have been paid or accrued if the payment met the requirements prescribed under Section 482. For example, if an amount of rent, annuity, interest or royalty actually paid or accrued by a controlled entity to its controlling tax-exempt entity exceeds the fair market value of that item as determined by Section 482, only the excess — and not the entire amount of the specified payment — is taxed as UBTI (but only to the extent that the excess reduces the net unrelated income or increases any net unrelated loss of the controlled subsidiary (determined as if the subsidiary were tax-exempt)). This favorable treatment applies to a specified payment received or accrued from a controlled organization under a binding written contract in effect on August 17, 2006 or a contract that is a renewal, under substantially similar terms, of a binding written contract in effect on August 17, 2006. This subsection had been temporary, but has now been made permanent. The Form 990-T reflects this permanence.

Form 990-T due date extension requests

Despite the language in the draft instructions, the automatic extension available to corporations to extend the Form 990-T due date remains six months, and can still be requested by using Form 8868. New for 2016, trusts may also file Form 8868 to request a single six-month extension, instead of filing two separate Forms 8868 to request two three-month extensions. See Tax Alert 2016-1684.

Implications

As noted above, the most significant change to the Form 990-T is the addition of Line 39 for reporting liability for tax on noncompliant hospital facility income from violations of the Section 501(r) requirements for tax-exempt hospitals. This tax is effective for tax years beginning after December 29, 2015 and is separate from the unrelated business income tax imposed by Section 511; consequently, the Form 990-T is being modified to reflect its applicability. Tax-exempt hospitals should take great care to ensure their compliance with Section 501(r); the revision to the Form 990-T goes hand-in-hand with the IRS's commencement of examinations of hospitals in this area.

Tax-exempt organizations wishing to comment on the draft Form 990-T instructions may submit their comments to the IRS on the Comment on Tax Forms and Publications page on IRS.gov.

Please contact your EY professional for further information.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg

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ENDNOTES

¹ Treas. Reg. Section 1.501(r)-2.

² Treas. Reg. Section 1.501(r)-2(d)(1).

³ Revenue Procedure 2015-21, 2015-13 I.R.B. 817.

⁴ Treas. Reg. Section 1.501(r)-1(b)(21); Treas. Reg. Section 1.501(r)-2(d)(2)(i).

⁵ Treas. Reg. Section 1.501(r)-2(d)(3).

⁶ IRC Section 512(b)(13)(A).

⁷ IRC Section 512(b)(13)(C).

⁸ IRC Section 512(b)(13)(D)(i).

⁹ IRC Section 512(b)(13)(D)(ii).

¹⁰ IRC Section 512(b)(13)(A).

¹¹ IRC Section 512(b)(13)(B)(i).

¹² IRC Section 512(b)(13)(B)(ii).