Medical Center Urges Delay of TCJA Provisions, Proposes Clarifications

September 14, 2018

Mr. Charles Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20024

Mr. David Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Dear Messrs. Rettig and Kautter:

UPMC (FKA, "The University of Pittsburgh Medical Center") is writing to offer recommendations on how the Department of the Treasury ("Treasury") and the Internal Revenue Service (the "Service") can implement certain provisions of Public Law Number 115-97 (commonly referred to as the Tax Cuts and Jobs Act or "TCJA") in a way that is true to the legislation's intent, that is administrable for the Service, and that minimizes burdens on affected entities.

UPMC is a Section 501(c)(3)¹ parent organization of an integrated healthcare delivery system based in Pittsburgh, PA with facilities and activities primarily in the Commonwealth of Pennsylvania. The UPMC system includes over 100 Section 501(c)(3) hospital and other healthcare subsidiary organizations, nearly 100 federally taxable healthcare and health insurance entities, and a substantial number of healthcare joint venture and other partnership interests. UPMC is the largest non-governmental employer in Pennsylvania with over 80,000 employees serving in numerous capacities across UPMC's tax-exempt and taxable entities.

Primarily, UPMC IRS Forms 990 and 990-T (with the exception of the Form 990-T filed for UPMC's Section 401(a) plan) are filed on a June 30^th fiscal year basis and are therefore due on November 15^th (May 15^th of the following year if fully extended). UPMC's Section 401(a) plan Form 990-T is filed on a calendar year basis and is due on April 15^th (October 15^th if fully extended). IRS Forms 1120 for taxable UPMC subsidiaries are also filed on a calendar year basis.

Providing administrable guidance that minimizes burdens is paramount, because it is consistent with the Administration's executive orders regarding regulations, enables efficient use of the Service's enforcement resources and, most importantly, enables charities such as UPMC to focus their resources and efforts on delivering quality care to the community, rather than on administrative tasks that neither help those in need nor add materially to federal revenue.

Our technical comments will focus on specific areas within the following three statutory provisions where significant administrative streamlining can be achieved:

However, our most pressing request is for Treasury and the Service to issue guidance delaying the implementation of each of these provisions until guidance is published upon which taxpayers can rely.

Delay of Implementation

We request that Treasury and the Service delay the implementation of new Sections 512(a)(6), 512(a)(7), and 4960, until guidance has been published upon which taxpayers can rely. As other commenters have pointed out, many of the provisions in these new Sections are ambiguous and there is significant uncertainty regarding how certain provisions should be interpreted and implemented, particularly in complex organizational structures with multiple related entities.

The need for a delayed implementation is most critical with respect to Section 512(a)(7). Section 512(a)(7) generally increases UPMC's unrelated business taxable income ("UBTI") by the amount of certain fringe benefit expenses paid or incurred by UPMC that are not otherwise deductible under Section 274. UPMC, like other organizations, will need guidance on how to calculate UBTI under Section 512(a)(7) for subsidized transit passes and the expense related to its parking facilities used by employees. UPMC has more than 80,000 employees and operates more than 30 academic, community, and specialty hospitals and more than 600 physician offices and outpatient sites throughout its service area. Each of the UPMC locations has multiple parking facilities where employees who commute to work may park if they are not utilizing public transportation. It is unclear how the expenses related to these parking facilities (UPMC owned or leased from third parties) should be determined, if at all, for purposes of Section 512(a)(7).

Further, unlike other TCJA provisions that apply to tax years beginning after December 31, 2017, Section 512(a)(7) is effective for amounts paid or incurred after December 31, 2017. As noted above, UPMC and its Section 501(c)(3) subsidiaries have a fiscal year that recently ended on June 30, 2018 and as such, the due date for Forms 990-T for which these tax-exempt organizations will first be required to report 512(a)(7) UBTI is November 15, 2018 (May 15, 2019 if extended). Without delayed implementation, it will be extremely difficult for UPMC to determine its UBTI under Section 512(a)(7) for its June 30, 2018 tax year with no guidance on how to calculate the amount of UBTI and without administrative systems in place to complete the calculation. In fact, UPMC has already experienced this burden in its efforts to calculate estimated payments for many of its entities that are subject to Section 512(a)(7).

While the effective dates of Sections 512(a)(6) and 4960 are somewhat later, the need for guidance before organizations can comply is no less significant. Compliance with Sections 512(a)(6), 512(a)(7), and 4960 will require UPMC to design and implement complex administrative systems and processes to capture the data necessary to calculate UBTI or excise taxes. It is unduly burdensome, costly and inefficient for UPMC to attempt to interpret and comply with these new provisions and to develop necessary systems and processes without clear guidance on how the provisions should be interpreted and administered with these processes then subject to change upon final guidance.

Thus, Treasury and the Service would promote sound tax administration, fairness, and efficiency by not requiring organizations to comply with Sections 512(a)(6), 512(a)(7), and 4960 until final guidance is published and UPMC requests Treasury and the Service to delay the implementation of these provisions until such final guidance is issued.

Section 4960, Tax on Excess Tax-Exempt Organization Executive Compensation

The TCJA created new Section 4960, which imposes a 21% excise tax on (1) remuneration in excess of $1 million and (2) any "excess parachute payments" paid to covered employees of a tax-exempt organization during a taxable year. This provision was intended to parallel the compensation deductibility limits for certain for-profit entities under section 162(m). There are two elements to this provision that we would like to comment on at this time:

Treasury and the Service should issue guidance applying the definition of "covered employee" on a controlled group basis for the purposes of Section 4960

Under Section 4960(c)(2), an employee is treated as a "covered employee" of an applicable tax-exempt organization if that employee was one of the five highest compensated employees of the organization in any tax year beginning after December 31, 2016. UPMC requests that Treasury and the Service issue guidance clarifying that the covered employees are to be determined on a controlled group basis because such guidance would be consistent with the application of Section 162(m) and the statutory intent of Section 4960.

When applying a similar definition of "covered employee" for purposes of the Section 162(m) compensation deduction limitation, Treasury and the Service concluded in regulations that it was consistent with the statute and appropriate to apply an affiliated group rule and to treat members of the affiliated group as a single employer. We also note that the Service takes a similar approach to aggregating related entities for purposes of reporting highest-compensated employees on the Form 990 group returns. Therefore we believe that Section 4960 is also properly interpreted to apply on an affiliated group or a "controlled group" basis for purposes of determining the covered employees.

This is supported by the Section 4960 related entity rules. Section 4960 does not define "highest compensated employee" or "compensation". However, it does define "remuneration" to include all remuneration paid from related organizations. The Sections 4960(c)(3) and (c)(4) definitions of "remuneration" and "remuneration from related organizations" indicate that the statutory intent was to aggregate all members of a controlled group for purposes of determining the five highest compensated employees and, hence, the covered employees of the organization. As a statutory provision that tracks Section 162(m), the intended application of Section 4960 appears to be directed at the highest compensated executives and employees of an organization and all related organizations. The TCJA Conference Report supports this interpretation in the summary of Section 4960 (page 349), where it states that for purposes of determining a covered employee, remuneration paid to a licensed medical professional which is directly related to the performance of medical or veterinary services by such professional is not taken into account. Just as this exclusion from the definition of remuneration is to be used in determining covered employee status, it follows that any amount included in the definition of remuneration, including remuneration paid to employees by related organizations, should be included in determining covered employee status.

Therefore, we request that Treasury and the Service issue guidance clarifying that an employee is a "covered employee" for purposes of Section 4960 if that employee is one of the five highest compensated employees of all "applicable tax-exempt organizations," as defined in Section 4960(c)(1), that are also "related organizations," as defined in Section 4960(c)(4)(B) and taking into account all remuneration from those related organizations. The controlled group as a whole would then have no more than five highest compensated employees for a given tax year. This is commonly referred to as a "controlled group rule."

In addition to being consistent with application of Section 162(m) and the statutory intent of Section 4960, a controlled group rule would minimize costs and burdens to applicable tax-exempt organizations and would be consistent with the Administration's Executive Order 13789 on reducing tax regulatory burdens, which states that the Federal tax system should be simple, fair, efficient, and pro-growth. The benefit of this controlled group rule would be considerable for UPMC and many similar organizations. UPMC's operations includes hundreds of entities and employs over 80,000 individuals. These employees include physicians and other healthcare professionals as well as officers and executives who fulfill multiple roles and responsibilities across various entities. There would be a significant administrative burden associated with calculating and year-to-year tracking of multiple lists of covered employees for each entity, as well as managing allocations of compensation for purposes of the Section 4960 tax.

Furthermore, without such a controlled group rule, organizations with different legal entity structures would have vastly different tax burdens under Section 4960. For example, an organization with a similar profile as UPMC (e.g., same number of employees and similar compensation practices) would have fewer covered employees for Section 4960 purposes if it utilizes fewer legal entities to accomplish operational and other objectives unrelated to tax such as the satisfaction of legal requirements specific to the location of its operations.

Thus, Treasury and the Service should issue guidance establishing a controlled group rule for purposes of determining covered employees under Section 4960, which will give effect to the statutory intent, enable efficiencies, and promote fairness.

Treasury and the Service should issue guidance clarifying that related entities for the purposes of Section 4960 include only those meeting the definition of "applicable tax-exempt entity"

According to Section 4960(c)(4), remuneration of a covered employee includes all remuneration paid to the employee by a related organization. A related organization, according to 4960(c)(4)(B)(i), includes an organization that controls, or is controlled by, the organization. The statute does not explicitly limit related organizations to entities that meet the definition of an "applicable tax-exempt organization" (referenced in Section 4960(c)(1)) to which Section 4960 applies. This leads to uncertainty as to which entities constitute "related organizations."

The Section 4960 excise tax applies only to "applicable tax-exempt organizations". We request that Treasury and the Service issue guidance clarifying that an entity is only a "related organization" for purposes of Section 4960 if it is a member of the controlled group that meets the definition of an "applicable tax-exempt organization."

While Section 4960(c)(6) provides coordination with the Section 162(m) deduction limitation, such that remuneration which is nondeductible under Section 162(m) is not taken into account for Section 4960 purposes, this should not be read to effectively subject taxable organizations that are outside the scope of Section 162(m) to the tax consequences of Section 162(m), which is what could happen if Treasury and the Service do not clarify the definition of related organization. There is no indication in the statute or legislative history that it was Congress's intent to subject taxable organizations to Section 4960 or to impose the effect of Section 162(m) on organizations that were not previously covered by it.

If Treasury and the Service have concerns regarding abusive arrangements involving compensation paid by taxable organizations, they can issue tailored anti-abuse regulations to prevent these actions. This should not prevent Treasury and the Service from addressing the larger policy concern around subjecting new types of taxable organizations to Section 162(m)'s effects absent explicit Congressional intent.

Section 512(a)(6), Special Rule for Organization with More than one Unrelated Trade or Business

The TCJA has updated the organization and calculation of UBTI. Previously, tax-exempt organizations were able to offset income from one trade or business with losses from another trade or business that was carried on by the same entity. Under new section 512(a)(6), in the case of an organization with more than one unrelated trade or business, the net operating losses from a given trade or business are effectively suspended and must be carried forward to offset income only of that trade or business.

In Notice 2018-67, the IRS provided interim and transition guidance on some of the issues raised by this new section, so we will focus our comments on those issues. UPMC appreciates that Treasury and the Service acknowledge the potential administrative burden posed by this provision and the effort they put forth in proposing solutions, some of which would be helpful. For example, we agree that UBTI determined under Section 512(a)(7) should not be subject to Section 512(a)(6) so that, as we interpret it, losses generated by other UBTI sources (including trades or businesses subject to Section 512(a)(6)) may be used to offset such Section 512(a)(7) UBTI. However, some of the proposals may create administrative burdens that would significantly reduce their usefulness.

If the North American Industry Classification ("NAICS") codes are used to identify separate trades or businesses, regulations implementing Section 512(a)(6) should provide that the Service will defer to an exempt organization's reasonable good faith determination as to which codes should be assigned to its activities and should provide for appropriate exceptions to use of the NAICS codes

Notice 2018-67 states that Treasury and the Service are considering using the NAICS codes, which are currently reported on the Form 990-T for informational purposes and have no bearing on an organization's UBTI calculation, as a basis for identifying separate trades or businesses for Section 512(a)(6) purposes. These codes were not designed to define trades or businesses for UBTI purposes, do not encompass the entire universe of UBTI activity, and do not account for the possibility that certain activities may cross multiple codes. Nor are the codes within the control of the IRS, so the IRS may not be able to add or modify codes to reflect actual trades or businesses conducted by tax-exempt organizations.

Therefore, if Treasury and the Service were to adopt an NAICS code-based standard for identifying separate trades or businesses for purposes of Section 512(a)(6), regulations and other guidance implementing such standard should allow organizations to make reasonable, good faith determinations as to which codes should be assigned to their activities, and to separately classify a trade or business for which a code does not apply. Without such deference, the application of such a standard could result in the identification of separate trades or businesses that do not sync up with the economic realities of organizations' activities. In addition, if an NAICS code-based standard is adopted, implementing regulations and other guidance should provide that an exempt organization can classify activities that could be described in multiple NAICS codes as a single trade or business when those activities are closely related, similar in nature, and essentially conducted as a single trade or business. For example, investment activities, as discussed in more detail below, should be treated as a single unrelated trade or business for Section 512(a)(6) purposes even though such activities may have more than one NAICS code assigned to them.

Regulations implementing Section 512(a)(6) should provide for the aggregation of investment activities as a single trade or business and should define investment activities to include both "qualifying partnership Interests" and UBTI determined under Sections 512(b)(3)(B), 512(b)(4), (13), and (17)

In addition to "qualifying partnership interests" as defined in Notice 2018-67 and as discussed further below, an organization's investment activities should include UBTI determined under Sections 512(b)(3)(B), 512(b)(4), (13), and (17). Each of these provisions generally applies to treat income that has consistently been treated as passive investment income — i.e., interest, dividends, rent, royalties, capital gains, and rental of personal property — as UBTI due to factors including debt-financing, the relationship between the organization and the source of the income, and the involvement of certain insurance activities. For example, with respect to the exclusion of such income from unrelated business income tax treatment in The Revenue Act of 1950, the Senate Finance Committee wrote that:

In addition, other Internal Revenue Code sections applicable to exempt organizations recognize these income types as investment in nature. Examples include the Section 509(e) definition of gross investment income for the purposes of Section 509(a)(2) publicly supported organizations and the Section 4940(c) definition of investment income for the purposes of the excise tax on private foundations' investment income.

Therefore, treating Section 512(b)(3)(B), 512(b)(4), (13), and (17) UBI as investment income that can be aggregated with other investment activities such as "qualifying partnership interests" in a single trade or business for Section 512(a)(6) purposes would be in line with the common definition of the term as applied to exempt organizations.

Regulations implementing Section 512(a)(6) should exclude the 20% or less capital interest in the partnership entity requirement from the "control test" for identifying "qualifying partnership interests"

With respect to the interim and transition rules set out in Section 6 of the Notice, UPMC appreciates that Treasury and the Service have provided some guidance regarding interpretation of Section 512(a)(6) in the context of partnership interests. However, in regulations implementing Section 512(a)(6), UPMC requests that Treasury and the Service focus on the aspect of control, without regard to ownership percentages (20% or otherwise), for the purposes of the "control test" set forth in Section 6.03 for identifying "qualifying partnership interests" that can be aggregated with other "qualifying partnership interests" as a single trade or business.

As the Notice acknowledges, organizations subject to the Section 512(a)(6) rules should be able to aggregate all of their "investment activities" that generate income but in which they do not significantly participate. For many partnership investments, the organization's capital interest has no correlation with the ability to participate in the underlying trade or business. For example, in a limited partnership structure, the limited partners may own the vast majority of the capital and profits of the partnership, but by definition have no control over the day-to-day operations of the partnership. Therefore, the concept of material participation defined in Section 469(h), or a similar standard, would provide a good approach to distinguishing "qualified partnership interests" from more active trade or business investment activities.

The capital interest percentage limitation would also create undue administrative burden for entities like UPMC. In order to determine whether the 20% threshold has been exceeded with respect to a particular investment, UPMC would need to identify and request information regarding investments from hundreds of disqualified persons, supporting organizations, and controlled entities.

Treasury and the Service should issue regulations or other guidance clarifying that for organizations subject to Section 512(a)(6), net operating loss ("NOL") carryforwards should continue to be applied as a deduction against UBTI in the order in which such NOLs were generated

Treasury and the Service should clarify that an organization subject to Section 512(a)(6) is to utilize its NOLs to offset UBTI in the order in which such NOLs were generated (i.e., first-in-first-out), consistent with the application of Section 172 to all taxpayers. More specifically, it should be made clear that NOLs generated prior to the effective date of the revisions to Section 172 should be used before NOLs generated after such effective date, whether to offset UBTI generated by a separate trade or business (even where an NOL calculated under Section 512(a)(6) for that particular trade or business is available) or to offset aggregate UBTI generated by multiple trades or businesses. Otherwise, organizations like UPMC might find themselves in a position where pre-TCJA NOLs, which are still subject to a twenty-year carryforward limitation, expire when they could have been utilized.

Section 512(a)(7), Increase in Unrelated Business Taxable Income by Disallowed Fringe Benefits

As described above, Section 512(a)(7) imposes new unrelated business income tax liabilities on many tax-exempt organizations by treating expenses paid or incurred for qualified transportation fringe benefits as UBTI.

Treasury and the Service should provide an administrative safe harbor for determining the amount of expense treated as UBTI under Section 512(a)(7)

Section 512(a)(7) imposes UBTI calculation and reporting requirements on many organizations that have never previously been responsible for calculating or reporting UBTI, with the associated compliance and administrative burdens. In addition, there is a great deal of uncertainty regarding which expenses in which proportion should be considered "for" one of the enumerated fringe benefits.

In order to lessen compliance burdens on both tax-exempt organizations and the Service, Treasury and the Service should adopt an administrative convenience safe harbor that provides organizations the option to treat the value of the qualified fringe that is excluded from employee income as the amount paid or incurred by the organization for that qualified fringe, for purposes of Section 512(a)(7). In many cases, such as transit passes and leased parking, this value will be the same as the organization's expense incurred in providing the benefit. In instances in which they are not the same, such an approach is consistent with the implicit legislative intent of removing the double benefit of an employee income exclusion and an employer deduction while preventing the overcorrection of this tax expenditure that would result from taxing cost that exceeds the excluded value. Additionally, a value-based safe harbor would reduce disparities in tax burden that are unrelated to the extent of the benefits provided. For example, the same $200 parking fee may incur different costs, depending on whether a parking facility is leased or owned, whether a surface or facility, when a facility was placed into service, and how the acquisition of the facility was funded. Finally, such a safe harbor would ease tax administration, providing certainty and simplicity for both taxpayers and the Service by avoiding the complexity inherent in allocating costs to portions or particular usages of a facility.

While this administrative convenience safe harbor approach has not been used in the taxable context, it may be appropriate to institute this approach for Section 512(a)(7) purposes. Unlike provisions that deny a deduction for certain expenses of taxable entities, such as Section 274, Section 512(a)(7) imposes an affirmative tax on these expenses, with little or no ability to reduce or offset this tax. In addition, affected exempt organizations that are subject to UBTI for qualified fringe expenses under 512(a)(7) are generally subject to a greater burden than for-profit organizations that are denied a deduction for those same expenses under Section 274. Many organizations now subject to UBTI due to Section 512(a)(7) lack the experience and process required to calculate phantom income subject to tax, whereas taxable entities previously and currently subject to Section 274 are merely denied a deduction for an expense they have previously identified.

Conclusion

Based on the discussion above, we respectfully request that Treasury and the Service:

We appreciate your time and consideration of these matters. We welcome the opportunity to provide any additional information that may be helpful in developing guidance under these new sections, and would be happy to discuss our comments in person if that would be helpful.

Respectfully,

Mauro L. Macioce
Vice President Corporate Tax
UPMC
Pittsburgh, PA

Cc:
Sunita Lough, Commissioner, Tax Exempt & Government Entities Division, Internal Revenue Service

Victoria Judson, Associate Chief Counsel (Tax Exempt & Government Entities), Internal Revenue Service

Janine Cook, Deputy Associate Chief Counsel (Tax Exempt & Government Entities), Internal Revenue Service

Elinor Ramey, Attorney Advisor, Department of the Treasury