For nonprofits seeking to maximize their ability to channel funds toward key program activities, a sophisticated tax strategy can have a huge impact. At first, this might sound incongruous: the majority of nonprofit organizations are classed as tax-exempt entities and are, by and large, not liable for tax.
However, many nonprofit organizations, particularly those in the performing arts space, often have significant Unrelated Business Activity (UBI): sources of revenue that are not directly related to the mission of the nonprofit. Common examples of this include gift shops or on-site restaurants that are open to the public.
Income derived from these activities is taxable and nonprofits are required to pay Unrelated Business Income Tax (UBIT) on this income. By exploring the various tax deductions and incentives available to nonprofit organizations, leaders can minimize this tax burden.
Ultimately, this enables more funds to be channeled back into the nonprofit’s core program activities. This overview explores the opportunities that exist for nonprofits in the performing arts space to minimize their tax liability, including tax credits, deductions and more.
Evolving tax legislation has seen significant changes to the tax laws that apply to nonprofit organizations. Legislation including the Tax Cuts and Jobs Act of 2017 and the CARES Act of 2020 changed UBIT regulations. More recently, the Inflation Reduction Act introduced new deductions nonprofits can take advantage of.
Additionally, recent years have also ushered in changes to the operations of many nonprofits in the performing arts space. After being forced to shutter for large portions of 2020, many performing arts organizations were forced to explore diversifying their revenue streams. This led to the creation of unrelated business income, which in turn, prompts nonprofits to embrace more sophisticated tax strategies.
While tax deductions may not have been top of mind for tax-exempt nonprofit organizations in recent years, the changing regulatory environment and ever-evolving operational activities of many nonprofits are certainly cause to reevaluate. Read on for an overview of the most notable tax deductions available to nonprofit organizations in the performing arts space.
A nonprofit’s ability to claim tax incentives is situational and varies significantly from organization to organization. Opportunities exist at both the federal and state level. It’s always advisable to consult with an experienced performing arts nonprofit accounting firm to explore the opportunities that may be available for your organization.
With that being said, here is an overview of three of the most common nonprofit tax deductions for performing arts organizations.
The recent passage of the Inflation Reduction Act expanded eligibility for the energy-efficient commercial building deduction to include tax-exempt organizations. If a performing arts organization is in the process of planning or building a new structure that will produce unrelated business income, such as a restaurant or gift shop, it may be able to apply this deduction against UBIT.
To claim this deduction, construction must be completed to certain energy efficiency standards. Nonprofit organizations can also transfer the benefits of this deduction to qualified construction partners, including architects, designers, engineers, and more.
This deduction goes into effect in 2023 and the nonprofit accounting community awaits further guidance from the IRS clarifying how nonprofit organizations can leverage this deduction. While certain aspects remain unclear, it’s worth noting that claiming this deduction requires nonprofits to partner with a third-party vendor that will visit the construction site, assess project schematics, and calculate the efficiency levels of the building.
During the pandemic, government stimulus provided a lifeline to many performing arts organizations who were forced to close their doors for months on end. Today, there may be opportunities to retroactively claim employee retention credits: a key component of the CARES Act that supported organizations in keeping employees on their payroll.
If you haven’t engaged in a meaningful tax planning session with a qualified nonprofit accounting firm since early 2020, your nonprofit may have overlooked this opportunity.
Beyond these newer deductions and credits, there are also a wide range of other, more general deductions that nonprofits should incorporate into their tax strategy.
When a nonprofit organization has unrelated business income, they also have expenses deriving from this income. Expenses that are directly connected to an unrelated business activity are fully deductible. That includes expenses such as salaries, depreciation, state taxes, and more. Expenses which are connected to both the unrelated business activity and the program activities of the nonprofit are considered dual-use expenses, and may be allocated toward the unrelated business income activity on a reasonable basis.
To build and execute an effective tax strategy that offsets the impact of UBI by claiming nonprofit tax deductions, it’s vital for performing arts organizations to maintain an ongoing relationship with their accounting and advisory firm.
A continuous relationship enables your accounting firm to fully understand your business activities, help structure operations in a tax-efficient manner, and identify opportunities to take significant tax deductions. Additionally, accounting firms with experience catering to the nonprofit sector, including Smith + Howard, often have a network of connections to trusted third-party vendors. These vendors are equipped to perform the services required to claim certain deductions in an efficient, responsive manner.
At Smith + Howard, we’ve served as trusted tax advisors to the nonprofit community for over 50 years. Our team of skilled professionals has an in-depth knowledge of nonprofit tax issues and a track record of helping leading performing arts organizations claim a variety of tax credits and deductions.
To learn more about nonprofit tax deductions for your performing arts organization, contact an advisor today.
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