ubti and ubit for exempt organizations: mastering form...
TRANSCRIPT
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UBTI and UBIT for Exempt Organizations:
Mastering Form 990-T Getting Calculations Right and Avoiding Audit Traps
TUESDAY, JULY 21, 2015, 1:00-2:50 pm Eastern
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FOR LIVE EVENT ONLY
July 21, 2015
UBTI and UBIT for Exempt Organizations
Brenda Blunt
Eide Bailly
Michele A. W. McKinnon
McGuireWoods
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
www.mcguirewoods.com
UBTI and UBIT for Exempt
Organizations:
Mastering Form 990-T
Unrelated Business Taxable Income: Overview
Michele A. W. McKinnon
McGuireWoods LLP
Richmond, Virginia
McGuireWoods LLP | 6
CONFIDENTIAL
General Rule
• Internal Revenue Code section 511 imposes a tax on the “unrelated business taxable income” of an exempt organization.
– Applies to all 501(c) organizations and state educational instrumentalities under Internal Revenue Code section 115.
• An activity must meet three criteria to be an “unrelated” trade or business:
– It must be a trade or business.
– It must be regularly carried on.
– It must not be substantially related to the organization’s exempt purpose.
• Exempt organizations report unrelated business income and compute the tax on Form 990-T.
McGuireWoods LLP | 7
CONFIDENTIAL
Definition of Trade or Business
• A trade or business is generally defined as any
activity carried on for the production of income from
the sale of goods or performance of services.
McGuireWoods LLP | 8
CONFIDENTIAL
General Concepts
• Fragmentation Rule – An activity will not lose its identity as a
trade or business merely because it is carried on within a larger
aggregate of similar activities that may, or may not, be related to
an organization’s exempt purposes.
• Examples:
– Advertising
– Museum gift shop – item by item analysis
– PLR 201106019 – Seminary providing rental housing for
students, faculty, potential students, family members of
students, and guest speakers found to have UBTI from
income from all users other than students because the
housing was operated in a manner similar to a commercial
hotel.
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CONFIDENTIAL
General Concepts (continued)
• Exploitation Rule – Generally, selling items produced
in connection with an exempt function activity is not
an unrelated trade or business, but this rule will not
apply if the organization has exploited the exempt
function in excess of what is necessary to accomplish
the exempt purpose.
• Examples –
– Sale of furniture that has been renovated by
handicapped individuals.
– Sale of apple butter at agricultural fair after
demonstration on how to prepare apple butter.
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CONFIDENTIAL
General Concepts (continued)
• Dual Use Rule – The dual use rule recognizes that a
facility may be used for both exempt and nonexempt
or commercial functions.
• Example – A university-owned ski facility primarily for
students is also made available to the general public.
Income from the use of the ski lift by the general
public is unrelated trade or business income.
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CONFIDENTIAL
Meaning of “Regularly Carried On”
• A business is regularly carried on if it is conducted
with a frequency and continuity that is similar to a
commercial or for profit business.
• If the organization conducts the business only
infrequently or intermittently, the business will not be
regularly carried on.
• Examples
– Fundraising gala held once every year.
– Annual advertising book distributed to members at the
annual convention, where advertising is solicited year-
round.
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CONFIDENTIAL
Specific Exclusions from UBTI
• There are a number of exclusions under the unrelated trade or
business income rules.
• Income will not be subject to unrelated business income tax if:
– Substantially all of the work in carrying out the activity is
carried out by volunteers.
– The trade or business is carried on for the convenience of
members, students, patients, etc.
• Student bookstore or dormitory
• Hospital pharmacy for patients
• Hospital gift shop, parking lot, cafeteria
– Substantially all of the merchandise sold is donated (referred
to as the “thrift shop” exception).
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CONFIDENTIAL
Specific Exclusions from UBTI (continued)
• Income will not be subject to unrelated business
income tax if:
– It is derived from bingo games that are legal under
state law and are not regularly conducted by for profit
organizations.
– It is attributable to the distribution of low cost items in
connection with a charitable solicitation.
– It is a qualified sponsorship payment.
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CONFIDENTIAL
Modifications to Computation of UBTI
• The following items are generally excluded from unrelated business taxable income (unless attributable to debt-financed property):
– Dividends, interest, payments with respect to securities loans, and annuities.
– Royalties (from intangible property rights but not services).
– Rents.
– Gains from the sale or exchange of property (unless inventory or held primarily for sale to customers in the ordinary course of a trade or business).
• Additional income excluded from UBTI includes:
– Income from charitable gift annuities over the life or lives of one or two individuals.
– Certain research income.
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CONFIDENTIAL
Special Rules
• All income from an S corporation, including gain on the sale of shares, is subject to UBIT.
• Income from partnerships is analyzed under a look-through rule.
• Special rules apply to income derived from a controlled subsidiary that would otherwise be excludable.
– Under these rules a controlled entity is one owned more than 50% by the organization.
– Interest, rents, royalties, or annuities will not be excluded from UBTI to the extent that such amounts reduced the net unrelated income or increased the net unrelated loss of the subsidiary.
– Example – A university receives royalty income from a taxable subsidiary established for the purpose of commercializing pharmaceutical products resulting from scientific research conducted at the university. PLR 9720036.
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CONFIDENTIAL
Debt-Financed Property
• Income otherwise exempt from UBIT is taxable to the
extent it is derived from debt-financed property.
• Debt-financed income can arise in a number of ways:
– Investing on margin.
– Investing in leveraged investment funds.
– Investing in a partnership that carries on a trade or
business or invests in a trade or business that is
conducted by a partnership.
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Form 990-T Filing Thresholds
Brenda A. Blunt, CPA, CGMA [email protected]
602-264-8607
UBTI and UBIT for Exempt
Organizations:
Mastering Form 990-T
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Form 990-T Filing Thresholds
Organizations required to file form 990-T: • The following organizations with gross UBI of $1,000 or
more: • Exempt organizations under §501(a); • Qualified Tuition Programs under §529; • Colleges and universities of states and other governmental
units (but not instrumentalities of the United States organized and exempt from tax by an Act of Congress);
• Trustees of IRA, SEP IRA, SIMPLE IRA, Roth IRA, Coverdell education savings accounts, Archer medical savings accounts and Health savings accounts trusts
• Applicable reinsurance entities under the ACA §1341(c)(1) Gross income = Gross receipts less Cost of Goods Sold
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Form 990-T Filing Thresholds
Organizations required to file form 990-T:
• Organizations liable for other taxes or recapture of taxes
• §1291 interest on tax deferral under the PFIC rules
• Look back rules for construction contracts
• Investment tax credit recapture
• Recapture of low income housing credit
• Etc.
• Organizations liable for the Proxy Tax
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Form 990-T Filing Thresholds
Also use the 990-T to claim relevant credits, such as:
• Small Employer Health Insurance Premiums
• Federal Fuels Tax Credit
• Credit for Employer Social Security and Medicare Tax paid
on Certain Employee Tips
• Any other applicable credits
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Form 990-T Filing Thresholds
Also use the form 990-T when certain disclosures must be made with an income tax return • Form 5713 International Boycott Report • Form 8865 Return of U.S. Persons with Respect to Certain
Foreign Partnerships • Form 8886 Reportable Transaction Disclosure Statement • Form 926 US Transferors of Property to a Foreign
Corporation • Form 8621Information Return by a Shareholder of a
Passive Foreign Investment Company or Qualified Electing Fund
• Etc.
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Form 990-T Filing Thresholds
A Note about the public disclosure of the 990-T
1. It is subject to public disclosure rules similar to those for
the 990 return
2. Only those forms, schedules and attachments related to
the imposition of tax on unrelated business income must
be made available for public inspection.
Specific forms, (arguably not all inclusive) are enumerated in
the instructions, but include many of the forms on the previous
two slides
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Form 990-T Filing Thresholds
Organizations with $10,000 or less in total UBI income only need
to the header; Part I, lines 1-13 for Col A; Part I, line 13 for Col B
and C; Part II, lines 29-34; Parts III-V and the signature area.
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UBTI Calculations and Schedules
Brenda A. Blunt, CPA, CGMA [email protected]
602-264-8607
UBTI and UBIT for Exempt
Organizations:
Mastering Form 990-T
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Tax Computation
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Tax Computation
Unrelated Business Income Tax (“UBTI”) is based on the net
Unrelated Business Taxable Income (“UBTI”) times the
applicable income tax rate.
In other words, organizations will pay tax on the gross
income from UBI activities, less expenses directly connected
with generating that income, less charitable contributions, less
net operating losses carrying from other years, less the
“specific deduction”.
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Tax Computation
The “specific deduction” is $1,000 per tax return.
There is an exception for a diocese, province of a religious
order, or a convention or association of churches. They may
take a specific deduction of $1,000 per each parish,
individual church, district, or local unit (“component units”)
that regularly conducts unrelated trade or business up to the
gross UBI generated by each component unit and only if such
components are not separate legal entities.
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Tax Computation
A charitable contribution is allowed for contributions made to
other governmental units and organizations (other than itself)
as described in §170(c).
The charitable contribution deduction does not need to be
directly connected to the activity that generated the UBI.
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Tax Computation
Beyond that, the limitations and definitions that apply to the charitable contribution deduction follow the rules for corporations or trusts, depending on the organizational structure of the filing entity. Example One An accrual corporation may deduct accrued contributions actually paid within two and ½ months following the year end, if the contributions are authorized by the board and the required statements are attached to the return. This rule is not available to trusts.
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Tax Computation
Example Two Corporations are limited to a deduction equal to 10% of taxable income before any deduction for contributions, the DPAD, NOL’s an any capital loss carrybacks. Trust contributions are limited to 50% of UBTI before the deduction for charitable contributions for contributions to §170(b)(1)(A) organizations. And limited to the smaller of 30% of UBTI before this deduction or the amount by which 50% of the UBTI is more than the deduction for 50% charitable contributions for contributions to other qualified charities.
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Tax Computation
Having arrived at taxable income, you must apply the applicable tax rate. Organizations taxed as corporations, which include incorporated exempt organizations, unincorporated associations and limited liability corporations who elected to be taxed as corporations, use the “C” corporation tax rates and rules. Trusts follow the trust rates and rules. Alternative minimum tax applies to both using the respective rules. 31
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Tax Computation
Corporations and entities taxed as corporations must follow the controlled group rules under §§ 1561 and 1563 to allocate the tax brackets, and other tax benefits, among members of the controlled group. (Other than §501(c)(2) Title Holding Companies and the organization(s) they support, exempt organizations are not permitted to file consolidated returns.) Other apportionable tax benefits include, AMT exclusion, §179 limitation, research credit, Domestic Production Activities Deduction, general business credit, etc.
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Tax Computation
Corporate Tax Rates Trust Tax Rates
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Tax Computation – Credits allowed
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Allocation of Expense Deductions
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Allocation of Expense Deductions
Expenses can be deducted against UBI to the extent the expenses are “directly connected with the carrying on of such trade or business” (Reg. §1.512(a)-1) To be “directly connected, a “deduction must have a proximate and primary relationship to carrying on of that business”. Expenses must also be “ordinary and necessary” under §162 and other normal tax limitations – for example, meals and entertainment expenses are normally limited to 50%, UNICAP and tax depreciation rules – apply.
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Allocation of Expense Deductions
Dual use of personnel and facilities
Many times people and facilities are directly used in both
related and unrelated activities. In this case, the expense
may be allocated to the unrelated business activity using a
reasonable method consistently applied.
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Allocation of Expense Deductions
Dual use of personnel and facilities
Example One
Unrelated business income is 10% of the organization’s
overall revenues. The organization does not have records to
show how much time and facilities are dedicated to the
unrelated business activity so the organization allocates 10%
of all expenses to UBI.
This would NOT be considered a “reasonable” method.
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Allocation of Expense Deductions
Dual use of personnel and facilities
Example Two
Unrelated business income is 10% of the organization’s
overall revenues. Through the use of time cards or a time
study, the organization can show the executive directors
spends 5% of her time on the unrelated business activity.
It would be reasonable to allocate 5% of her salary and
benefits to the UBI activity. It may also be reasonable to
allocate 5% of her office space and related expenses.
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Rent Income
Schedule C
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Rent Income
Most organizations should use Schedule C to report:
1. Personal Property rentals that are rented with real estate
if the personal property rents are more than 10% of the
rental contract.
2. Rents from Real and Personal Property contracts if more
than 50% of the contract is for the rental of personal
property or the rent depends on the income or profits
derived by the person renting the property (except
amounts that are a fixed percentage of sales).
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Rent Income
Schedule C does not apply to 501(c)(7), (9) or (17)
organizations. They should report Rent income on Part I and
expenses on Part II.
Debt-financed real estate rentals not meeting the description
in item 2 from the previous screen should be reported on
Schedule E.
Personal Property rented separately from Real Estate should
be reported on Part I, line 12.
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Unrelated Debt-Financed Income
Schedule E
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Unrelated Debt Financed Income
Debt-Financed Property – Property held to produce income when such property has acquisition indebtedness at any time during the year, or, if the property was disposed of, at any time during the 12 months prior to the disposition. Includes real estate rentals, interest, royalties, dividends, investment capital gains and similar other investment/passive income. There are numerous exceptions.
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Unrelated Debt Financed Income
Acquisition Indebtedness
• Debt incurred to acquire or improve the property
• Debt incurred before acquiring or improving the property
if the debt would not have been incurred but for the
acquisition or improvement
• Debt incurred after acquiring or improving the property if
the debt would not have been incurred but for the
acquisition or improvement and the need was reasonably
foreseeable
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Unrelated Debt Financed Income
Acquisition Indebtedness
• Property acquired is subject to a mortgage, the debt
secured by the mortgage is acquisition indebtedness even if
the organization does not assume or agree to pay the
debt.
• If property acquired by bequest or gift is subject to a
mortgage, the debt is not acquisition indebtedness for the
first 10 years.
• Includes bequest of a partnership interest with debt financed
income inside the partnership (Ltr. Rul. 2000011051)
• This exception does not apply if the organization assumes,
agrees to pay, or makes payments on the debt.
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Unrelated Debt Financed Income
Report on Sch E:
Gross Rents (Col 2)
Directly Connected Expenses (Col 3a and 3b)
Note: Depreciation must use straight line method
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Unrelated Debt Financed Income
Average Acquisition Indebtedness (Col. 4)
• Outstanding debt on the first day of each month
• Add together
• Divide by the total number of months the organization held
the property (including any months the property is owned
after pay-off)
• In the year of disposition, use the highest debt balance
during the preceding 12 months.
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Unrelated Debt Financed Income
Average Adjusted Basis (Col. 5)
Adjusted Basis – Cost, plus additions less depreciation,
(allowed or allowable) since acquisition. Use depreciation
for all years the property was owned, not just subject to UBI.
Average Adjusted Basis – Adjusted Basis at the beginning
and end of the year divided by 2.
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Unrelated Debt Financed Income
Col. 6 (Leverage)
Average Acquisition Indebtedness (Col 4)
Average Adjusted Basis of the Rental Property (Col 5)
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Unrelated Debt Financed Income
Debt-Financed Property Taxable Income
Col. 6 (Leverage)
Gross Income (Col. 2)
Gross Reportable Income
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Unrelated Debt Financed Income
Debt-Financed Property Taxable Income
Col. 6 (Leverage)
Total Deductions (Col. 3a + 3b)
Allocable Deductions
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Interest, Royalties and Rents from
Controlled Organizations
Schedule F
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Interest, Royalties and Rents from Controlled
Organizations
General Principle: When the reporting exempt organization has income from interest, annuities, royalties and rents that it received from a controlled organization subject to income tax, the income is UBI to the reporting exempt organization, if it reduces unrelated taxable income of the controlled organization. (IRC §512(b)(13)) From 12/31/05 – 12/31/14, only UBI if amounts exceeded FMV (Transfer Pricing rules) and paid pursuant to a written binding contract in place at 8/17/06
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Interest, Royalties and Rents from Controlled
Organizations
The controlled organization could be either an exempt
organization or an nonexempt organization.
Either way, the “net unrelated taxable income” is the income
of the controlled organization that would be unrelated
(subject to UBIT) if it were an exempt organization AND had
the same exempt purpose as the controlling organization.
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Interest, Royalties and Rents from Controlled
Organizations
An entity is a “Controlled Organization” if the reporting entity owns: • By vote OR by value more than 50% of a corporation’s
stock; • More than 50% of a partnership’s profits OR capital
interest; or • More than 50% of the beneficial interest in an
organization. • Ability to control more than 50% of the vote (through the power
of appointment or otherwise) of an exempt organization.
The constructive ownership rules of §318 apply. Use similar principles to determine interests in other organizations.
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Interest, Royalties and Rents from Controlled
Organizations
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Other Schedules
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Other Schedules
Other Schedules in the Form 990-T include • Investment Income of §§501(c)(7), (9) or (17)
organizations; Schedule G • Exploited Exempt Activity Income, Other Than Advertising
Income; Schedule I • Advertising Income, Schedule J • Compensation of Officers, Directors, and Trustees;
Schedule K Due to the time allotted and the depth of the topics, we will only be covering Schedules G, I and J at an overview level.
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Other Schedules
Investment Income of §§501(c)(7), (9) or (17) organizations;
Schedule G
§§501(c)(7), (Social Clubs); (9), (Voluntary Employee
Beneficiary Associations (VEBA’s)); and (17) (Supplemental
Unemployment Benefit Trusts (SUBT’s)) fall under a complete
separate structure for UBTI. Generally, these organizations
are taxed on non-member (non-exempt function) income.
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Other Schedules
Investment Income of §§501(c)(7), (9) or (17) organizations;
Schedule G
These organizations are allowed a deduction against non-
exempt function income for amounts set aside for
1. Religious, charitable, scientific, literary or educational
purposes or for the prevention of cruelty to children or
animals;
2. Payment of life, health or accident insurance or other
benefits by VEBA’s and SUBT’s; and
3. Reasonable administration costs for the above.
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Other Schedules
Exploited Exempt Activity Income, Other Than Advertising
Schedule I
There are times when an organization’s exempt function
activities generate goodwill or other services and products
that can be exploited commercially. The revenue from the
exploitation is generally UBI. Organizations may offset net
UBI from exploited activities with the net losses of the exempt
activity that generated them, but may not create a UBTI loss.
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Other Schedules
Exploited Exempt Activity Income, Other Than Advertising
Schedule I
Example:
A photographic equipment manufacturer underwrites a
photography exhibit at a local museum. In return for the
underwriting, the manufacturer gets an advertisement in the
exhibition catalog with also includes educational materials,
pictures of the exhibited works, interviews with
photographers, and other exempt-function content. The
advertising revenue is exploited activity income.
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Other Schedules
Advertising Income
Schedule J
This is a subset of the Exploited Exempt Activity category
and includes income from advertising sold in periodicals.
Other advertising revenue should be reported on Schedule I.
The general principles applicable to Exploited Exempt
Activities apply here as well.
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Other Schedules
Advertising Income
Schedule J
Unique aspects include the ability to elect to combine all
periodical advertising as a single activity (Sch I, Part I), or
separately (Sch I, Part II). Also, if there is not a separate
charge for the periodical, known as circulation income, then a
portion of the member revenue is deemed to be circulation
income, to determine the exempt function income from the
periodical, (Rev. Rul. 81-101).
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Other Schedules
Compensation of Officers, Directors, and Trustees
Schedule K
List here all of the organization’s Officers, Directors and
Trustees where some or all of their compensation was directly
attributable to unrelated business income. If a particular
Officer, Director or Trustee spent 10% of his time (col. 3)
devoted to the unrelated business activity, the deductible
compensation is 10% of the total compensation (col. 4).
This should include total compensation – salary, allowances
and other benefits.
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www.mcguirewoods.com
UBTI and UBIT for Exempt
Organizations:
Mastering Form 990-T
IRS Audit Triggers
Michele A. W. McKinnon
McGuireWoods LLP
Richmond, Virginia
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CONFIDENTIAL
UBIT Concerns
• The IRS has indicated its concern that unrelated business income of nonprofits is being underreported.
• The college and university questionnaire responses appear to have confirmed the IRS’s suspicions.
• IRS audits of colleges and universities focused in part on unrelated business taxable income.
– Of the colleges and universities responding to the questionnaire, the number of colleges and universities that reported conducting particular activities exceeded the number that reported the activity on a Form 990-T.
• All nonprofits can expect greater scrutiny of their unrelated trade or business activities as a result of this increased scrutiny of this area of the nonprofit tax laws.
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CONFIDENTIAL
Activities Identified in College and University
Questionnaire with Potential Underreporting of UBTI
• Advertising
• Corporate Sponsorships
• Rental Activities
• Others
– Catalog and internet sales
– Travel tours
– Broadcast rights
– Royalties from oil and gas interests
– Affinity cards and credit card promotions
– Mailing list rentals
– Logo usage
– Commercial research and patents
– Operation of hotel or conference center
– Restaurant and food and catering services
– Bookstore
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CONFIDENTIAL
Common Reasons Provided for Underreporting
• Income was substantially related to exempt purpose
• Activity conducted primarily for convenience of
student body or faculty
• Activity generated continuous losses over number of
years and therefore not a trade or business
• Not regularly carried on
• Excludable under modifications of Section 512(b)
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CONFIDENTIAL
Final Report on IRS Examination of 34 Colleges
and Universities
• 100% required to file Form 990-T
• 90% underreported UBTI
• 70% had disallowed non-operating loss deductions
• 40% misclassified activities as related to exempt
purpose
• 40% improperly calculated or were unable to
substantiate NOLs
• 60% misclassified expenses
• UBIT was increased to $90M across 90% of the
colleges and universities audited
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CONFIDENTIAL
Tax Reform Proposals affecting UBIT
• Draft discussion of Tax Reform Act of 2014 released
by former Rep. Dave Camp (R-MI), as Chairman of
US House of Representatives’ Ways & Means
Committee on February 26, 2014
• Intended as a discussion draft for members of
Congress
• The Draft’s broad reforms include changes that
directly impact exempt organizations, including
changes to UBIT.
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CONFIDENTIAL
UBIT Provisions in Tax Reform Act of 2014
Draft
• Increases specific deduction against UBIT from $1,000 to $10,000.
• Expands the impact of UBIT by:
– Subjecting organizations exempt from tax under sections of the IRC
other than 501(a) (such as section 115) to UBIT.
– Limiting the deduction for trusts making charitable contributions for
UBIT purposes to 10% of the trust’s UBTI (to conform to the rules
that apply to corporate entities).
– Including the gain or loss from the sale of distressed property in
UBTI.
– Treating any income derived from the sale or licensing of a name or
logo as per se unrelated trade or business income subject to UBIT.
– Excluding income derived from fundamental research from UBTI
only if the results of the research are freely available to the public.
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UBIT Provisions in Tax Reform Act of 2014
Draft
• Conduct of Multiple Unrelated Trade or Business
Activities
– The Draft eliminates an organization’s ability to offset
UBTI from one unrelated trade or business with losses
from another unrelated trade or business.
– Organizations will be required to compute their UBTI
separately for each trade or business activity and could
not aggregate their income and losses derived from
such activities.
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UBIT Provisions in Tax Reform Act of 2014
Draft
• Corporate Sponsorships
– Under the proposals, if an organization uses or
acknowledges the name or logo of a sponsor’s product
line, the sponsor’s payment will be treated as per se
UBTI.
– If the organization receives more than $25,000 of
qualified sponsorship payments for any one event, the
use or acknowledgement of the sponsor’s name or
logo must appear with the names of a “significant
portion” of the other donors to the event.
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UBIT Provisions in Tax Reform Act of 2014
Draft
• A new penalty would be imposed on the “managers” of any
organization that substantially understates its unrelated
business income tax liability.
– The penalty is 5% of the underpayment attributable to the
understatement.
– “Manager” includes officers, directors, trustees, employees,
and any other individual under a duty to perform an act in
respect of which the underpayment occurred.
– There is joint and several liability if there are multiple
managers.
– The penalty is capped at $20,000.
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