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Understanding And Planning For UBIT

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Tax Planning for Exempt Organizations; Dealing with Income that is unrelated to an Organization's Tax Exempt Purpose.

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Understanding And Planning For UBIT

  1. 1. Understanding and Planning for UBIT Brian T. Whitlock CPA, JD, LLM
  2. 2. <ul><li>Tax Exemption is Granted by Section 501(c(3) of the Internal Revenue Code where </li></ul><ul><li>“ organized” and “operated” exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competitions…, or for the prevention of cruelty to children or animals… </li></ul>Why does the Congress Grant Tax Exempt to Certain Organizations?
  3. 3. <ul><li>Governments generally provide services to the Public </li></ul><ul><ul><li>Efficiency </li></ul></ul><ul><ul><ul><li>Some services such as Police and Fire are best provided in a highly regulated manner </li></ul></ul></ul><ul><ul><ul><li>Government Bureacracies are not always the most efficient method for providing social and cultural services </li></ul></ul></ul><ul><ul><ul><li>Some private individuals are highly motivated to provide artistic and cultural services </li></ul></ul></ul><ul><ul><li>Cost </li></ul></ul><ul><ul><ul><li>The cost of providing the services can be high </li></ul></ul></ul><ul><ul><ul><li>Tax incentives can induce the public to spend dollars at a cost to the Treasury equal to the marginal tax rate (Maximum of 35% currently) </li></ul></ul></ul>Why does the Congress Grant Tax Exempt to Certain Organizations?
  4. 4. <ul><li>As early as 1924, the Supreme Court acknowledged charitable activities can not be operated without money. Trinidad v. Sagrada Orden de Pedicadores . The religious order owned real estate, a business in engaged in the sale of wine, chocolate and other articles. The Court noted that there was no competition and that the profit was negligible. </li></ul><ul><li>The ruling of the Court led to the creation of the operational test in the Treasury Regulations and a rule that was referred to as “the destination of income test”. </li></ul><ul><li>The “destination of income test ended in 1950 beginning with the passage of the feeder organization rules and continuing with the tax on Unrelated Business Income </li></ul>What is the History of the Unrelated Business Income Tax?
  5. 5. <ul><li>To help keep Exempt Organizations true to their mission </li></ul><ul><ul><li>Section 501 (c)(3) exemption can be lost if the activities are “substantial” </li></ul></ul><ul><li>To level the playing field </li></ul><ul><ul><li>Exempt Organizations would have a competitive advantage over taxable organizations (of as much as 35% of net revenue) if the two competed head to head in the similar businesses. </li></ul></ul>What is the Purpose the UBIT Rules
  6. 6. <ul><li>All Exempt Organizations and Exempt Plans (EO/EP) </li></ul><ul><ul><li>S ection 501(a) organizations </li></ul></ul><ul><ul><li>State and municipal Colleges and Universities </li></ul></ul><ul><ul><li>Section 401(a) plans (i.e., pension, profit-sharing, 401(k) Plans, ESOPS, etc.) </li></ul></ul><ul><ul><li>Sections 408 and 408A (i.e., IRAs and ROTH IRAs) </li></ul></ul><ul><ul><li>Sections 529 and 530 college savings plans </li></ul></ul><ul><ul><li>Section 220(d) Medical Savings Accounts </li></ul></ul>Who is Subject to UBIT?
  7. 7. <ul><li>Trusts </li></ul><ul><li>Taxable Income Rate </li></ul><ul><li>$ 0 - 2,200 15% </li></ul><ul><li>2,200 – 5,150 25% </li></ul><ul><li>5,150 – 7,850 28% </li></ul><ul><li>7,850 -- 10,700 33% </li></ul><ul><li>10,700 - 35% </li></ul><ul><li>Corporations </li></ul><ul><li>Taxable Income Rate </li></ul><ul><li>$ 0 - 50,000 15% </li></ul><ul><li>50,000 – 75,000 25% </li></ul><ul><li>75,000 – 100,000 34% </li></ul><ul><li>100,000 - 335,000 39% </li></ul><ul><li>335,000 – 10 Million 34% </li></ul><ul><li>10 million – 15 million 35% </li></ul><ul><li>15 million – 18,333,333 38% </li></ul><ul><li>$18,333,333 - 35% </li></ul>What are the Rates of Tax?
  8. 8. <ul><li>IRS Form 990-T </li></ul><ul><ul><li>Trusts (15 th day of the fourth month after year end) </li></ul></ul><ul><ul><li>Corporations (15 th day of the fifth month after year end) </li></ul></ul><ul><ul><li>Extension of Time to File (not time to pay) are available for up to 6 months via IRS Form 8868 </li></ul></ul><ul><li>Estimated Tax Payments (IRS Form 990-W) </li></ul><ul><ul><li>25% of Tax on 15 th day of 4 th month (after first quarter) </li></ul></ul><ul><ul><li>25% of Tax on 15 th day of 6 th month (during second quarter) </li></ul></ul><ul><ul><li>25% of Tax on 15 th day of 9 th month (during third quarter) </li></ul></ul><ul><ul><li>25% of Tax on 15 th day of 12 th month (during fourth quarter) </li></ul></ul><ul><li>Public Disclosure Required </li></ul><ul><ul><li>Pension Protection Act of 2006 now requires Exempt Organization to make this document available for public inspection. </li></ul></ul>What IRS Form is Applicable?
  9. 9. <ul><li>The TEST: </li></ul><ul><li>Activity is Trade or Business </li></ul><ul><li>The Trade or Business is not be “Substantially Related” to the organization’s exempt purpose </li></ul><ul><li>The Trade or Business is “Carried on Regularly” </li></ul><ul><li>The Income is not specifically “excluded” from tax or under Section 512, 513 or 514 (See Exclusion Codes IRS Form 990) </li></ul>When is Income Subject to UBIT?
  10. 10. <ul><ul><li>The Term Trade or Business generally includes any activity carried on for the production of income from the sale of goods or the performance of services. </li></ul></ul>Trade or Business
  11. 11. <ul><ul><li>Whether the business contributes importantly to accomplishing the purpose for which tax exemption was granted to the organization. </li></ul></ul><ul><ul><li>[Treas. Reg. Sec. 1.513‑1(d)(1) and 1.513‑1(d)(2)]. </li></ul></ul><ul><ul><li>Is part related to performance of exempt function </li></ul></ul><ul><ul><li>Are the activities larger in scale than reasonable necessary to perform the function </li></ul></ul>Substantially Related
  12. 12. <ul><li>Business activities of an exempt organization ordinarily will be considered to be “regularly carried on” if they show a frequency and continuity and are pursued in a manner similar to comparable commercial activities of nonexempt organizations. </li></ul>Carried on Regularly
  13. 13. <ul><ul><ul><li>General Exceptions </li></ul></ul></ul><ul><ul><ul><li>Activity is “Not Regularly Carried On” (e.g., annual dinner dance) </li></ul></ul></ul><ul><ul><ul><li>85% Volunteer Labor (e.g., Hospital Flower/Gift Shop) </li></ul></ul></ul><ul><ul><ul><li>Activity is for the Convenience of the organizations members, students, patients, visitors, officers, or employees (e.g., Parking, food service) </li></ul></ul></ul><ul><ul><ul><li>(5) 85% Donated Merchandise (e.g., Thirft Shop) </li></ul></ul></ul>Statutory Exceptions, Modifications, and Exclusions
  14. 14. <ul><ul><ul><li>Specific Exceptions </li></ul></ul></ul><ul><ul><ul><li>(6) Trade Show </li></ul></ul></ul><ul><ul><ul><li>Bingo </li></ul></ul></ul><ul><ul><ul><ul><li>Must not violate state law </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Exception not available for Homeowners Association or Employee Benefits Associations </li></ul></ul></ul></ul><ul><ul><ul><li>(12) Low Cost Articles </li></ul></ul></ul><ul><ul><ul><ul><li>Return address labels </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Coffee cups </li></ul></ul></ul></ul><ul><ul><ul><li>(13) Rental of Membership and Donor Lists </li></ul></ul></ul><ul><ul><ul><ul><li>Only available for rentals between (c)(3) Organizations of Veterans Organizations </li></ul></ul></ul></ul>Statutory Exceptions, Modifications, and Exclusions
  15. 15. <ul><ul><ul><li>Modifications and Exclusions </li></ul></ul></ul><ul><ul><ul><li>(14) Dividends, Interest or income from ordinary and routine investments </li></ul></ul></ul><ul><ul><ul><li>(15) Royalty Income </li></ul></ul></ul><ul><ul><ul><ul><li>Payments for Trademarks, Copyrights or Logos </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Affinity relationships </li></ul></ul></ul></ul><ul><ul><ul><li>(16) Real Property Rental Income </li></ul></ul></ul><ul><ul><ul><li>(18) Proceeds from the Sale of Investments </li></ul></ul></ul>Statutory Exceptions, Modifications, and Exclusions
  16. 16. <ul><ul><ul><li>&quot;Debt‑financed property&quot; means any property held to produce income, like rental real estate, tangible personal property and corporate stock, for which there is acquisition indebtedness during the taxable year. </li></ul></ul></ul><ul><ul><ul><li>Income from such debt‑financed property, including capital gains, is generally subject to UBIT </li></ul></ul></ul>Debt Financed Property
  17. 17. <ul><ul><ul><li> (30) If at least 85% of the use of the property is for the organization;s exempt purposes, then the income generated on the remaining 15% non-exempt use is excluded from UBIT. </li></ul></ul></ul>Exclusion for Debt Financed Income
  18. 18. <ul><ul><ul><li>(41) If a “Trade or Business” was consistently losing money, the losses might not be available to offset actual UBIT income. </li></ul></ul></ul><ul><ul><ul><ul><li>Profit Motive Test </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Similar to Hobby Loss Rules </li></ul></ul></ul></ul><ul><ul><ul><li> (42) Qualified Sponsorship Payments </li></ul></ul></ul><ul><ul><ul><ul><li>Allowed </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Sponsor may display Corporate Name, Logo, or product lines without qualitative endorsement </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>Disallowed </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>No qualitative endorsement or comparative description </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>No arrangement or expectation that Sponsor will receive a substantial return benefit </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Benefits will be disregarded if value is 2% or less than the amount of payment </li></ul></ul></ul></ul></ul>Trade or Business Exclusions
  19. 19. <ul><ul><ul><li>Directly Connected Expenses </li></ul></ul></ul><ul><ul><ul><li>- Section 512(a)(1) permits the deduction of all Ordinary and Necessary expenses of carrying on the trade or business [Section 162]. </li></ul></ul></ul><ul><ul><ul><li>Dual Use of Facilities or Personnel </li></ul></ul></ul><ul><ul><ul><li>- Treasury Regulation Section 1.512(a)-1(c) requires that where the same facilities and/or staff are used to carry on both exempt and non-exempt activities, the expenses must be allocated on “a reasonable basis”. </li></ul></ul></ul><ul><ul><ul><li>Exploitation of Exempt Activities </li></ul></ul></ul><ul><ul><ul><li>- Treasury Regulation Section 1.512(a)-1(e) states that the costs of maintaining the mailing list are not deductible because they are incurred primarily in connection with the fundamental purpose of the organization. </li></ul></ul></ul><ul><ul><ul><li>Net Operating Loss </li></ul></ul></ul><ul><ul><ul><li>- Net Loss incurred in one year may be offset against income in prior (carryback) or later (carryforward) years . </li></ul></ul></ul>Computing Net Unrelated Trade or Business Income
  20. 20. <ul><ul><ul><li>Charitable Contribution </li></ul></ul></ul><ul><ul><ul><li>Organization may claim a charitable contribution deduction for grants made to other organizations. Significant for Foundations. </li></ul></ul></ul><ul><ul><ul><li>Limitations </li></ul></ul></ul><ul><ul><ul><li>- Corporations are limited to 10% of Taxable Income </li></ul></ul></ul><ul><ul><ul><li>- Trusts are limited to 50% of Adjusted Gross Income </li></ul></ul></ul>Computing Net Unrelated Trade or Business Income
  21. 21. <ul><ul><ul><li>Consequences of UBI </li></ul></ul></ul><ul><ul><ul><li>(1) Tax on UBI </li></ul></ul></ul><ul><ul><ul><li>(2) Loss of Exempt Status if Unrelated Income is deemed to be “Substantial” and thus violative of the Operational Test </li></ul></ul></ul>Planning for UBI
  22. 22. <ul><ul><ul><li>Internal Revenue Service audit/assess additional tax </li></ul></ul></ul><ul><ul><ul><li>Three Year Statute of Limitations </li></ul></ul></ul><ul><ul><ul><li>Applies from the date the return is actually filed </li></ul></ul></ul><ul><ul><ul><li>Six Year Statute of Limitations </li></ul></ul></ul><ul><ul><ul><li>Applies if Gross income is understated by 25% </li></ul></ul></ul><ul><ul><ul><li>WARNING : No Statute of Limitations applies if no return is filed or if fraud exists in the return that was filed. </li></ul></ul></ul>Statute of Limitations
  23. 23. CPAs and Consultants