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UBTI and UBIT for Exempt Organizations:

Mastering Form 990-T

THURSDAY, JUNE 7, 2018, 1:00-2:50 pm Eastern

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THURSDAY, JUNE 7, 2018

UBTI and UBIT for Exempt Organizations: Mastering Form 990-T

Brenda A. Blunt, CPA, CGMA, Tax Partner

Eide Bailly, Phoenix

[email protected]

Deb D. Nelson, CPA, Partner

Eide Bailly, Minneapolis

[email protected]

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.

UBTI AND UBIT FOR EXEMPT ORGANIZATIONS:Mastering Form 990-T

Brenda A. Blunt, CPA, CGMA

Deb Nelson, CPA

Tax Partners – Exempt Organizations

UNRELATED BUSINESS TAXABLE INCOME (UBTI) OVERVIEW

TAX CUTS AND JOBS ACT

UBTI CALCULATIONS AND SCHEDULES

IRS ACTIVITY

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3

4

1

6

UBTI OVERVIEW

UBTI OVERVIEW

• Purpose: Eliminate unfair competition

• Places business activities of EOs on the same tax footing as

nonexempt business endeavors with which they compete

• Applies to organizations exempt under IRC Sections 401(a), 408,

408A and 501(c).

• Section 401(a) provides federal income tax exemption to trusts

created or organized in the United States forming part of a stock

bonus, pension, or profit-sharing plan.

• Section 408 – IRA accounts

• Section 408A – ROTH IRA accounts

8

UBTI OVERVIEW

• Section 501(c) provides federal income tax exemption to

organizations that are organized and operated for exempt

purposes

• For example, 501(c)(3)

• Charitable, scientific, educational, religious, etc.

• Must engage primarily in activities that further an exempt purpose

• No more than an insubstantial part of total activities may be

non-exempt purpose activities

• No bright line for determining insubstantial

• Subjective test comparing many factors

• UBI, as it applies to 501(c)(7), (9) or (17) organizations, is outside

the scope of this course.

9

UBTI OVERVIEW

To be UBI, activity must meet all three requirements:

Trade or Business

Regularly Carried On

Not Substantially

Related

10

UBTI OVERVIEW

Trade or Business

• Any activity carried on for the production of income from selling goods or performing services

• Must be conducted with intent to make a profit

• Recovering costs without a profit motive does not equal a trade or business

• Single business activity may be divided into related and unrelated

• Commercial activities do not lose their business identity because they are conducted by tax-exempt organizations

• Generating funds to be used for mission-related activities does not make a trade or business activity an exempt purpose activity

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UBTI OVERVIEW

Regularly Carried On

• Frequency and continuity similar to comparable commercial activities of taxable entities

• Hospital’s auxiliary operation of a sandwich stand for 2 weeks at state fair – not regularly carried on

• Operating a commercial parking lot every Saturday, year-round – regularly carried on

• Christmas card program operated by veterans organization –regularly carried on

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UBTI OVERVIEW

Not Substantially Related

• Must demonstrate substantial causal relationship to exempt purposes

• Activity must contribute importantly to accomplishing exempt purposes

• Size and extent of activities must be considered in relation to the nature and extent of the exempt function they intend to serve

• If conducted on larger scale than necessary, it doesn’t contribute importantly

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UBTI OVERVIEW

• Selling of products of exempt functions

• Generally selling products that result from performance of exempt

functions is not UBI

• Must be sold in substantially same state

• Examples:

• Organization engaged in rehabilitating handicapped persons sells

articles made by these individuals as part of their rehabilitation

training – not UBI

• Organization maintains an experimental dairy herd for scientific

purposes, the sale of milk and cream produced in the ordinary

course of operation isn’t UBI

• But if the milk and cream are used to manufacture other food

items (ice cream, pastries), the sale of these products would be

an unrelated activity, subject to UBTI, if they are not

substantially related14

UBTI OVERVIEW

• Dual use of assets or facilities

• Just because an asset/facility is used in exempt activities doesn’t

mean the commercial activities conducted are related

• Example: Museum has theater auditorium that is operated

continuously during open hours as part of exempt purpose. If

museum operated the theater as a motion picture theater for the

public when the museum was closed, it would be an unrelated

activity.

• Exploitation of exempt functions

• Exempt activities may create goodwill/intangibles that can be

exploited in a commercial manner

• When assets are exploited in commercial activities, the fact that

the income depends in part upon an exempt function doesn’t

make the commercial activities related

• Must contribute importantly to exempt purpose to not be UBI15

UBTI OVERVIEW

Common UBIT Activities

Selling advertising

Selling merchandise with no relationship to exempt purposes

Leasing space in debt-financed buildings

Earning income from activities open to the public – parking,

café, pharmacy

Pass-through income from investments

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UBTI OVERVIEW

• Excluded trade or business activities

• Primarily for the convenience of members, students, patients,

employees

• Parking lot, cafeteria/coffee shop, pharmacy

• Substantially all of the work (approximately 85%) is done by

volunteers

• Gift shop staffed by auxiliary

• Substantially all of merchandise sold (approximately 85%) was

donated

• Thrift store

• Bingo games

• Must meet legal definition, be legal where played, and

played were not regularly conducted by for-profits

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UBTI OVERVIEW

• Convention/trade show activity

• Conducted by a qualifying organization in conjunction with an

international, national, state, regional, or local

convention/annual meeting/show, if:

• Promotes and stimulates interest in products/services of that

industry or educates those in attendance of that industry; and

• Designed to achieve its purpose through character of exhibits

and the extend of the industry products displayed

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UBTI OVERVIEW

• Distribution of low cost articles

• Applies to those eligible to receive charitable income tax

deductible contributions

• Recipient must not request distribution,

• Distribution is made without express consent of recipient, and

• Article is accompanied by a request for a donation and a

statement that recipient may keep the low cost article

regardless of whether a contribution is made

• Many more – see IRS Publication 598

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UBTI OVERVIEW

• Income exclusions

• Passive income – dividends, interest, annuities and royalties

• Rent from real property

• If personal property is < 10%, all rent excluded

• If personal property is between 10% - 50%, only rents

attributable to real property excluded

• If personal property is > 50%, no rent is excluded

• Income from research

• Extent of exclusion depends on nature of the organization and

type of research

• Research does not include ordinary/routine testing – inspecting

materials or products, designing or constructing equipment, etc.

• Research also does not include research conducted for the

primary purpose of commercial or industrial application

• Extends to SMLLC owned by the organization (PLR 200223067)20

UBTI OVERVIEW

Pass-through Entities and UBTI

Partnership, LLC (2 or more members), REITS, etc.

No entity level tax; activities are attributed to partners/members

S-Corporations are always UBI

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UBTI OVERVIEW

• Debt-financed income

• Taxed on dividends, interests, royalties and rent if from “debt-

financed” property

• Applies to property held to produce income for which there is

acquisition indebtedness

• Rental real estate, tangible personal property, and corporate

stock

• Debt incurred in performing exempt purpose isn’t acquisition

indebtedness

• Property substantially related (85% or more) to the

organization’s exempt purpose is not subject to debt-financed

property rules

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UBTI OVERVIEW

• Advertising vs. Qualified Sponsorship Payments

• Soliciting, selling, and publishing commercial advertising is a

trade or business subject to UBTI

• Advertising includes

• Endorsements

• Inducements to purchase, sell, or use the products or services

• Messages containing qualitative or comparative language,

price information, or other indications of savings or value

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UBTI OVERVIEW


• Qualified Sponsorship

• Recognizes a sponsor as a benefactor

• Uses or acknowledges the sponsor’s business name, logo, or

product lines

• Organizations can

• Use logos or slogans that are part of the sponsor’s

established identity

• Acknowledge a program underwriter on the air or during the

broadcast

• Payment cannot be contingent on broadcast ratings or other

factors indicating the degree of public exposure

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UBTI OVERVIEW


• Links to website

• Link to sponsor’s website without any endorsement is a

qualified sponsorship

• Link to sponsor’s website with an endorsement is advertising

• Banner advertisements

• Used generally on the website is advertising

• Used as part of an online periodical is advertising, but

deductions are available

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UBTI OVERVIEW

Gross receipts from UBI > $1,000 trigger Form 990-T

May deduct expenses, direct and indirect, attributable to activity

UBI taxed at regular corporate/trust rates

Consider state income tax filing requirements

Too much UBTI can jeopardize your tax-exempt status

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TAX CUTS AND JOBS

ACT

TAX CUTS AND JOBS ACT

• Most significant piece of tax legislation in 30 years

• Most provisions are effective for tax years beginning after

December 31, 2017

• Will require IRS guidance on implementation and interpretation of

many of the provisions

• Technical corrections could occur in 2018, but likely will take

considerable time for guidance

• IRS has indicated guidance on unrelated business income will be

provided by end of June

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GENERAL CORPORATE IMPACTS

• Change in corporate tax rate to flat 21%• Tax years beginning after 12/31/17

• Fiscal year taxpayers can use alternative calculation for years beginning in 2017

• Example: • For year ending 6/30/18, taxable income is $1,000,000• Old rate structure:• Tax = $340,000

• New rate structure:• Tax = $210,000

• Tax for 6/30/18 • $340,000 x 184/365 = $171,397 [July- Dec. 2017]• $210,000 x 181/365 = $104,137 [Jan- June 2018]

• TOTAL $275,534

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TRUST INCOME TAX RATES

Old Rates:

If taxable income is: The tax is:Not over $2,550 15% of taxable incomeOver $2,550 but not over $6,000 $382 + 25% of excess > $2,550Over $6,000 but not over $9,150 $1,245 + 28% of excess > $6,000Over $9,150 but not over $12,500 $2,127 + 33% of excess > $9,150Over $12,500 $3,232 + 39.6% of excess > $12,500

New Rates - for tax years after December 31, 2017

If taxable income is: The tax is:Not over $2,550 10% of taxable incomeOver $2,550 but not over $9,150 $255 + 24% of excess > $2,550Over $9,150 but not over $12,500 $1,839 + 35% of excess > $9,150Over $12,500 $3,011 + 37% of excess > $12,500

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GENERAL CORPORATE IMPACTS

Net Operating Losses:

Can only offset 80% of income with net operating

losses

No longer eligible for carryback

Carry forward indefinitely

Repeal of Corporate AMT:

AMT credits will be refundable from 2018-

2020

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SEPARATELY COMPUTED INCOME (CORPS/TRUSTS)

• Added §512(a)(6)

• Gain/loss computed separately for each trade or business activity

• No definition of trade or business activity

• Losses of one activity cannot be used to offset income of another

• Taxable income with respect to any trade or business cannot be

less than zero

• Can use losses in one year to offset income on same activity in the

future

• Transitional rule

• NOLS generated before 2018 do not have to be allocated

among activities

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FRINGE BENEFITS (CORPS/TRUSTS)

Expenses paid/incurred for fringe benefits provided to employees are treated as UBI

Qualified transportation fringe §132(f)

• Commuter transportation

• Transit passes

• Qualified parking

• Qualified bike commuting reimbursement

Facility used in qualified parking

§132(f)(5)(C)

On-premises athletic facilities §132(j)(4)(B)

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UBIT CALCULATIONS

AND SCHEDULES

FORM 990-T FILING THRESHOLDS

Deadlines and Payments

• Due date = 15th day of the 5th month

• Due date for employee’s trusts (including IRA’s, Coverdell ESA and

Archer MSA accounts) = 15th day of the 4th month

• Six month extension available

• $1,000 Exclusion

• Estimate tax payments

• Annualized method

• Large organizations

• Due the 15th day of the 4th, (5th for private foundations) 6th, 9th

and 12th months

• Payments required to be made electronically (EFTPS)

• Proxy tax on lobbying and political expenditures

• Non-Compliant Facility Income Tax, Treas. Reg. §1.501(r)-2

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FORM 990-T FILING THRESHOLDS

Organizations with $10,000 or less in total UBI income only need to

complete 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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TAX COMPUTATION

Tax rates

• Normal corporate/trust tax rules

and rates*

• Trusts use Schedule D to calculate

tax on capital gains

• Alternative Minimum Tax rules

apply*

• Controlled group rules also apply

• Proxy tax rate = 35% through

12/31/2017; 21% after

1/1/2018*

*See prior slides on Tax Cuts and Jobs Act

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TAX COMPUTATION – CREDITS ALLOWED

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CreditCarbon Dioxide Sequestration Holders of Tax Credit Bonds

Clinical Testing Expenses for Certain

Drugs for Rare Diseases or Conditions

(Orphan Drug Credit)

Investment Credits

Disabled Access Low-Income Housing

Distilled Spirits Low Sulphur Diesel Fuel

Employee Retention Credit New Markets

Employer Differential Wage Payments Prior Year Minimum Tax

Employer-provided Child Care Facilities

and ServicesPuerto Rico Economic Development

Employer Social Security and Medicare

Taxes Paid on Certain Employee Tips

Small Employer Health Insurance

Premiums

Empowerment Zone Employment Small Employer Pension Startup Costs

Foreign Tax Work Opportunity

Gasoline and Special Fuels

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TAX COMPUTATION – CREDITS ALLOWED

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The Bipartisan Budget Act of 2018 retroactively reinstated the

following credits through 2017:

Credit

Biofuel Fuel Producer

Alternative Fuel Vehicle Refueling Property

Alternative Motor Vehicle

Biodiesel and Renewable Diesel Fuels

Energy Efficient Home

Indian Employment

ALLOCATION OF EXPENSE DEDUCTIONS

• Deductions not taken elsewhere

• Directly connected expenses

• Charitable contributions

• Overhead allocations / dual use property

• “Regular” tax rules apply to depreciation, section 179,

inventory capitalization, method of accounting, meals &

entertainment, etc.

• Reasonable, necessary and consistent

• Documentation is key!

• Activities lacking a profit motive cannot generate losses

42

RENT INCOME (SCHEDULE C)

Definition and Exclusions

• Rents from real property are generally excluded from UBTI, unless

the rent is based on a percentage of the net income or profits of

the lessee, or significant services are provided

• Real property is broadly defined

• Ex. Rooftop sites for telecommunications antennae are

considered rents from real property

• Rent received where exempt organization provided services for

the convenience of the renter is not exempt

• Ex. Renting parking spaces in a garage or lot does not

constitute rent from real property

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UNRELATED DEBT-FINANCED INCOME (SCHEDULE E)

• Rents derived from debt-financed property not related to the

organization's exempt purpose are not excluded from UBTI

• Debt financed property:

• Property held to produce income;

• Income is typically real estate rents, but can also be interest,

dividends and/or royalties; and

• Presence of acquisition indebtedness: debt incurred in

connection with the purchase or improvement of real estate,

whether incurred before, after, or at the time of the

acquisition

• Amount received that is taxable is the amount corresponding to the

ratio of the amount of the indebtedness relative to the

organization's adjusted basis in the property

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Report on Schedule E:

Gross Rents, (and/or Interest, Dividends, Royalties) (Col 2)

Directly Connected Expenses (Col 3a and 3b)

Note: Depreciation must use straight line method

45


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.

46


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.

47


Col. 6 (Leverage)

Average Acquisition Indebtedness (Col 4)

Average Adjusted Basis of the Rental Property (Col 5)

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Debt-Financed Property Taxable Income

Col. 6 (Leverage)

Gross Income (Col. 2)

Gross Reportable Income

49


Debt-Financed Property Taxable Income

Col. 6 (Leverage)

Total Deductions (Col. 3a + 3b)

Allocable Deductions

50

INTEREST, ROYALTIES AND RENTS FROM CONTROLLED

ORGANIZATIONS (SCHEDULE F)

General Principle:

When the 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))

If paid pursuant to a written, binding contract in place at 8/17/06,

only UBI if amounts exceeded FMV (Transfer Pricing rules, IRC §482).

51

INTEREST, ROYALTIES AND RENTS FROM CONTROLLED

ORGANIZATIONS (SCHEDULE F)

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.

52

EXPLOITED ACTIVITIES (SCHEDULE I)

• An unrelated activity that is connected to and “exploits” a related

activity

• Examples:

• Website

• Conference brochures and other non-periodical publications

• Career center

• Allowed to offset net unrelated income with net loss from exploited

activity

• Not a lot of guidance on how narrow or broad to define

“exploited”

• Need to be able to identify exploited income and expenses

53

ADVERTISING INCOME (SCHEDULE J)

• Is it really advertising?

• Advertising (call to action, comparative language, pricing,

endorsement)

• Acknowledgements

• Qualified sponsorship payments

• Marketing services/Affinity contracts

• Third party publishing contracts

• Does the publication qualify as a periodical?

• Can you consolidate the periodicals?

• Can electronic/website activities be considered periodicals?

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Calculations:

Separate activities into “buckets”

• Advertising income

• Circulation income

• Subscriptions and reprints

• Allocation of membership dues

Expenses

• Direct advertising

• Direct editorial

• Allocable costs (page count)

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• Net income from advertising can be offset by excess readership

costs

• Periodicals can be consolidated if advertising income>25% of

readership costs

• If third party publishing contract is an active business, gather

documentation that allows you to correctly determine treatment

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G. OTHER SCHEDULES

• Cost of Goods Sold (Schedule A)

• Investment income of 501(c)(7), (9) or (17) organizations (Schedule

G)

• Compensation of Officers, Directors and Trustees (Schedule K)

• Percentage of time and compensation related to UBI activities

57

IRS ACTIVITY

UBI AUDIT TRIGGERS

• Continual Losses

• 990-sourced triggers

• Advertising revenue

• The word “Partnership”

• Schedule D, Partnership, Trust and Closely-held Corporate Stock

• Schedule R, Controlled Entities

• Schedule R, Related and unrelated partnerships

• Schedule R, Related S-corporations

• Rental income with debt on balance sheet

• K-1’s sent to the IRS by partnerships, trusts and S-corporations

59

IRS HOT BUTTONS

Expense allocations between activities and related entities

• The IRS is suspicious of continual losses – assume over allocation

of expenses to UBI or related for-profit activities, or activity

does not have a profit motive.

Royalty contracts often come with the expectation the exempt

organization provide some level of service.

If the organization has “too much” UBI, exempt status can be lost.

60

IRS INITIATIVES

• May 2017, the IRS brought online a new Compliance, Planning &

Classification unit in order to use a more comprehensive approach

to identify, research and monitor compliance risks using data

analytics.

• Looking at for-profit entities prior to their conversion to 501(c)(3)

• Issue Snapshots https://www.irs.gov/government-entities/tax-

exempt-and-government-entities-issue-snapshots• 5/24/2017 – Identification and Treatment of Income from Mailing Lists

• 6/16/2017 – Exclusive Provider Arrangement within Qualified Sponsorship

Agreements

• 10/18/2017 – Exclusion of Bingo from UBI; Rents from Personal

Property/”Mixed Leases” and Rental Exclusion from UBI; Exclusion of Rent

from Real Property from UBIT

• 11/15/2017 – Unrelated Business Income from Debt-Financed Property

• 4/5/2018 – Exempt Organization Gaming and UBI

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https://www.irs.gov/government-entities/tax-exempt-and-government-entities-issue-snapshots

Questions?

THANK YOU!

Brenda A. Blunt, CPA, CGMA

EO Tax Partner, Eide Bailly LLP

Phoenix Office

602.264.8607

[email protected]

Deb Nelson, CPA

EO Tax Partner, Eide Bailly LLP

Minneapolis Office

612.253.6560

[email protected]

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