UBTI and UBIT for Exempt Organizations: Mastering Form...

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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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mailto:[email protected]

July 21, 2015

UBTI and UBIT for Exempt Organizations

Brenda Blunt

Eide Bailly

[email protected]

Michele A. W. McKinnon

McGuireWoods

[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.

www.mcguirewoods.com

UBTI and UBIT for Exempt

Organizations:

Mastering Form 990-T

Unrelated Business Taxable Income: Overview


McGuireWoods LLP

Richmond, Virginia

[email protected]

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.


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.


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.


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.


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.


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.


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).


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.


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.


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.


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.

w w w . e i d e b a i l l y . c o m

Form 990-T Filing Thresholds

Brenda A. Blunt, CPA, CGMA [email protected]

602-264-8607


Organizations:


17



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

18



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

19



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

20



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.

21



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

22



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.

23


UBTI Calculations and Schedules

Brenda A. Blunt, CPA, CGMA [email protected]

602-264-8607


Organizations:


24

Tax Computation

25


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”.

26


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.

27


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.

28


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.

29


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.

30


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


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.

32


Tax Computation

Corporate Tax Rates Trust Tax Rates

33


Tax Computation – Credits allowed

34

Allocation of Expense Deductions

35



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.

36



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.

37




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.

38




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.

39

Rent Income

Schedule C

40


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).

41


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.

42

Unrelated Debt-Financed Income

Schedule E

43


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.

44



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

45



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.

46



Report on Sch E:

Gross Rents (Col 2)

Directly Connected Expenses (Col 3a and 3b)

Note: Depreciation must use straight line method

47



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.

48



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.

49



Col. 6 (Leverage)

Average Acquisition Indebtedness (Col 4)

Average Adjusted Basis of the Rental Property (Col 5)

50



Debt-Financed Property Taxable Income

Col. 6 (Leverage)

Gross Income (Col. 2)

Gross Reportable Income

51



Debt-Financed Property Taxable Income

Col. 6 (Leverage)

Total Deductions (Col. 3a + 3b)

Allocable Deductions

52

Interest, Royalties and Rents from

Controlled Organizations

Schedule F

53


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

54



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.

55



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.

56



Organizations

57

Other Schedules

58


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.

59


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.

60


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.

61


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.

62


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.

63


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.

64


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).

65


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.

66



Organizations:


IRS Audit Triggers


McGuireWoods LLP

Richmond, Virginia

[email protected]


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.


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


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)


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


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.


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.


CONFIDENTIAL


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.


CONFIDENTIAL


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.


CONFIDENTIAL


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.


CONFIDENTIAL

Questions or Comments?


2015 McGuireWoods LLP


This presentation is presented with the understanding that the information contained does not constitute legal, accounting or other professional advice. It is not intended

to be responsive to any individual situation or concerns, as the contents of this presentation are intended for general informational purposes only. Viewers are urged

not to act upon the information contained in this presentation without first consulting competent legal, accounting or other professional advice regarding implications of

a particular factual situation. Questions and additional information can be submitted to your Eide Bailly representative, or to the presenter of this session.

78

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