Unrelated Business Income Tax Matters Eugene J. Logan, Tax Shareholder Sarah R. Piot, Tax Senior Manager elogan@schneiderdowns.com | (412) 697-5684 spiot@schneiderdowns.com | (412) 697-5303
Exempt Organization Income • Related Income – An exempt organization is relieved of taxation to the extent it engages in activities that are substantially related to its tax exempt purposes • Unrelated Income – IRS § 511(a)(1) imposes a tax for each taxable year on net income derived by exempt organizations from the conduct of a business that is regularly carried on regularly carried on and that is not substantially relat not substantially related t d to e exem empt pur pt purposes. oses. 2
What is Unrelated Business Income (UBI)? • Three elements of UBI: 1. The income is generated from a “trade or business;” 2. The trade or business is “regularly carried on;” and and 3. The conduct of the trade or business is not substantially related to the organization’s tax exempt purpose 3
1. Trade or Business • An activity carried on for the production of income, sells goods or performs services • Exceptionally broad definition and almost any activity carried on for the production of income qualifies • Commerciality doctrine • Fragmentation rule 4
2. Regularly Carried On • Does the tax-exempt organization carry on the activity with the same frequency as a comparable commercial enterprise? • Typically “one-off” activities, like the one time sale of old office furniture or a used maintenance vehicle will not meet the definition of “regularly carried on” • An activity does not need to be ongoing throughout the year 5
3. Substantially Related • A trade or business is related to an exempt purpose where the conduct of the business activity has a casual casual relationship relationship to the achievement of the exempt purpose. – A causal relationship exists when the income generating activity contributes importantly to the accomplishment of the organization’s exempt purpose. – Mere receipt of income to further the mission of the organization is insufficient to make the income substantially related to the organization’s exempt purpose. 6
Statutory Modifications § 512(b) • Excluded from UBTI: Income derived in a “passive” manner is generally not commercial as compared to activities requiring “active participation” – Dividends, interest – Royalties – Rents from real property – Rents from personal property which are incidental to a real property rental (less than 10% of rent value) Note: if more than 50% of total rent is attributable to personal property all rent is taxable 7
Statutory Modifications § 512(b) • Gains and losses on sales other than inventory are excluded from UBTI under § 512(b)(5) • Research activities may be excluded from UBTI – Subject to specific requirements as discussed in § 512(b)(7), (8) and (9) 8
Statutory Exceptions • Volunteer Exception - § 513(a)(1) – Unrelated trade or business does not include a trade or business in which substantially all the work is performed without compensation • Convenience Exception - § 513(a)(2) – Unrelated trade or business does not include a trade or business that is carried on by a § 501(c)(3) or by a state college or university primarily for the convenience of its members, students, patients, officers or employees 9
Reporting Requirements • Form 990-T, Exempt Organization Business Income Tax Return • Required to be filed if gross unrelated business income is $1,000 or more • Pension Protection Act requires public disclosure for § 501(c)(3) organizations • First introduced in 1952 • Substantially similar to what we see today • Not eligible for electronic filing 10
Common Sources of Unrelated Business Revenue • Advertising vs. Qualified Sponsorship Income • Alternative Investments • Rental Income from Debt-Financed Real Property • Parking • Operation of a Cafeteria or Bookstore • Catering 11
Advertising = UBI • Any message or other programming material which is broadcast or otherwise transmitted, published, displayed or distributed, and which promotes or markets any trade or business, or any service, facility or product. • A single message that contains BOTH advertising and an acknowledgement is advertising. 12
Advertising = UBI • Advertising includes messages containing: – Qualitative or comparative language; – Price information or other indications of savings or value; – An endorsement; or – An inducement to purchase, sell, or use any company, service, facility or product 13
Established Part of Identity? 14
Qualified Sponsorship Income = NOT UBI • Qualified sponsorship income does not constitute unrelated business income [ § 513(i)(1)] • Qualified sponsorship income – Any income to which there is no arrangement or expectation for receiving any “substantial return benefit” other than the use of acknowledgement of name or logo [ § 513(i)(2)(A)] • No comparative or qualitative descriptions • May display product lines/service listings 15
Qualified Sponsorship Payments 16
Substantial Return Benefit • Any benefit received by the sponsor other than: – Use or acknowledgement; or – Goods, services or other benefits of insubstantial value • Aggregate fair market value of all benefits is less than 2% of the amount received 17
Substantial Return Benefit • If a payor gets a substantial return benefit in exchange for a payment, the safe harbor of § 513(i) does not apply, and the UBI analysis should be continued under §§ 512, 513 and 514 • Benefits can include: – Advertising – Tickets – Exclusivity provider arrangements – Payment for services 18
Income from Partnerships • Income from partnerships carrying on an unrelated trade or business is taxable [ § 512(c)(1)] • Gross income and deductions determined same as if organization carried on activity directly – If partnership activity is related to exempt purpose of organization, no UBI – If the income item would not be taxable if the exempt organization received it directly, it is not considered UBI 19
Income from Partnerships • A Schedule K-1 is issued by the partnership • Identified as a tax-exempt organization • Schedule K-1 footnote review 20
Parking • Parking income received from the normal conduct of the college/university’s mission (students, faculty, staff) would not be considered taxable. • General Rule: Parking income generated from the general public for non-college/university events is generally considered unrelated business income • “Net leases” to a third party operator – income derived can qualify for the rental income exclusion, provided only minimal services provided 21
How Much is Too Much? • No safe harbor test, facts and circumstances • IRS and courts look to time spent not necessarily gross receipts • Theoretically it could jeopardize exempt status • Various structuring options available – C Corporation – S Corporation – Limited Liability Company 22
IRS Focus on Higher Education • IRS Tax-Exempt Colleges and Universities Compliance Project – Began in 2008, Final report issued in 2013 • TE/GE Key Areas of Focus for FY16 – Data-driven decision-making • IRS 2016-2017 Priority Guidance Plan – Guidance under IRC Section 512 regarding methods of allocating expenses to dual use facilities 23
Tax Reform Highlights To Topic Current Ta Tax L Law White House Ta Tax GOP A Be GOP A Bett tter er Way y Plan Plan Ta Tax P Plan Individual Tax Rates Currently 7 rates Reduce to 3 rates Reduce to 3 rates (10/15/25/28/33/35/39.6 (12/25/35%) (12/25/33%) %) Standard Deduction Single: $6,350 Single: $12,000 Single $12,000 HOH: $9,350 MFJ: $24,000 HOH: $18,000 MFJ: $12,700 MFJ: $24,000 Personal Exemptions $4,050 per individual Eliminated Eliminated Itemized Deductions Eliminate all except Eliminate all except mortgage interest & mortgage interest & charitable contributions charitable contributions Cap at $100,000 (Single)/$200,000(MFJ) AMT (Individual) The sum of 26% of Repealed Repealed amount less than $187,800 plus 28% of amounts in excess of $187,800 * White House Tax Plan is a combination of President’s Trump’s Campaign Tax Plan as well as the most recent changes as released on April 26, 2017. 24
Tax Reform Highlights To Topic Current Ta Tax L Law Trump C Campaign GOP A GOP A Be Bett tter er Way y Ta Tax P Plan Ta Tax P Plan Corporate AMT 20% of income above Repeal Repeal $40,000 Business Businesses can deduct Eliminate most business Full & immediate write-off of Deductions/Credits ordinary & necessary deductions & credits except business investment (both business expenses the research credit tangible & intangible) Many deductions and credits targeted to specific groups & Allow deduction of interest taxpayers expense against interest income but no current deduction for net interest expense.. Eliminates “special interest” deductions (DPAD) Maintains R&D Credit Estate Tax For 2017, rate is 40% with Repeal. Capital Gain held Repeal lifetime exclusion of until death and valued over $5,490,000 $10MM subject to tax. * White House Tax Plan is a combination of President’s Trump’s Campaign Tax Plan as well as the most recent changes as released on April 26, 2017. 25
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