unrelated business income tax (ubit)

It's UBI! Now What Do I Do? presented by Joseph Irvine, CPA, JD The Ohio State University

Deborah G. Kosnett, CPA Tate & Tryon, CPAs, Washington, DC

American Institute of CPAs

Joseph R. Irvine is Development and Tax Counsel and a faculty member of the Fisher College of Business at The Ohio State University, Columbus, Ohio. His practice includes tax planning and compliance as well as resolving conflicts with the IRS and state and local tax agencies. He handles charitable gift planning, donor tax issues as well as issues regarding UBIT, compensation and benefit matters, and state and local tax matters. He was an attorney with a multistate law firm prior to joining the University. He also has experience with one of the Big Four accounting firms. He is past Chair of the Tax Council of the National Association of College and University Business Officers and the past co-chair of the Taxation Section of the National Association of College and University Attorneys. He is also a member of the Ohio State Bar Association and the Tax Lead of the Steering Committee for the AICPA Not-For-Profit Industry Conference. He is a recipient of the NACUBO Tax Award. His article, “Does Exclusivity Create Liability for UBIT?,” appeared in the July/August 2002 edition of Taxation of Exempts and “Proposed FICA Regulations Go Far Beyond A Response To Mayo,” appeared in the September/October 2004 edition of the same publication. Mr. Irvine is a graduate of Kent State University (BBA, summa cum laude), the University of Cincinnati (MS, taxation) and Duke University Law School (JD, high honors). He is admitted to practice in Ohio and the Federal Court for the Southern District of Ohio. He is also a certified public accountant and a frequent speaker on tax issues.

Speaker Biography


Speaker Biography Deborah G. Kosnett, CPA, is a Tax Principal with Tate & Tryon, CPAs and Consultants, in Washington, DC, a firm specializing solely in not-for-profit organizations. She has 25 years' experience as a tax advisor to not-for-profit organizations throughout the country. Prior to joining Tate & Tryon in 1999, Ms. Kosnett was a senior tax manager with both KPMG and Ernst & Young in Washington, DC, where she worked with numerous exempt organizations, as well as with not-for-profit hospitals and multi-entity health systems. Ms. Kosnett is a frequent contributor to American Society of Association Executives (ASAE) publications, including “2011 Form 990: Reporting Requirements for AMCs,” and “Need-to-Knows in the New 990.” She is also a regular presenter at conferences held by AICPA, ASAE, the Greater Washington Society of CPAs, and the Finance and Administration Roundtable, and is a co-author of ASAE's "Guide to the Newest Form 990.” Ms. Kosnett currently serves on the AICPA's Exempt Organizations Technical Resource Panel, where she assists with numerous initiatives, including the TRP's Form 990 Task Force.


“I’ve Just Found UBI!”

Is It As Bad As You Think?


Unrelated Business Income

Trade or Business

Regularly Carried On Not Substantially Related


Modifications in IRC Section 512(b)

Investment income (interest, dividends, annuities) Royalties Real property rents Capital gains and losses Research (not testing) Exception for debt financed income Exception for income from controlled entities


Exceptions in IRC Section 513

Substantially all work by volunteers (85%?) Convenience ((c)(3)s and colleges and universities only) • Members • Students • Patients • Officers and employees

Sale of donated goods (substantially all) Qualified sponsorship payments


Additional Exceptions in IRC Section 513

Bingo games Low cost articles Hospital services Pole rentals Fair entertainment Trade shows


Fragmentation: IRC IRC Section 513(c)

… an activity does not lose identity as a trade or business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may, or may not, be related to the exempt purposes of the organization.



PLR 200148057: sales of golf equipment and food and drink at snack bar related, but sales of clothing with course logo unrelated Publication of a journal two activities: publication of editorial content and publication of advertising Rev. Rul. 73-105: museum gift shop sales fragmented. Reproductions, copies, and books pertaining to the collection were related. Souvenirs were unrelated.



Rev. Rul. 78-98: Fees for ski facility from general public use were unrelated. Use by students was related. PLR 9720035: golf course fees from students, faculty and staff was related. Fees from alumni, spouses and children of students, faculty and staff, general public was unrelated. PLR 9720035 not always followed by IRS


Pass Through Entities

All income of S corporation, including gain on sale, is treated as unrelated business income. Income from partnerships and LLCs flows through to partner or member, retaining its character.


The Attack on Loss Activities

Where an activity carried on for profit constitutes an unrelated trade or business, no part of such trade or business shall be excluded from such classification merely because it does not result in profit. 513(c).



Form 5701 issued by the IRS: the facts clearly show no desire on X’s part to operate its catering and recreation center activities at a profit. First, X has reported losses in nine consecutive years ... Second, X indicated that these activities are budgeted to operate at breakeven or a loss with no future plans to make a profit.... Accordingly, X’s losses from its catering and recreation center activities are being disallowed in full because the required profit motive is not present … .


History of Losses Weller, TC Memo 2011-224: 4 consecutive yrs. Dennis, TC Memo 2010-216: 5 consecutive yrs Lamb, TC Memo 1996-166: 6 consecutive yrs. Storey, TC Memo 2012-115: 6 consecutive yrs. Helmick, TC Memo 2009-220: 11 consecutive yrs. Engdahl, 72 TC 659: 12 consecutive yrs. Allen, 72 TC 28: 12 consecutive yrs. Eldridge TC Memo 1995-384: 14 consecutive yrs. Haladay, TC Memo 1990-45: 15 consecutive yrs. Rinehart, TC Memo 2002-9: start up period for horse breeding 5-10 yrs.



Have a business plan Document purpose of the activity Document changes to that plan in the event of multiple year losses Conduct operations in a business-like manner


“What Expenses May I Use?”

The G/L and Beyond


Expense Allocation: Directly Connected

512(a)(1) and 1.512(a)-1(a) Depreciation, and similar items attributable solely to the conduct of unrelated activity Must meet requirements of 162 and 167 Dual use of facilities and personnel • A reasonable basis • Proximately and primarily related • Example of president: approximately 10% of

his time


Reasonable Allocation Methods

NACUBO draft revenue procedure from 1997 Proposes use of OMB Circular A-21 methodology

Regulation example: advertising activity - deduct direct costs, allocable portion dual use expenses, but no portion of costs of developing membership and carrying on exempt activities No guidance from IRS



Gross receipts Actual use or time spent Must be able to substantiate expense as well as allocation between exempt and unrelated activity. Core Special Purpose Fund, TC Memo 1985-48. GCM 39843 (4/15/91) held that hospital could not use Medicare costs reported to HCFA for UBI purposes



Regulation example: exhibit catalog advertising Ad income $100,000 Direct expense (25,000) 75,000 Catalog inc 60,000 Catalog exp (110,000) (50,000) UBI 25,000 None of the expenses related to exhibit allowable


Rensselaer Polytechnic Institute

Allocation based on actual use or available use? Variable expenses were allocated based on actual use. Allocation of a fixed expenses was the issue IRS position: allocate based on available use. Taxpayer position: allocate based on actual use.


Rensselaer Polytechnic Institute

Example: • 150 days of related use • 100 days of unrelated use • $300,000 of fixed expenses

Allocation to unrelated use IRS: • 100/365 X $300,00 = $82,192

Taxpayer: • 100/250 X $300,000 = $120,000


Exploitation of Exempt Activities

1.512(a)-1(d) Unrelated activity is kind carried on for profit by taxable organizations Exempt activity exploited is a type normally conducted by taxable organization Exempt expenses in excess of exempt income may be deducted against unrelated income Cannot produce unrelated loss


Exploitation Example

Ad income $100,000 Direct expense (25,000) 75,000 Program inc 60,000 Program exp (110,000) (50,000) UBI 25,000 Football loss (25,000) UBI 0


“Where Does It All Go?”

Form 990-T


The Unrelated Business Income Tax Imposed by the Revenue Act of 1950 Tax originally levied on “supplement U net income” Initially applied only to § 501(c)(2), (3) (except churches), (5), (6) organizations Tax Reform Act of 1969 expanded to virtually all organizations Form 990-T substantially revised in 1970, periodical advertising section added in 1971 No substantial revisions since


1971 – Not Too Different!


The 1971 990-T Introduced . . . Schedule H – Exploited Exempt Activity Income (other than advertising income) Schedule I – Advertising Income and Advertising Loss (consolidated and separate) In 1970 there was a single “Allowable Exempt Activity Expenses” schedule In 1971, IRS split off advertising from other “exploited exempt activities”


Form 990-T Has Changed Little . . . … but unrelated activities (especially advertising) have changed a lot!

1971 . . . • Magazines • Newsletters • Show guides (all printed, of course)

2012 . . . • Magazines • Newsletters • Internet • Phone/tablet apps • Social media

• Facebook • Twitter • Linked-In

• YouTube • Podcasts


Who Has To File a 990-T?

Organizations exempt under § 501(a) with gross income >= $1,000 from a UTB Organizations liable for the “proxy tax” Organizations liable for certain other taxes Fiduciaries for certain trusts that have >= $1,000 of UTB gross income


When to File the 990-T

Surprise! There’s more than one due date Most entities must file by the 15th day of the 5th month after year end But! § 401(a) employees’ trusts, IRAs, SEPs, SIMPLEs, Roth IRAs, Coverdell ESAs, and Archer MSAs must file by . . . A maximum 6-month extension is permitted

The 15th day of the 4th month


What To Report, and Where Activity Where it goes on the 990-T

Rent from personal or personal/real property Schedule C

Unrelated debt-financed income Schedule E

Interest, annuities, etc. from controlled orgs Schedule F

§501(c)(7), (9), (17) investment income Schedule G

Non-periodical advertising Schedule I (no better place!)

Periodical advertising Schedule J

Goods/services sales, gains/losses, passthrus Part I, specific lines

Everything else . . . Parts I, line 12

There are exceptions . . . §501(c)(7), (9), (17)’s report advertising, other exploited activity in Part I

§501(c)(7), (9), (17)’s report rental activity in Part I


What Is A Periodical?

Regularly scheduled and printed material . . . … not associated with a specific event Periodical rules are specific; little ‘wiggle room’ If periodical rules do NOT apply, an “ad” may not actually be taxable


Non-Periodical – Ad vs. Acknowledgement


A Word About Circulation Income … Circulation income = a portion of member dues PLUS actual sales To allocate dues, use only the method that applies • Method 1: >= 20% of total circulation is nonmember sales

- Use the subscription price charged to nonmembers • Method 2: >= 20% of members get no periodical and pay

less - Use the reduction in member dues

• Method 3 – neither of the first two applies - Use this allocation formula:

Total periodical costs Dues x -------------------------------------------------------------------------------

Total periodical costs + other exempt costs


Consolidated Periodical Election For organizations publishing 2 or more periodicals Treats ALL periodicals as if they were one Eligible periodicals are those: • Actively engaged in for profit • With gross ad revenue at least 25% of readership

costs

To elect, fill out Schedule J, Part I You may NOT un-elect without IRS permission


Consolidated Periodicals - Example

No excess readership costs on a consolidated basis


Do NOT Do This!!

You MUST include all items of income and expense in a consolidated calculation!


Exploited Exempt Activity - Example

• Remember that especially on the Web, an “ad” may actually be a non-taxable “acknowledgement”

• “Related” gross income may be -0- in many instances, as here

• For web sites, directly-connected advertising costs may be hard to calculate


“Everything Else” - Income

Line 1 – sales of goods and services (also § 501(c)(7), (9), (17) items) Line 4 – taxable capital (UDFI) gains, ordinary gains on sales of business property, disposal of debt-financed property Line 5 – taxable income/losses from partnerships and S corporations Line 12 – other income


“Everything Else” – Other Deductions

Few of these lines will be used if UBI is reported in the separate schedules.


Can You File a Consolidated 990-T? Organizations with §501(c)(2) title holding companies may consolidate their 990-T’s A Form 1122 authorization is required for the first year Form 851, “Affiliations Schedule,” is required for all years


“What ‘Regular’ Tax Rules Apply?”

Book-Tax Differences

and More


Net Operating Loss Deduction

Deductible only if incurred in a UBI activity Allowable only in a year where UBI occurs Losses go back 2 years; forward 20 years Non-UBI years do count toward expiration Excess exploited exempt activity expense and excess readership costs do NOT create an NOL Activities that continually lose money may not have a profit motive … NOLs may be

denied


Differing Tax Rates

• Controlled group bracket apportionment rules also apply • Parent/subsidiary • Brother-sister • Combined group

• Adoption and amendments – consents must be attached


Book-Tax Differences: Not Just For 1120s Book vs. tax depreciation Special depreciation rules Passive activity loss limitations Travel, meals and entertainment expense • 50% M&E rule applies • No deduction for spousal travel

Advance payments (see Rev. Proc. 2004-34) Nonaccrual experience method (services) Transactions between related taxpayers • Accrual-basis taxpayers may only deduct expenses owed a

related party in the year that it’s income to the related party

Uniform capitalization rules - § 263A Organizational and start-up costs


Tax Credits Also May Apply

General business credit Credit for prior year minimum tax Foreign tax credit Credit for certain Federal excise taxes Credit for small employer health insurance premiums Qualified plug-in electric and electric vehicle credit And more


Potential Form Attachments Open to Public Inspection (501(c)(3) NOT Open to Public Inspection

Form 4626 (alternative minimum tax) Form 4562 (depreciation) Form 2220 (underpayment penalty)

Form 926 (US transferor to foreign corp) Form 5471 (ownership in foreign corps) Form 8271 (tax shelter registration #) Form 8594 (1060 asset acquisition) Form 8621 (passive foreign investment co) Form 8832 (entity classification election) Form 8858 (info return/disregarded entities) Form 8865 (certain foreign partnerships) Form 8886 (reportable transaction disclosure) Form 8913 (Federal telephone excise tax) Form 8925 (employer-owned life insurance) Form 8941 (health insurance premiums credit)

--This is not an exhaustive list--


Questions?

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unrelated business income tax (ubit)

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