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Unrelated Business Income Tax Information for Charities & Other Nonprofits

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This document covers important unrelated business income tax information for charities and other nonprofits, including: …

This document covers important unrelated business income tax information for charities and other nonprofits, including:

*The definition of unrelated business income (UBIT)
*What income is subject to UBIT
*Alternative revenue sources

Published in Economy & Finance
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  • 1. Unrelated Business IncomeTax Information for Charitiesand Other Nonprofits Joe Giso, CPA, MST Director in the Not-for-Profit & Education Tax Practice September 24, 2012
  • 2. AgendaI. Definition of Unrelated Business Income (UBIT) A. History B. Basic Principles C. Tax Rates, Tax Forms and Organizations Subject to UBITII. What Income Is Subject to UBIT? A. Substantially Related Income B. Specifically Excluded Income C. Debt Financed Property D. Rents From Real Property Based On Net ProfitIII. Alternative Revenue Sources A. Website Activities B. Acknowledgments or Sponsorship vs. Advertising C. Digest of Published Rulings D. Supplemental Information 1
  • 3. Definition of Unrelated Business Income (UBIT)I.A. History and Background• Current State of Events:  ―As part of an inquiry conducted last year, Grassley and his colleagues discovered that the Boys and Girls Clubs of America held more than $50 million in off-shore equity and partnerships, including hedge funds and limited partnerships. This included funds held in the Cayman Islands, British Virgin Islands, and Bermuda. When asked why the money was held off-shore, the organization said the answer was to avoid paying unrelated business income tax under the Internal Revenue Code. WRONG ANSWER!  The IRS is also scrutinizing whether the large endowments held by universities and colleges are properly paying taxes due on income related to debt financing.  IRS ―College and University Compliance Check Questionnaire‖  The questionnaire solicited detailed information on governance, executive compensation, endowments, and unrelated business income: 40 percent on UBIT. 2
  • 4. Definition of Unrelated Business Income (UBIT)I.A. History and Background• Current State of Events:  The New Champion of Not for Profits! Congressman Charles W. Boustany Jr., MD (R-LA), Chairman of the Subcommittee on Oversight of the Committee on Ways and Means.  Hearings examining operations and oversight of tax-exempt organizations  May 16, 2012- First in a series of hearings by the Subcommittee on the tax-exempt sector and IRS oversight of tax-exempt activities.  “In my letter to the IRS last October, I asked the IRS about recent efforts to address certain concerns that have been raised regarding the operation of tax-exempt organizations, including corporate governance issues and mishandling of funds by officers.”  July, 25, 2012- Second in its series of hearings on tax-exempt organizations, this time examining the revised Form 990, reasons for the increasing organizational complexity of public charities, including unrelated business income tax issues, and their effect on transparency and tax compliance. 3
  • 5. Definition of Unrelated Business Income (UBIT)I.A. History and Background Dual Test: An organization has to be both "organized" and "operated" exclusively for one or more IRC 501(c)(3) purposes. Fail either and it is not exempt. The organizational test concerns the organization’s articles of organization or comparable governing document. The operational test relates to the entity’s activities. A deficiency in an entity’s governing document cannot be cured by the entity’s actual operations. ―Substance over Form.‖ Outcomes that may arise if an entity conducts a trade or business. – The entity may be subject to the UBIT. – The entity may be denied tax-exempt status if the trade or business constitutes the primary purpose of the entity. 4
  • 6. Definition of Unrelated Business Income (UBIT)I.A. History and Background Court cases focused on if the activities are a) incidental in nature; b) time/resources used in the activities; c) total receipts/expenses; and d) the importance of the activity to the exempt entity. Fact and Circumstance. The principal stumbling block was the "destination of income" test. US Court in Trinidad v. Sagrada Orden de Predicadores, (1924) – ―the destination and not the source of the income was the ultimate test of the right of exemption.‖ As a subsidiary of the New York University School of Law, the Mueller Macaroni Company paid no income taxes. (C.F. Mueller Co. v. Commissioner, 190 F.2d 120 1951). It all began with pasta! Why? Eliminate unfair competition between tax exempt organizations and for profit entities. 5
  • 7. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles UBI is income from a regularly-carried-on trade or business that is not substantially related to the organization’s exempt purpose. To find out if an activity of your 501(c)(3) generates UBI, conduct the UBI test.  With this three-part test, you’ll determine whether the activity is: – A trade or business – Regularly carried on – Not substantially related The IRS will consider each separate line of merchandise in its search for a nexus between items sold and the exempt purpose. The "fragmentation" rule. 6
  • 8. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles The key issue when assessing liability for UBIT is whether or not it is substantially related to its exempt purpose. There must be causal relationship between the activities of producing or distributing the goods or performing the services involved and the accomplishment of the entity’s exempt purpose. What is the primary purpose of sale? – ―Merely imprinting an object with the museums name was insufficient to establish a substantial causal relationship.‖ (TAM 9550003, 9/18/1995). Note: most holiday cards, hats, aprons or other objects with entity’s name or logo only will be considered UBIT. Merchandise sales can mean big business. 7
  • 9. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles Part 1: Is your activity a trade or business? The first part of the UBI test is to determine if your activity is a trade or business. 1) A trade or business 2) Regularly carried on 3) Not substantially related If your organization is selling goods or services to generate income, even if it is conducting the activity within a larger group of activities related to its exempt purpose, the activity is a trade or business. 8
  • 10. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles Part 1: Is your activity a trade or business? The term "trade or business" generally includes any activity carried on for the production of income from selling goods or performing services. Business activities of an exempt entity ordinarily are considered "regularly carried on" if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations. Trade or business is related to exempt purposes, in the statutory sense, only when the conduct of the business activities has causal relationship to achieving exempt purposes (other than through the production of income) – Important factor to consider is whether a profit motive exists. American Bar Endowment v. United States, 477 U.S. 105 (1986). 9
  • 11. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles Part 1: Is your activity a trade or business? Examples: – Hospital pharmacy furnishes supplies to the hospital, but it also sells to the general public. Sales made to the public are treated as an unrelated trade or business. – Tax-exempt solicits, sells, and publishes advertisements for commercial vendors in its publication. Publication contains exempt content, the advertising is still an unrelated trade or business. – Tax Court in Veterans of Foreign Wars v. Commissioner, 89 T.C. No. 2 (1987), found that the organization’s Christmas card program was in direct competition with Christmas cards marketed by commercial entities. – In Hope School v. US, the court strongly endorsed the concept of unfair competition as an essential element in the analysis of unrelated business taxable income. The court concluded by stating: "We find no problem with unfair competition in this case." Greeting card business. 10
  • 12. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles Part 2: Is your activity regularly carried on? Regs: "specific business activities of an exempt organization will be deemed to be regularly carried on if they manifest a frequency and a continuity, and are pursued in a manner, generally similar to comparable commercial activities of nonexempt organizations." – Key : Is the frequency in which for-profit operates. Regs 1.513–1(c)(2)(i) examples - operation by tax exempt of: – sandwich stand for only two weeks at a fair, not a trade or business. For profit generally operates year-round. – a commercial parking lot on Saturday of each week year-round would be trade or business. For profit - same basis. 11
  • 13. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles Part 3: Is the activity not substantially related? The last part of the UBI test is to decide whether the activity is substantially related to furthering the exempt purpose. Sometimes, activities that ARE related to exempt purposes can still generate UBI if they are conducted on a larger scale than is reasonably necessary to perform an exempt function. The activity engaged in by the organization may be commercial and not be subject to the UBIT, as long as the activity is substantially related to the exempt purpose. 12
  • 14. Definition of Unrelated Business Income (UBIT)I.B. Basic Principles Part 3: Is the activity not substantially related? Examples: – Rev. Rul. 73-127, NFP formed to operate a cut-rate retail grocery store in a poverty area, and to provide job training for unemployed residents. While the store operation is used in part "as a vehicle for the training program," nevertheless, it is "conducted on a scale larger than is reasonably necessary.‖ – Rev. Rul. 75-472, NFP that operated a halfway house and a furniture shop. Any profits realized from the furniture shop operations were applied toward the cost of operating the halfway house. The furniture shops activities were related to the NFP’s purpose; therefore, the NFP did not have unrelated trade or business income. – Rev. Rul. 76-94, held that the operation of a retail grocery store by a NFP, as part of its therapeutic program for emotionally disturbed adolescents, was not unrelated trade or business income. 13
  • 15. Definition of Unrelated Business Income (UBIT)I.C. Tax Rates, Tax Forms and Organizations Subject to UBIT All organizations subject to UBIT are taxable at corporate rates. The foreign tax credit is available to organizations filing Form 990–T. If an exempt organization is eligible for such a credit, it must compute the limitations upon the credit on the basis of its unrelated business taxable income. An investment credit under IRC 38 is available for property used predominantly in an unrelated trade or business, the income of which is subject to tax. Various other credits are also available. 14
  • 16. Definition of Unrelated Business Income (UBIT)I.C. Tax Rates, Tax Forms and Organizations Subject to UBIT What to File – Report UBI using Form 990-T, Exempt Organization Business Income Tax Return. – Form 990-T is required in addition to the regular Form 990, 990-EZ, or 990-PF (for private foundations). Who Must File – Any tax-exempt organization with a gross income of $1,000 or more for any tax year from the conduct of unrelated trade or business must file. When and Where to File – File Form 990-T no later than the 15th day of the 5th month following the end of the organization’s accounting period. For example, a calendar year end of December 31 would require you to file form 990-T by May 15 of the following year. – Where: IRS, Ogden, Utah 84201 15
  • 17. Definition of Unrelated Business Income (UBIT)I.C. Tax Rates, Tax Forms and Organizations Subject to UBIT Interest and Penalties – Late returns or failure to pay tax when due can result in interest and penalty charges. Generally, you are not required to include the interest and penalty charges on Form 990-T. The filing of Form 990 by an exempt organization does not start the running of the statute of limitations for purposes of Form 990–T, unless Form 990 discloses sufficient facts to apprise the Service of the potential existence of unrelated business taxable income. California Thoroughbred Breeders Association v. Commissioner, 47 T.C. 335 (1966) and Rev. Rul. 69-247 Public Disclosure: – An exempt organization under 501(c)(3) must make available for public inspection and copying any Form 990-T filed after August 17, 2006. 16
  • 18. What Income Is Subject to UBIT?II.A. Substantially Related Income Factual question: Is there a relationship between activity and accomplishment of organization’s exempt purpose? Direct relation to the NPO’s exempt purpose. – IRS compares incorporation documents and operations – New activities should be reviewed to ensure consistency with exempt purpose Just because an activity raises needed funds for the NPO does not mean, in the eyes of the IRS, that the activity is exempt Examples of exempt income: 1. Tournaments held by an organization formed to promote such events 2. Operation of a cafeteria, coffee shop, gift shop and parking lots by a hospital 3. Sale by a museum and its gift shop of greeting cards reproducing art works. – Note: If this unrelated business taxable income (UBTI) becomes ―substantial‖ (a term not defined by the IRS), the NPO could even lose its exempt status. 17
  • 19. What Income Is Subject to UBIT?II.B. Specifically Excluded Income Publication 598, Tax on Unrelated Business Income of Exempt Organizations, lists many of the excluded trade or business activities such as the ones described below: 1. Volunteer workforce - IRC § 513(a)(1) 2. Convenience of members - IRC § 513(a)(2) 3. Sale of donated merchandise - IRC § 513(a)(3) 4. Distribution of low-cost articles - IRC §513(h)(1)(A) 5. Convention or trade show activity - IRC §513(d)(1), (3); Regs. §1.513-3 6. Sponsorship - IRC § 513(i)(1) 7. Traditional bingo - IRC §513(f); Regs. §1.513-5 8. Mailing lists - IRC 513(h)(1)(B) 18
  • 20. What Income Is Subject to UBIT?II.B. Specifically Excluded Income Volunteer workforce Income from any trade or business where uncompensated volunteers perform 85% or more of the work for the NFP is exempt from UBIT. Convenience of members Trades or businesses operated primarily for the convenience of members, students, patients, employees, or officers are also exempt. – For example, a college laundry facility used to launder dormitory linens and students’ clothes is not an unrelated trade or business and therefore not subject to UBI tax. Sale of donated merchandise When an exempt organization sells merchandise, substantially all of which was donated as gifts or contributions, the activity is not considered an unrelated trade or business. – This exception can apply to national and local thrift stores, as well as to 501(c)(3)s that conduct yard sales in which substantially all merchandise sold was donated. 19
  • 21. What Income Is Subject to UBIT?II.B. Specifically Excluded Income Distribution of low-cost articles When soliciting donations through the mail, NFPs include incidental items like greeting cards to encourage the recipient to make a donation. The recipient is allowed to keep the item. – Contributions received in this manner will not be included in the UBI tax calculation. – It must be ―low-cost.‖ Adjusted annually. 2012-$9.90 Convention or trade show activity Many NFPs regularly conduct activities in conjunction with a convention, annual meeting, or trade show. The purpose of these activities must be to either: – Promote and stimulate interest in the products and services of the exempt organization or its community, or – Educate attendees about issues of the organization’s industry. – An example of income from a qualified activity is the rental fee charged to an exhibitor for booth space at an annual meeting of the exempt organization. 20
  • 22. What Income Is Subject to UBIT?II.B. Specifically Excluded Income Sponsorship To qualify as income from sponsorship, payments received: – Can only buy an acknowledgment of the contributor’s name, logo, or product line. – Can’t be used to advertise products or services. NO qualitative statement. Traditional bingo To qualify for a special tax exception, it must be: – Traditional type of bingo, not scratch-off or pull-tab games. In order to qualify as ―traditional bingo,‖ the wagers must be placed, winners must be determined, and prizes must be awarded in the presence of all persons playing in that game. – Legal under state and local law. – Not ordinarily carried out on a commercial basis. If for-profit entities can legally conduct bingo in a particular jurisdiction (usually the entire state), then bingo games conducted by NFPs in that jurisdiction would not qualify for the ―bingo exception.‖ 21
  • 23. What Income Is Subject to UBIT?II.B. Specifically Excluded Income Exclusions The Code excludes from tax some types of income that might otherwise meet the UBI test: – Interests and dividends - IRC § 512(b)(1) – Rents from real property - IRC § 512(b)(3) – Royalty income - IRC § 512(b)(2) – Gains or losses from the sale of property - IRC § 512(b)(5) – Research - IRC § 512(b)(7)-(9) – ―Not testing‖ Interests, dividends, and other income from routine investments: – Interest from bank accounts, – Annuities, – Payments with respect to securities loans, and – Any other incomes from routine investments which the IRS determines are largely similar to these types of income. 22
  • 24. What Income Is Subject to UBIT?II.B. Specifically Excluded Income Royalty income is another allowable exclusion. IRC § 512(b)(2) – A royalty is the money paid for the use of a right like a trademark, trade name, or copyright. Similarly, payments for the use of an athlete’s name, photo, likeness, or facsimile signature are also considered royalties. – Right is used by someone other than the owner of that right. – Be careful not to confuse royalties with payments for services. For example, payments for interviews or personal appearances with an athlete cannot be excluded from the UBI tax calculation. Gains or losses from the sale of property —like gains on the sale ofstock held by the organization as an investment—can be excluded. Noexclusion for inventory and property held primarily for sale in the course of aregular trade or business. 23
  • 25. What Income Is Subject to UBIT?II.C. Debt Financed Property You can normally also exclude rents from real property, including elevators and escalators, when calculating UBI. – For example, let’s say your 501(c)(3) rents out an assembly hall for special events. Provided you wholly own the building and provide no additional services such as bartending, you can exclude the rental received from your taxable income. However, the exclusion does not apply to: – Rents from personal property, – Rents from real property based on net profit, – Rents from real property when personal services are provided, or – Rents from debt-financed real property. 24
  • 26. What Income Is Subject to UBIT?II.C. Debt Financed Property For each debt-financed property, the unrelated debt-financed income is a calculation as detailed below: – The average acquisition indebtedness with respect to the property for the tax year of the propertys average adjusted basis for the year (the debt/basis percentage): Average acquisition X Gross income from = Unrelated debt Indebtedness debt-finance property financed income Average adjusted basis Unrelated trade or business decreases as indebtedness decreases. – X owns an debt-financed office building. The building produces $10,000 of gross rental income. The average adjusted basis is $100,000, and the average acquisition indebtedness is $50,000. The debt/basis percentage is 50% (the ratio of $50,000 to $100,000). The unrelated debt-financed income is $5,000 (50% of $10,000). 25
  • 27. What Income Is Subject to UBIT?II.C. Debt Financed Property If property is converted to a use which results in treatment as debt-financed property, the outstanding principal indebtedness with respect to such property is thereafter treated as ―acquisition indebtedness.‖ The deductions allowed with respect to each debt-financed property are determined by applying the debt/basis percentage to the sum of the deductions allowable. To be ―directly connected with‖ debt-financed property or the income there from, an item of deduction must have proximate or primary relationship to such property or income. Expenses, depreciation, and similar items attributable solely to such property qualify for deduction, to the extent they meet the above requirements. Reasonable Allocation Method 26
  • 28. What Income Is Subject to UBIT?II.C. Debt Financed Property Under § 514(c)(9), certain categories of exempt organizations are excused from the debt-financed property rules with respect to the acquisition and improvement of real property. Specifically, the term ―acquisition indebtedness‖ does not include indebtedness incurred by a qualified organization in acquiring or improving real property. The following types of exempt organizations (three others not covered) are qualified organizations for purposes of this exception: – Educational organizations described in § 170(b)(1)(A)(ii); – Qualified trusts under § 401 27
  • 29. What Income Is Subject to UBIT?II.C. Debt Financed Property The first category of qualified organizations includes educational organizations described in § 170(b)(1)(A)(ii).  Normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.  The primary function of an educational organization must be the presentation of formal instruction. Include the traditional educational institutions such as primary and secondary schools, preparatory schools, high schools, colleges, and universities Other instructional organizations may also qualify, however, if they maintain a regular faculty, curriculum, and student body. Note: Rev. Rul. 73-434, 1973-2 C.B. 329-Survival skills school. Rev. Rul. 67-447, 1967-2 C.B. 121 -Ballet school. 28
  • 30. What Income Is Subject to UBIT?II.C. Debt Financed Property The second category of qualified organizations includes any § 401 qualified trust  Stock bonus, Pension, or Profit-sharing plan of an employer for the exclusive benefit of employees and their beneficiaries. A qualified plan must satisfy numerous requirements under IRC and ERISA. Note: PLR 200318076 (qualified plan). The application of § 514(c)(9) is restricted by the operation of five limitations set forth in § 514(c)(9)(B). This special treatment does not apply if: – The acquisition price is not fixed; – The debt is contingent; – The property is leased back to the seller; – The real property is acquired from or leased to a related party; – The seller provides financing; or – The property is held by a partnership or other pass-through entity that does not allocate items of deductions, losses, and income in accord with special rules. 29
  • 31. What Income Is Subject to UBIT?II.D. Rents From Real Property Based On Net Profit IRC 512(b)(3) excludes all passive rents from tax. Not an active business. Where the real or personal property rentals are measured by reference to the net income or profits from the property, the total rent from real and personal property is taxed. However, a lease based on a fixed percentage of the gross receipts or sales will not be taxed solely by reason of such lease.  Example: an exempt agricultural society conducted an annual fair and also rented its fair grounds to a horse sales company. Under a lease agreement, the exempt organization was paid 10 percent of the first $10,000 of the lessee organization’s yearly net profits from sales conducted on the premises, 20 percent of the next $10,000, and 25 percent of all net profits in excess of $20,000. The court held that the rents are based on a percentage of the lessee’s net profits and, therefore, in accordance with IRC 512(b)(3)(B)(ii), are not excluded in computing the tax on unrelated business income. 30
  • 32. Alternative Revenue Sources “I get this on a daily basis! And these are legitimate sites…for the most part”. 31
  • 33. Alternative Revenue SourcesIII.A. Website Activities1) Ensure Accuracy A. Your website is an open file. Make sure your content is accurate and corresponds with your traditional hard copy records. B. Make sure there is a screening process for online content.2) Register Your Organization A. Trademark B. Copyright3) Various Consumer Privacy Protection Legislation – MA Data Breach Law4) Backup or Disaster Recovery Policy and Procedures5) Linking and Liability Issues 32
  • 34. Alternative Revenue SourcesIII.A. Website Activities IRS personnel have been trained to look at your website for unrelated business income and other tax and non-tax issues. No restrictions on access. Cost-effective way to audit. No unnecessary field visits. Agents can audit you from virtually anywhere! Internet issues: – Website ―advertising‖ versus ―corporate sponsorships‖ – Website solicitation of contributors – Links (such as to a business) and banners – Merchant affiliate programs – Lobbying – Unrelated Business Income TaxNote: The IRS has stated, “the use of the Internet to accomplish a particular task does not change the way the tax laws apply to that task. Advertising is still advertising, and fundraising is still fundraising.” 33
  • 35. Alternative Revenue SourcesIII.A. Website Activities The latest and greatest from the IRS! ―Excuse me? You want what?‖ Whatever happened to the ―Paperwork Reduction Act (44 U.S.C. 3501 et seq.)”? The IRS is not “Green Friendly”. You heard it hear first. 34
  • 36. Alternative Revenue SourcesIII.A. Website Activities Announcement 2000-84, I.R.B. 2000-42, 385: Request for Comments  ―Exempt organizations use the Internet to carry on activities that otherwise can be conducted through other media, such as radio or television broadcasts, print publications, or direct mailings. The growing use of the Internet by exempt organizations raises questions regarding whether clarification is needed concerning the application of the Code to Internet activities.‖ 1. General Issues 2. Political and Lobbying Activities 3. Advertising and Other Business Activities 4. Solicitation of Contributions 35
  • 37. Alternative Revenue SourcesIII.A. Website Activities Announcement 2000-84, I.R.B. 2000-42, 385:– 3. Advertising and Other Business Activities To what extent are business activities conducted on the Internet regularly carried on under section 512? What facts and circumstances are relevant in determining whether these activities on the Internet are regularly carried on? Are there any circumstances under which the payment of a percentage of sales from customers referred by the exempt organization to another website would be substantially related under section 513? Are there any circumstances under which an online ―virtual trade show‖ qualifies as an activity of a kind ―traditionally conducted‖ at trade shows under section 513(d)? 36
  • 38. Alternative Revenue SourcesIII.A. Website Activities Receive contributions from the state on a repeated and ongoing basis or a substantial basis through website? E-mail messages that promote the website and target persons physically located in that state? The terms ―charitable‖ and ―solicitation‖ are defined very broadly. A letter, email, phone call, newspaper ad or website posting requesting support from a states residents may trigger that states solicitation law. Drop down menu with all 50 states: – Are they keeping track of where contributions are coming from? – If a website that can be accessed by individuals in all 50 states: is there an implied intent to solicit from all 50 states? 37
  • 39. Alternative Revenue SourcesIII.A. Website Activities Fully describe the organization, location and areas servicing on the web page containing solicitation for donations. Bungee Institute is a Section 501(c)(3) organization fostering scientific research and testing in the sport of bungee jumping in MA. We are a locally based organization with our training and testing facility located on The Tobin Bridge located in Chelsea, MA. Your generous tax-deductible donations will help keep this sport safe and enjoyable. “We jump first so it won’t be your last.” Volunteers are always welcomed and needed at our testing facility. 38
  • 40. Alternative Revenue SourcesIII.A. Website Activities Merchant affiliate programs – A link from the NFP website to a merchant’s web page can be characterized only by looking at the specific facts and circumstances. – Some links simply state that "We receive a royalty on ...books purchased through X bookseller.― • The exempt organization earns a percentage of sales of exempt books as well as a lesser commission on other purchases via the link. – An NFP’s commissions from sales by affiliated merchants can be analyzed using rules similar to those for merchandise sales. – Merchandise sales items are looked at from the point of view of whether they contribute to the NFP’s exempt purpose. 39
  • 41. Alternative Revenue SourcesIII.A. Website Activities Merchant affiliate programs Question: UBTI from affiliate commissions? If a tax exempt organization provides a link to Amazon.com from its website, and receives a commission when its visitors buy from the store, is the income taxable UBTI? Example: JaneDoe.org is the website of a tax-exempt organization devoted to knitting. It carries on its site links to knitting books that can be purchased from Amazon.com. If a visitor clicks on one of these links, and buys a knitting book, the resulting commission to JaneDoe.org will probably not be UBTI, because the sale of the book is in line with the organizations exempt purpose. If, however, on the same visit the person also buys a stereo, the resulting commission will be UBTI. This is because the sale of the stereo is not in line with the organizations exempt purpose of safe knitting for all ages. 40
  • 42. Alternative Revenue SourcesIII.A. Website Activities Another way of looking at affiliate programs is to compare them to affinity programs. – There are similarities in earning revenues from member use of affinity cards and earning revenues from member purchases from certain vendors. This construction would allow NFPs to earn tax-free revenues from all sales to their members, not just sales of products that are in line with exempt purposes. – Courts have found that the fees from affinity card use represent tax- exempt royalties from the use of an NFP’s intangibles, such as trademarks and goodwill. The IRS does not agree with characterizing receipts from affinity programs as royalties but has finally relented. IRS Exempt Organizations Division instructed area managers not to pursue cases challenging tax exempt organizations affinity credit card arrangements and rentals of mailing lists. 41
  • 43. Alternative Revenue SourcesIII.B. Acknowledgments or Sponsorship vs. Advertising Acknowledgements, in order to avoid being characterized as advertisements, must have the effect of identifying the sponsor without promoting the sponsor’s products, services or facilities. A ―qualified sponsorship payment‖ is a payment in exchange for which the corporate sponsor neither gets nor expects any return benefit other than: – Goods or services, or other benefits, the total value of which does not exceed two percent of the sponsorship payment; or – Recognition, i.e., use or acknowledgment of the sponsor’s name, logo, or product lines in connection with the nonprofit’s activities. ―Advertising‖ includes any message containing an endorsement, qualitative or comparative language, price information, other indications of savings or value, or any inducement to purchase, sell, or use the sponsor’s products or services. 42
  • 44. Alternative Revenue SourcesIII.B. Acknowledgments or Sponsorship vs. Advertising The regs provide six acceptable actions that would avoid the "substantial benefits realm―: 1. Listing the name or logo or product line of sponsor; 2. Awarding exclusive sponsorship award; 3. Providing logos or slogans that do not contain any qualitative language or comparative description of the products; 4. Listing of payors locations, addresses, phone numbers, and internet addresses; 5. Providing value-neutral descriptions of the sponsor’s product displays; and 6. Listing sponsor’s brands or trade names. ―Qualified sponsorship payments‖ would also include: – The sponsor’s logo on signage at an athletic event; – Describing the corporate partner as ―the exclusive sponsor‖ of an art exhibit or conference in a brochure; or – Including the sponsor’s name and logo in newspaper ads about a walkathon and on T-shirts worn by participants. 43
  • 45. Alternative Revenue SourcesIII.B. Acknowledgments or Sponsorship vs. Advertising There are four items that cannot be done. If any of these items are done, then you are relegated to traditional UBIT analysis: 1. advertising; 2. designating a sponsor as an exclusive provider; 3. providing facilities, services or other privileges to the sponsor unless they are of "insubstantial value"; and 4. granting of either exclusive or nonexclusive rights to use sponsor’s intangible asset (e.g., name or logo). Exclusivity arrangements. An arrangement that acknowledges a payer as the exclusive sponsor of an organization’s activity (or the exclusive sponsor in a particular trade, business or industry) will not, in and of itself, result in the payments being taxable as substantial return benefits. However, exclusive provider arrangements (commonplace for many colleges and other large exempt organizations) that limit the sale, distribution, availability or use of competing products or services in connection with an organization’s activity will generally result in a substantial return benefit and thus may be taxable. 44
  • 46. Alternative Revenue SourcesIII.C. Digest of Published Rulings A corporation that planned on offering consulting services for a fee to nonprofits engaged in various rural-related activities. The court determined that the taxpayer had completely failed to show that its own services, or the services performed by its consultants, would not be in competition with commercial businesses such as personnel agencies, consulting referral services, real estate agents, housing rental services, banks, loan companies, trash disposal firms or environmental consulting companies. B.S.W. Group, Inc., 70 TC 352, Dec. 35,175. An organization formed to provide managerial and consulting services for unrelated tax-exempt organizations for the purpose of improving administration of their charitable programs did not qualify as a Code Sec. 501(c)(3) organization. The furnishing of services at cost fell short of the donative element necessary to classify the activities as charitable. Rev. Rul. 72-369, 1972-2 CB 245. An organization controlled by a group of exempt organizations and providing them investment, management, and other services for a charge substantially less than cost qualified for charitable organization status under Sec. 501(c)(3). Rev. Rul. 71-529, 1971-2 CB 234. 45
  • 47. Alternative Revenue SourcesIII.C. Digest of Published Rulings The Tax Court properly determined that proceeds received by a tax-exempt state police association from the publication of a magazine constituted UBTI, rather than nontaxable royalty income. The taxpayers participation was more than de minimis. The essence of the agreement between the publisher and the taxpayer was the imposition of a duty on the publisher to perform on the taxpayers behalf and under the taxpayers control. – Arkansas State Police Association, Inc., CA-8, 2002-1. A tax-exempt organizations income from the sale of periodical and banner advertising on its website was deemed unrelated business income, and no allocation between periodical and non-periodical advertising was warranted. – IRS Letter Ruling 200303062, October 22, 2002. An organization composed of state high school athletic and activities associations had unrelated business income to the extent of income derived from advertising, but not subscription, in the organizations two periodicals. – IRS Letter Ruling 9211004, November 7, 1991. 46
  • 48. Alternative Revenue SourcesIII.C. Digest of Published Rulings A loss resulting from an exempt organizations provision of food service to a NFP nursing home was not allowable in computing the organizations UBIT. The food service activity did not constitute a trade or business. It was not undertaken for the primary purpose of producing income and was carried on temporarily for the nursing homes convenience. – IRS Letter Ruling 9719002, November 27, 1996. The investment of an exempt employees trust as a limited partner in a partnership carrying on an unrelated trade or business may result in unrelated business taxable income. No distinction between limited and general partners. – Rev. Rul. 79-222, 1979-2 CB 236. A broadcast tower, which was leased by an EO to a company providing paging services, was tangible personal property. Therefore, rental income did not qualify for the exclusion for UBTI derived from real property. – IRS Letter Ruling 200104031, March 15, 2000. 47
  • 49. Alternative Revenue SourcesIII.C. Digest of Published Rulings A tax-exempt educational organizations activity of renting its facilities to corporate and business patrons for special events constituted an UBIT. The special events were regular occurrences and did not contribute to the accomplishment of the organizations exempt purposes. – IRS Letter Ruling 9702003, August 28, 1996. Rents received by a tax-exempt organization from a parking garage did not constitute unrelated business taxable income because the organization did not render services to the entity that rented the garage. – IRS Letter Ruling 8720005, February 20, 1987. A EOs activities in providing information about and links to third-party service providers to its members did not qualify as an UBIT. The income received from providing links to the third-party service providers was determined to be royalties. Similarly, links to the Web sites of the organizations sponsors constituted an acknowledgement and was not UBIT. – IRS Letter Ruling 200303062, October 22, 2002. 48
  • 50. Supplemental InformationIII.D. Supplemental Information Schedule K-1 : Areas to review 49
  • 51. Supplemental InformationIII.D. Supplemental Information 50
  • 52. Supplemental Information III.D. Supplemental Information 51
  • 53. Supplemental Information III.D. Supplemental Information 52
  • 54. Supplemental Information III.D. Supplemental Information 53
  • 55. Supplemental Information• III.D. Supplemental Information Fitness Center – A health club or fitness center is a facility containing exercise equipment and/or facilities for activities such as jogging, squash, racquetball and swimming. – Increasing commercial character of fitness centers operated by exempt organizations. – The need for clarity in produced the publication of a TAM, LTR 9803001 – Issues regarding health clubs in the exempt organization context arise in two ways. • First, a health club can be a part of a larger system such as a hospital system or a university. • Second, operating a health club can be an organizations primary activity. – In the first instance, the question is whether the health club activity is substantially related to an exempt purpose or whether the activity is an unrelated trade or business . UBIT Test – In the second instance, the question is whether the health club activity furthers an exempt or non-exempt purpose 54
  • 56. Supplemental Information• III.D. Supplemental Information Fitness Center : Exempt or non-exempt purpose 1) Benefiting the Community in General - "significant segment of the local population― TAM 8505002 and GCM 39327 involve an organization that used three methods to establish that its health club fees were set at a level within the reach of the community as a whole. significant percentage of families making under $15,000 were members of the health club 2) The Promotion of Health as an Exempt Purpose – ―the promotion of health is considered to be a charitable purpose‖ Activities promoting health are considered beneficial to the general community even though the class of beneficiaries eligible to receive a direct benefit from such activities does not include all members of the community, provided that the class is not so small that its relief is not of benefit to the community. Rev. Rul. 83-157 2) Education as a Charitable Purpose – ―activities with significant instructional content are educational or may also serve to help prevent delinquency‖ Promoting and protecting the health of high school athletes through uniform interscholastic competition under the direction and control of school officials, and of cultivating the ideals of good sportsmanship, loyalty and fair play. Rev. Rul. 55-587 55
  • 57. Contact Information Joe Giso, CPA, MST  Director in CBIZ Tofias’ Not-for-Profit & Education Tax Practice  Over 25 years of experience in tax consulting and compliance issues with a specialization in not-for- profit organizations in the education, healthcare, human services, and cultural sectors  Direct: (617) 761-0623  JGiso@CBIZtofias.com 56