Debt-financed income may lead to unrelated business taxable income (UBTI) for tax-exempt organizations under certain conditions. The IRS has established through private letter rulings (PLRs) that short-term borrowing for administrative needs does not count as acquisition indebtedness, but questions remain regarding the duration and amount of such debt. Lisa B. Petkun, a partner at Pepper Hamilton LLP, specializes in tax planning and nonprofit tax compliance and provides extensive counsel on related issues.

1. UBIT ISSUE
If a tax-exempt organization incurs indebtedness to acquire income-producing property, Sections
512(b)(4) and 514(a)(1) may require taxation of the debt-financed portion of the income as
"unrelated business taxable income." UBTI arises only if there is "acquisition indebtedness", which
is indebtedness incurred in acquiring or improving property. The IRS has held in PLRs 200235042
and 200233032 that short-term borrowing to meet administrative needs is not acquisition
indebtedness. These PLRs involved indebtedness incurred by a pension fund to meet deadlines for
payment of pension benefits where the loan was repaid within about 20-30 days and was a relatively
small amount. In these PLRs, the IRS reasoned the loan was not incurred for the purpose of
acquiring investment property, but rather for the purpose of solving temporary cash flow problem in
a relatively small amount. The debt was, in effect, traced to its use to pay pension benefits.
The same concept was found in PLR 200320027, in which short-term borrowing (20-30 days) by a
common trust fund in which an exempt organization owned shares was undertaken to redeem units.
The borrowing was found not to constitute acquisition indebtedness.
Although these PLRs are welcome, they leave open the issue of what is the outer limit on the time
for the borrowing to remain outstanding. Is indebtedness that is outstanding for 60 days to
effectuate a redemption covered under these rulings? What about 90 days? How significant is the
amount of the borrowing? It was a de minimis amount in one of the PLRs, but what if it is a large
amount? The answer to these questions are not known, and advisors often have to provide guidance
on fact patterns that do not fit precisely into the PLRs.
Lisa B. Petkun
Lisa B. Petkun is a partner in the Tax Practice Group of Pepper Hamilton LLP. Ms. Petkun
concentrates her practice on sophisticated tax planning on behalf of individuals, partnerships and
corporations. Her areas of concentration include choice of business entity, tax and compliance issues
associated with nonprofit organizations, taxation of lawsuit payments and recoveries, estate, gift and
personal planning, independent contractor compliance, and tax structuring for Marcellus Shale
owners.

2. Ms. Petkun counsels nonprofit organizations on a wide range of issues, including unrelated business
taxable income, Forms 990 and 990-PF compliance, excess benefit transaction matters, formation of
new exempt entities, and state charitable solicitation and registration laws. In the area of
independent contractor and wage/hour compliance, Ms. Petkun designs programs for companies to
enhance compliance with such laws at the federal and state levels. She co-heads Pepper's
Independent Contractor Compliance Practice Group, an interdisciplinary team of more than 30
labor, tax, employee benefits and class action attorneys. She also co-publishes a blog on the subject
atwww.IndependentContractorCompliance.com, including a monthly update of IC Compliance News.
She also co-authored "Michigan Limited Liability Company," which is published by Data Trace Legal
Publishers, Inc. Ms. Petkun is a co-author of BNA Tax Management Portfolio, "Charitable Remainder
Trusts and Pooled Income Funds" (First Edition).
In December 2013, Ms. Petkun received The William R. Klaus Pro Bono Award from Pepper
Hamilton for her work in assisting with the formation of numerous charitable organizations on a pro
bono basis and for conducting training sessions for both Pepper attorneys and clients.
For more information on Lisa B. Petkun, please see her full biography here.
Lisa B. Petkun is a partner in the Tax Practice Group of Pepper Hamilton LLP. Ms. Petkun
concentrates her practice on sophisticated tax planning on behalf of individuals, partnerships and
corporations. Her areas of concentration include choice of business entity, tax and compliance issues
associated with nonprofit organizations, taxation of lawsuit payments and recoveries, estate, gift and
personal planning, independent contractor compliance, and tax structuring for Marcellus Shale
owners.
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