The Unrelated Business Income Tax (UBIT ) Law 603: Howard Bunsis Spring 2012. UBIT (Unrelated Business Income Tax).
The Unrelated Business Income Tax (UBIT ) Law 603: Howard Bunsis Spring 2012
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The Unrelated Business Income Tax (UBIT)Law 603: Howard BunsisSpring 2012
UBIT (Unrelated Business Income Tax)
The UBIT is generally imposed on the income derived from profit-seeking activities that are regularly carried on by a nonprofit organization if those profit-seeking activities are not substantially related to the organization's exempt purpose
The UBIT applies to virtually all nonprofit organizations otherwise exempt from tax under Internal Revenue Code section 501 at normal corporate income tax rates.
The primary purpose of the UBIT is "to eliminate a source of unfair competition by placing the unrelated business activities of certain exempt organizations upon the same tax basis as non-exempt endeavors with which they compete
The Treasury Regulations require three conditions to be met before an activity will be classified as an unrelated trade or business.
Section 512 defines UBTI as:
From any unrelated trade or business;
That is regularly carried on by the organization;
Less deductions regularly connected with the business.
Lack of profit in these sales of goods or services is irrelevant.
Specifically excluded from UBTI are "royalties"
Mailing list rentals fit under royalties
3 Conditions for the UBIT to Apply
Whether the nonprofit organization is engaged in a "trade or business.
Whether a nonprofit organization's trade or business is “regularly carried on.”
Whether the activity of a trade or business is "substantially related" to the nonprofit organization's exempt purpose
Condition 1: Trade or Business
The regulations provide that a trade or business includes "any activity carried on for the production of income from the sale of goods or performance of services."
When health or public service organizations conduct walkathons, bike-alongs, or other such events, they are engaging in activities that are unique to such charitable organizations.
Because the income- generating activity does not pose any competitive threat to for-profit organizations, the UBTI rules do not apply.
This would be true even if some good or service is given away in conjunction with the event, such as a prize to the volunteer who collects the most pledges
The entire nature of the pledge drive is non-commercial gift-giving. Token (or even valuable) prizes, given away in this context, still differ fundamentally from goods or services bargained for in the normal course of business
More on Condition 1
The following are not considered a trade or business:
the sale of mailing lists to another exempt organization. n20 Because this exclusion is expressly limited to sales to other non-profit organizations, the common practice of renting lists to for-profit businesses continues to present charitable organizations with tax problems.
low cost items "sold" incidental to soliciting charitable contributions. Example:
Disabled American Veterans (DAV) sent, in its solicitation letters, an "idento-tag," a small replica of the recipient's registered automobile license plate. The idento-tag was not commercially available and had negligible value
Similar items often used by charitable solicitors could include mailing address labels, calendars, and small packages of greeting cards or stationery.
As of 1995, an item could be valued at $ 6.60 and still qualify for the "low cost" solicitation exclusion
American College of Physicians
U.S. Supreme Court, 1986
Concluded that the sale of advertising space in journals of exempt organizations is a "trade or business"
The Supreme Court also concluded that not all advertising in all tax- exempt journals would yield the same result.
By rejecting a per se analysis on the issue, the Court dictated that taxation of all future advertising income for tax-exempt organizations would be decided on a case-by-case basis.
Probably all sales of advertising in professional journals will be viewed as a trade or business, since such sales are so similar to sales in for-profit publications.
Condition 2: Regularly Carried on
This condition considers the "frequency and continuity with which the activities productive of the income are conducted and the manner in which they are pursued."
A nonprofit organization will not be subject to the UBIT if it only briefly conducts the sort of income-producing activity which a taxable business conducts on a year-round basis.
If an income-producing activity is normally only undertaken by a for-profit organization on a "seasonal" basis, then comparable activities by a nonprofit organization will be deemed the regular conduct of a trade or business
More on Condition 2
Compare the conduct of the activity to similar commercial activities of taxable entities.
a seasonal greeting card sales program by a tax-exempt organization could be a "regular" business activity because a for-profit business would sell its seasonal greeting cards on the same intermittent basis.
sales of advertising space in the program for an annual fund raising show were not a regular business activity since advertising sales in commercial publications are much more frequent and continuous.
income from program advertising sales for an annual collegiate athletic tournament was non-taxable, even though sale of the advertising in the program was carried on by a professional agency, year round and from year-to-year
Condition 3: Activity “Substantially Related”
The regulations require “an examination between the business activities which generate the particular income in question" and the nonprofit organization's exempt purpose.”
A trade or business is related to a nonprofit organization's exempt purpose when there is a substantial causal relationship that requires the activity to "contribute importantly" to the accomplishment of the exempt purpose.
The "facts and circumstances"of each case determine whether the activities contribute importantly to the exempt purpose, with particular consideration given to the size and extent of the activity.
If activities are conducted on a scale larger than "reasonably necessary" to carry out an exempt purpose, the excess constitutes unrelated business taxable income.
Most forms of passive investment income, which include dividends, interest, rents and royalties, are exempt from the UBIT
Facts and Circumstances Test - Factors
Profits – is this evidence of a commercial purpose?
In Scripture Press Foundation, the IRS lost the argument that where there are large profits, commercial purposes will follow. However, the opposite conclusion was reached in Fides Publishing, where the sale of religious material resulted in large profits
In Golden Rule Church Association, consistent non-profitability can suggest the absence of commercial purpose
Competition and Fees or Cost of Services
If there is competition, then there is strong evidence of nonexempt purposes
Charging fees below cost usually gets you out of UBIT. But this could hurt the charity.
Commercial Hue or Manner of Operations
Does the commercial activity in question have a commercial hue?
Museum Gift Shops
Items clearly for the convenience of the patrons, such as food or beverage are excludible from UBIT
The IRS rules state that where the primary purpose is to further the organization's exempt purpose, the sale is considered related thus not taxable. It is only where the primary purpose is to generate income that the sale is taxable.
The IRS has taken the position that an art museum's gift shop sales of interpretive teaching items with artistic themes furthered the museum's educational purpose.
Thus, items that develop artistic ability were considered substantially related to the museum's educational purpose.
Other Museum Stuff
Original museum pieces. In most instances, sales of original museum pieces are subject to UBIT because they don't promote public education.
Reproductions/adaptations. Sales of prints, slides, posters, postcards, and greeting cards depicting museum pieces generally are not subject to UBIT.
The sale should include descriptive literature highlighting the artistic, cultural, historical, or educational connection between the item and the museum's exempt purpose.
Neckties with depictions from a folk art object, a cookbook with illustrations from a collection, and playing cards with designs from a museum's prints are free from UBIT.
Educational toys and games. Sales of puzzles, craft kits, kites, and similar items that incorporate artistic themes and educate the public generally are not subject to UBIT.
Convenience items. The IRS usually considers the sale of food, film, newspapers, and other convenience items to be primarily for the production of income and not related to an organization's mission.
However, the IRS has ruled that a sale of film by a zoo wasn't taxable because the sales aided the public in recording the nature experience.
Done on a case-by-case basis
When tax-exempt organizations undertake marketing programs with their focus only on the income potential, the activities likely will fail to satisfy the requirement that the income-producing trade or business be substantially related to the organization's exempt purpose.
For example, an exempt business league contracted with an advertising agency to mail commercial advertising materials to league members for a per-enclosure fee. The materials did not contribute to the league's exempt goals. Thus, the income from the mailings was taxable.
IRS regulations provide that a tax-exempt university may be able to sell advertising in its college newspaper and treat the income as non- taxable, regardless of content, if the advertising is solicited under the instruction and supervision of college faculty or student editors, then that effort is part of the students' educational experience.
Even though the services offered to the advertising buyers is a commercial service, the sale of the advertising by students, under supervision, contributes to the university's educational purpose.
Presumably, if the university newspaper used a professional advertising firm to solicit advertisers, UBIT applies. Why?
Another Causal Example
If a goal of Mothers Against Drunk Drivers (MADD) is to improve awareness about the impact of drinking on driving skills, MADD could develop T-shirts illustrating how many shots of whiskey equate to .08% blood alcohol content.
Other shirts could use blurred printing to illustrate the impact of drinking on a driver's vision.
The sale of these educational "messages" on T-shirts could produce non-taxable income
The sale of a shirt containing only the MADD logo would generate unrelated business taxable income.
Thus, with a slight product modification, the organization can improve public awareness and avoid the tax burden.
Sponsorship and the UBIT
Corporate sponsorship payments. No UBIT if:
There is no arrangement or expectation that the nonprofit organization will provide a substantial return benefit other than the "use or acknowledgement" of the corporate sponsor's name or logo.
Mere recognition of a corporate contributor, which identify the sponsor instead of promoting the sponsor's products or services
The exclusion does not extend, however, to "advertising" the sponsors products and services.
Advertising is any message or other programming material which is broadcast or otherwise transmitted, displayed or distributed, and which promotes or markets any trade or business, or any service, facility or product
University Stuff Exempt from UBIT
Admission fees from athletic events, student performances, theater performances by pro artists open to the general public and students
Advertising revenue from advertising in the student newspaper, when the newspaperis run by students are part of an educational program
Businesses provided for the convenience of students, faculty, and staff
Mailing list rentals to commercial organizations,
Rental income from real property
Fee for facilities rented to outside organizations for the conduct of meetings, conferences and seminars
Research ‐ Income derived from research for government, tax‐exempt, college, university, and “of fundamental research” units
Use of a facility by students for recreational purposes and its physical education program
University Stuff Subject to UBIT
Advertising revenue received from a company placing an ad in an athletic or performing arts program, or online ads
Advertising revenue that goes beyond mere acknowledgement of sponsorship
Alumni and public use of recreation center
Hyperlink to a sponsor’s website where an endorsement appears for the sponsor’s product
Pharmacy sales to the general public
Professional entertainment events operated in a commercial manner and not part of an educational program
Rental of campus facilities to professional sports teams
Rental of laboratory facility to non‐university users
Rental payments for the lease of space on antenna towers and transmission facilities
Sale of advertising space in periodicals, telephone directory, or yearbook
Travel tour programs that are not authentic educational activities (i.e. sightseeing, recreational, cruise, etc.)
IRS Form 990-T and Instructions
Form is at: http://www.irs.gov/pub/irs-pdf/f990t.pdf
Instructions are at: http://www.irs.gov/instructions/i990t/index.html
Notice lines 2 and 3 – you get to deduct Cost of goods sold
So you really get to deduct some significant costs
The UBTI is on line 34
You determine the tax on line 35, per page 13 of the instructions
The rate starts at 15% of UBTI, and goes up to 38% on UBTI between 15 million and 18.3 million (back to 35% for UBTI over 15 million). Seehttp://www.irs.gov/instructions/i990t/ch02.html#d0e2430