Tax reform unrelated business taxable income | Baker Tilly
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Q&A: Impact of tax reform and unrelated business taxable income on not-for-profit organizations
Jan. 7, 2019 · Authored by Patty Mayer, Pam Alexanderson
On Aug. 16, 2018, Pamela Alexanderson and Patty Mayer hosted a webcast to discuss unrelated business taxable income (UBTI), tax-reform provisions, and their possible impact to not-for-profit and higher education organizations.
Questions the presenters weren’t able to address during the live webcast have been answered within this article.
Filing and payment
What’s the purpose of the $1,000 standard exemption?
The standard exemption of $1,000 is an automatic subtraction from taxable unrelated business income (UBI). For example, if an organization has a net UBI income of $5,000, taxable UBI would be $4,000 — that’s $5,000 less the standard exemption of $1,000. Tax would then be calculated based on taxable income of $4,000.
How much UBI is allowed before a not-for-profit’s exempt status is at risk?
There’s no strict UBI percentage an exempt organization can generate before its exempt status is at risk. Commentators vary on what constitutes an excessive amount of UBI, with the estimated range spanning from over 50% of an organization’s total gross revenue to as low as 10%.
The threshold is generally court-case driven, which helps to provide guidance on what’s an acceptable level. In addition, case law has referred to the following specifics:
The amount of employee resources devoted to a UBI activity versus exempt activities
The percentage of total assets that pertain to UBI activity versus exempt activity
For example, the IRS revoked the tax-exempt status of a county fair association that’s existed since the 1800s because it derived between 29% and 35% of its revenues from an unrelated racetrack.
The IRS has acknowledged the lack of clear limits on the extent to which an organization can engage in commercial activities. Although there’s no bright-line test, it’s generally considered prudent to not allow a for-profit activity to exceed 15% of an organization's gross income. If it does, an organization should consider transferring the activity to a for-profit entity to help ensure it maintains exempt status.
What’s a common threshold used by clients to determine if state UBI returns needs to be filed?
Best practices would be to file UBI returns in the states in which an organization has a filing requirement — however, it depends on the risk level with which an organization is comfortable.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
In most states, the threshold for filing a state UBI return is $1,000 of unrelated business gross income, but each state is different. Because of this, some organizations file in every state while others only file if allocated income exceeds $2,000–$5,000. Losses shouldn’t be forgotten either, and some organizations may wish to file to establish a net operating loss (NOL).
It’s important to note if an organization chooses not to file in a particular state, the state can access its taxes at any time because the statute of limitations generally doesn’t start until a return is filed.
Accordingly, organizations should consider, at minimum, filing a state return if they meet the filing requirements — keeping in mind states can assess penalties and interest for late returns or noncompliance.
We’ve already made estimated quarterly tax payments on fringe benefits for the first and second quarters of 2018. Should we continue making payments?
Organizations that have already been making estimated quarterly tax payments can continue to make them. If the provision is repealed, any taxes paid relating to fringe benefits would be eligible for refund.
Is there a possibility fringe benefits UBI might go away?
Yes, there’s current legislation to remove the UBI fringe-benefit laws that were passed as part of tax reform. Organizations should continue to plan for UBI taxes, however, given the law still stands.
Commuter benefits
Is parking for employees taxable even if it has nothing to do with UBI?
Yes, if an organization pays for employee parking — even if the parking facility has nothing to do with UBI — the value of the parking now constitutes UBI and is reportable on Form 990-T.
Would transportation-benefit UBI be offset by parking expenses if an organization purchases parking for its employees?
No, qualified transportation benefits and parking fringe benefits are both UBI that’s taxable to the organization. The fringe benefits themselves cannot offset each other.
Qualified transportation benefits include commuter highway vans, carpooling, and transit passes and vouchers for mass transit — such as buses and trains. Fringe-benefit UBI may be offset by applicable expenses under the new law.
For example, an expense might constitute a portion of an employee’s salary attributable to monitoring fringe benefits. If the person spends 2% of his or her time on this, 2% of his or her compensation could be used as an expense to offset the fringe-benefit income.
If an organization annually spends $100,000 to hold parking spots for its employees, would it need to pay $21,000 in tax?
Not exactly. The $100,000 UBI may be offset by other expenses to lower the taxable amount. For example, an organization has the following expenses:
State income tax expense: $2,000
Charitable grants: $1,000
Accounting fees relating to UBI: $2,000
NOL prior to 2017: $50,000
The taxable UBI for this organization would be $44,000 — that’s $100,000 less $5,000 expenses, less $50,000 NOL, less $1,000 UBI exemption — and the associated tax would equal $9,240.
However, if the taxable UBI is $100,000, then $21,000 is the appropriate tax amount.
If an employee is reimbursed for parking at a conference or an off-site meeting, does UBI need to be reported?
No, reimbursement for this type of parking isn’t considered UBI because it’s a reimbursed business expense rather than a fringe benefit.
How should pretax commuter benefits, including parking permits, be treated?
Providing employees with pretax commuter benefits under a compensation-reduction agreement will be UBI. IRS Publication 15-B provides examples for the for-profit sector noting the benefits are nondeductible; and the IRS has publicly stated these arrangements will be taxable UBI. This was further confirmed in IRS Notice 2018-99.
Is it UBI if the city owns the parking lot around an organization’s building and the entity purchases parking permits so employees can park there?
Yes, that’s now taxable to the organization as UBI.
Rentals
Is rental income considered taxable income if it isn’t a normal source of income?
In general, rental income isn’t taxable if isn’t a normal source of income. It does constitute UBI if one of the following criteria are met, however:
It’s debt financed.
Rent is paid by a controlled organization.
Rent is calculated as a percentage of a tenant’s net income.
Payment includes compensation for services rendered.
More than 50% of the rent is attributable to personal property.
Lessor is a social club, voluntary employees' beneficiary association, or supplemental unemployment benefit trust.
Is equipment leased to an outside party when is isn’t being used by the not-for-profit lessor classified as rental income UBI?
To determine if an equipment rental is UBI, first conduct the three-part test and then determine if any exceptions apply.
Three-part test
Is this activity not related to the organization’s exempt purpose?
Is the activity regularly carried on?
Is the activity a trade or business?
If the answer to one of these three requirements is no, the equipment rental isn’t UBI — for example, if an organization is furthering its exempt purpose by renting equipment or it’s only renting it occasionally.
Exceptions can include the following:
The rental of equipment is done by volunteers.
The rental is this for the convenience of organization members.
If the three-part test is passed and no exceptions apply, the personal property rental is UBI. Additionally, if the rental is made to a controlled group, then the income would most likely be UBI under the controlled-group rules.
Athletic facilities
How can the value of an athletic facility be determined?
Athletic facilities aren’t UBI unless discrimination issues apply, such as exclusive use being given to top management.
Net operating loss
Does the 80% rule for NOLs refer to an organization using 80% of its loss to offset future income?
The short answer is yes; an organization may carry forward 100% of its NOL to offset future income. However, if the NOL was incurred after 2017, it may only offset 80% of its taxable income with such NOL and any remaining NOL is carried forward indefinitely.
Can NOL earned prior to 2018 be applied to UBI activities until the NOL has been exhausted?
Yes, pre-2018 NOLs can be used to offset 100% of UBI while any remaining NOL can be carried forward to a future year. Pre-2018 NOLs can be carried forward 20 years.
Miscellaneous
Is advertising UBI if it isn’t conducted on a regular basis?
Generally, no; if advertising isn’t regularly carried on then it isn’t UBI. Regularly carried on in this scenario means frequent, continuous, and pursued in a manner that’s comparable to similar commercial activities of nonexempt organizations.
Will received dividends be partially UBI for a member of an LLC filing as a corporation that generates income that isn’t wholly related to its exempt purpose?
Dividends aren’t subject to UBI unless the investment generating the dividends is debt financed. Likewise, if an LLC was considered a controlled organization, the dividend income paid to an association wouldn’t be UBI if the LLC isn’t taking a tax deduction for the dividends paid.
Is a royalty agreement subject to UBI if it says the association endorses a vendor within it?
In general, royalty agreements aren’t UBI if services aren’t provided. If an organization is a business-league type or has a required membership to receive benefits, a vendor should be fine as long as the business is being promoted through the agreement. Having an attorney review any current agreements can help ensure a royalty agreement will be considered royalty payments received by an organization.
It’s worth noting that providing any endorsement information to nonmembers may cause problems and result in the royalty agreement being considered a provided service.
Are the concessions and merchandise sold by a not-for-profit theater before a show UBI?
In general, theater concessions sold to patrons before a show or during intermission aren’t UBI. The UBI exception most often used in these cases is the convenience of member or patron. For example, with merchandise sold, it’s possible the convenience exception applies because the patron might need an item and it’s convenient to buy it at the theater.
Merchandise sold can also be related to the exempt purpose if it ties into the production or helps educate patrons. Lastly, merchandise might be altogether nontaxable if it’s sold almost entirely by volunteers.
What’s an example of a qualified public entertainment activity?
A qualified public entertainment activity is an activity generally conducted at fairs or expositions to promote agriculture or education.
For example, the Baxter County Fair Association is a Section 501(c)(5) organization that annually puts on a county fair with numerous agricultural and educational exhibits — as well as horse races. Even if the activity otherwise meets the definition of an unrelated trade or business, the horse racing isn’t an unrelated business because it’s a qualified public entertainment activity.
What’s a qualified sponsorship?
Generally, it’s a corporate sponsorship payment made to an exempt organization where there isn’t a substantial return benefit to the sponsor — less than 2% of the sponsorship amount is a benefit back to the sponsor.
A tax-exempt organization doesn’t have to worry about a sponsorship payment being reclassified as advertising revenue as long as it only entails the display of a corporate logo, name, address, or product description.
If the sponsorship benefit includes a substantial return benefit in excess of 2% or includes an inducement or endorsement of the sponsor, however, the sponsorship payment may be taxable as UBI.
Which payments from controlled organizations may have UBI?
Payments from controlled groups that can be UBI include the following:
