Unrelated Business Income Tax (UBIT)

That's Not UBIT! . . . Is It? presented by Deborah G. Kosnett, CPA Tate & Tryon, CPA’s, Washington, DC

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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 nearly 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 not-for-profit hospitals and multi-entity health systems. Ms. Kosnett is a frequent contributor to American Society of Association Executives (ASAE) publications; her most recent article is "Need-to-Knows in the New 990," published in the January 2010 Associations Now Volunteer Leadership Issue. 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.

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UBIT is Easy to Spot. Right?? We all know what UBIT is . . . • A trade or business, • Regularly carried on, • That is not related to exempt purpose.

Seems pretty simple . . . magazine ads, etc. Yes . . . but! There are other interesting creatures out there in the UBIT universe. Come along with me as we do some exploring! I promise to get you home before dark . . .

Let’s GO! 3


What’s Out There?

UBIT may be hiding in: Property rentals Services Web and web-based media Goods and products Facilities operations And more . . .

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Property Rental

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But Aren’t Rents Excluded?? Only for real property UBI can arise when: • Real property is leased with significant

personal property • Rents are entirely from personal property • Rents are based on income or profits • Services are rendered • Property is debt-financed (UDFI)

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More on the UDFI Rules Applies to “property” . . . • Held to produce income • With acquisition indebtedness • Use of which is not “substantially related” to the

organization’s exempt purpose Taxed to the extent of indebtedness: • Income stream • Capital gains

UDFI rules do not trump UBI rules! 7


Services

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The Wide World of Services Accounting and administration Special projects • Being a “consultant,” not a “librarian”

Mediation and arbitration Data processing Pathology and lab work Speakers’ bureau Language translation Catering Printing and mailing

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Particular Services Unique to membership associations Benefits purchaser over industry Particular service? • Does the activity provide an industry-wide benefit?

- Require cooperative effort and/or sharing of expense? - Provide intangible, indirect benefit?

• To whom do benefits flow? - Members and nonmembers equally? - Members more than nonmembers? - No benefit to nonmembers?

But there may be an exception . . .

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TAXABLE Standard documents: • “Boilerplate” contracts • Merely a convenience • Not markedly different from

commercially-available Where goods and services are available on the open market, “a trade association need not provide [them] to accomplish

an exempt purpose.” -Illinois Ass’n of Pro’s Ins Agents v. Comr.,

801 F.2d 987 (7th Cir. 1986)

EXCEPTED “Gold standard” docs: • Preprinted lease forms & • Landlord’s manual • Used in educational and

legislative programs “…the educational benefits

from TAA's dissemination of its updated materials improved

management practices in Texas.”

-Texas Apartment Assn v. U.S., 869 F.2d 884 (5th Cir. 1989)

“Best Practice” Documents

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Web and Web-Based Media

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Ads, Trade Shows, and More

Banner and pop-up advertising Web-based periodicals E-mail and web-based newsletters “Virtual” trade shows Job boards Databases Business – to – business sites

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Goods and Products

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Goods and Products . . .

Insurance Pharmaceutical supplies Standard forms and agreements Housing Affinity products By-products of exempt function Even . . . cattle!

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Facilities Operations

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Operation of . . . Cafeterias, cafes, snack bars Shops and stores Stadiums, arenas, and theatres Health clubs, recreational facilities Storage facilities Parking garages Orchards and farms

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And More . . (the really WEIRD stuff!)

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Exotic UBI Specimens Income from partnerships/LLPs Securities purchased on margin “Cash out” refi investments Travel tours Associate member dues (rare) Certification activities of §501(c)(3)s 501(c)(7), (9), (17) and (20) – special rules Drug testing Mailing lists! 19


And One Other Thing . . . The dreaded “commerciality doctrine!”

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“I often tell my Nonprofit Law students that the Commerciality Doctrine is like a “bludger” in a game of quiddich . . . The bludger is a small, hard ball that flies

through the air knocking quiddich players off their broomsticks when they are concentrating on other

aspects of the game . . The bludger produces anxiety in players because it is utterly unpredictable. No one knows when it will strike and what kind of damage it

will cause.” -- Thomas A. Kelley III, Professor of Law, UNC School of Law

“Nonprofit Law Prof Blog”


The Commerciality Doctrine Reins in charities operating in a “commercial manner” Limits supposed “unfair competition” with for-profit sector Fabricated entirely by case law Is unevenly applied: • Hospitals and educational institutions

frequently have a “commercial hue” Focuses on “means” rather than “ends”

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Commerciality Factors Competition with for-profit sector Generation and accumulation of profits Market-rate pricing “For-profit” business and marketing practices “Customer” base – general public vs. other charities Lack of donative support

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How Can I Make it “Not UBIT?”

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The Original Exceptions

Not regularly carried on! The 1950 exceptions: • “Volunteer” exception • “Convenience” exception • “Donation” exception

More than one can apply

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Other Common Exceptions Qualified public entertainment Qualified convention/trade show Certain hospital services Noncommercial bingo games Distribution of low-cost articles/solicitation Exchange/rental of certain membership lists 25


Other Common Exceptions Qualified sponsorship payments Certain research activities Activities consistently losing money Dividends, interest, rents, royalties, etc. • But may be taxable if from controlled orgs

(§512(b)(13)) Certain exceptions applying to social clubs and VEBAs

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Property Rental Keep personal property rentals to a minimum Lease your garage to a commercial enterprise Eschew income- or profit-based rents Leave catering and other services to lessees

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Debt-Financed Income Unrelated use not more than 15% Elimination of debt (“year and a day” rule for capital gains) Certain UBI exceptions and exclusions apply: • Property used for research & excluded under §512(b)(7),

(8) or (9) • The “volunteer,” convenience,” and “donation” exceptions • Property used by a “related” org for exempt purposes

Why only these exceptions, and not all of them? • (Hint: it has nothing to do with an exclusion’s merits)

The “neighborhood land rule”

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Services Let a 3rd party operate • Especially for potential “particular services” • Try to avoid “agency” relationship • Lease name/logo/mail list and nothing else

Try to meet “volunteer,” “convenience” exceptions Services to related EOs may escape UBI Be a “librarian;” avoid private projects Minimize/eliminate services in affinity contracts Make lessees provide their own services • Catering, music, security

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Web and Web-Based Media Job board: 3rd party operation • Consider a disclaimer: “All services offered on this

page are products of JobsNow, LLC, and are not offered by the ABC Association”

Frame potential ads as “acknowledgements” • Does not work for “periodicals” – online magazines,

e-newsletters “Related” web costs usually -0- out tax Limit “virtual” trade shows – time and/or ad content

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Goods and Products As with services: • Let a 3rd party do the selling

- Try to avoid “agency” relationship - Lease name/logo/mail list and nothing else

Try to utilize “volunteer” and “donation” exceptions Qualified trade show – permits sales and order-taking

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Facilities Operations Use “convenience,” “volunteer,” and “donation” exceptions where possible Offer space rental but no additional services Make items sold relate to purpose Let a 3rd party operate • Avoid income or profit-based rents

Be aware of “dual use” rules

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“Commerciality” Avoidance Charities relying heavily on goods and services revenue: • Periodically revisit pricing policies • Adjust advertising budgets • Boost charitable fundraising

Large-scale operations: taxable subsidiary may be an option

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