Chapter 23 Review Questions

CHAPTER 23

EXEMPT ENTITIESTRUE/FALSE

1. The only purpose of the Federal income tax law is to raise revenue.

ANS: FThe major purpose of the Federal income tax law is to raise revenue. Among the other purposes are social considerations and economic objectives.

PTS: 1 REF: p. 23-2 | p. 23-3

2. One reason for granting an exemption from Federal income tax to certain organizations is the belief that such organizations can perform certain government-like functions, and thereby reduce the financial burden that would otherwise fall on the Federal government.

ANS: T REF: p. 23-3

3. Qualified state tuition programs are exempt from Federal income tax under § 501(c)(3).

ANS: FQualified state tuition programs are exempt from Federal income tax under § 529.

PTS: 1 REF: Exhibit 23-1

4. To satisfy the “not-for-profit” requirement for exempt status, the entity may not be engaged in a trade or business.

ANS: FTo satisfy the “not-for-profit” requirement for exempt status, the organization must not be organized or operated for the purpose of making a profit. For example, the operation of a museum can be considered as a trade or business. But this does not cause the otherwise exempt museum to be ineligible for exempt status.

PTS: 1 REF: p. 23-5

5. A general requirement for exempt status is that the net earnings of the organization not be used for the benefit of the members of the organization.

ANS: TThe net earnings of an exempt organization must not benefit the members of the organization.

PTS: 1 REF: p. 23-5

6. General requirements for exempt status include the organization serving the common good and the organization being a not-for-profit entity.

ANS: T REF: p. 23-5

23-1

23- 2008 Comprehensive Volume/Test Bank

7. While engaging in a prohibited transaction can result in an exempt organization being subject to tax, it will not result in an exempt organization losing its exempt status.

ANS: FEngaging in a prohibited transaction can result in an exempt organization being subject to tax and to losing its exempt status.

PTS: 1 REF: p. 23-7

8. The League of Women Voters is a § 501(c)(3) organization.

ANS: FThe League of Women Voters is a § 501(c)(4) organization (e.g., a civic league).


9. An exempt educational organization is permitted to take lobbying expenditures if they relate to education and do not exceed $25,000.

ANS: FThere is no statutory provision permitting educational organizations to make lobbying expenditures as specified.

PTS: 1 REF: p. 23-7 to 23-9

10. Certain § 501(c)(3) exempt organizations are permitted to engage in lobbying activities in the same manner as taxable organizations.

ANS: FCertain § 501(c)(3) exempt organizations which elect under § 501(h) are permitted to engage in lobbying activities on a limited basis.

PTS: 1 REF: p. 23-8 | p. 23-9

11. Certain § 501(c)(3) exempt organizations are permitted to engage in lobbying activities on a limited basis. An example of such an exempt organization is a church.

ANS: FCertain § 501(c)(3) exempt organizations which elect under § 501(h) are permitted to engage in lobbying activities on a limited basis. However, a church is not eligible to make the § 501(h) election.

PTS: 1 REF: p. 23-7

12. Intermediate sanctions enable the IRS to revoke the exempt status of an exempt organization for a negotiated time period.

ANS: FThe IRS has the statutory authority to revoke the exempt status of an exempt organization if it fails to continue to qualify as an exempt organization. Intermediate sanctions provide the IRS with an alternative to the revocation of exempt status. Intermediate sanctions take the form of excise taxes.

PTS: 1 REF: p. 23-9

Exempt Entities 23-3

13. A feeder organization is an exempt organization that provides funding for nutritional programs for children.

ANS: FA feeder organization is an entity that carries on a trade or business for the benefit of an exempt organization and remits its profits to the exempt organization. Such organizations are not exempt from Federal income tax.

PTS: 1 REF: p. 23-9

14. A feeder organization is exempt from Federal income taxation because it carries on a trade or business for the benefit of an exempt organization and remits its profits to the exempt entity.

ANS: FWhile this is the appropriate definition of a feeder organization, it is subject to Federal income taxation.

PTS: 1 REF: p. 23-9

15. Theater, Inc., an exempt organization, owns a printing company, Printers, Inc., which remits 80% of its profits (i.e., taxable income of $100,000) to Theater, Inc. Since Printers remits at least 80% of its profits to Theater, neither Theater, Inc., nor Printers, Inc., must pay income tax on this $80,000 ($100,000 80%).

ANS: FPrinters, Inc., is subject to the regular income tax on its earnings of $100,000. Printers is classified as a feeder organization. Theater, Inc., is not taxed on the receipt of the $80,000.

PTS: 1 REF: p. 23-9 | 23-10

16. Public charities receive more favorable tax treatment than do exempt organizations which are classified as private organizations.

ANS: T REF: p. 23-10 | 23-11

17. The tax consequences to a donor of making a charitable contribution to an exempt organization classified as a private foundation are the same as the tax consequences to a donor of making a charitable contribution to an exempt organization that is not classified as a private foundation.

ANS: FClassification of the exempt organization as a private foundation may have an adverse impact on the amount of the contributions received by the donee exempt organization, because the tax consequences for donors may not be as favorable as they would be if the entity were not a private foundation.

PTS: 1 REF: p. 23-10

18. To be classified as a private foundation, the exempt status of an organization can be provided under either § 501(c)(1) or § 501(c)(3).

ANS: FTo be classified as a private foundation, the exempt status of an organization must be provided under § 501(c)(3). A § 501(c)(1) organization (Federal or related agency) is never classified as a private foundation. Note also that certain § 501(c)(3) organizations are not private foundations (e.g., churches, educational institutions, and hospitals).

PTS: 1 REF: p. 23-10 | p. 23-11


19. Receiving too little of its support from gross investment income and unrelated business taxable income can result in an exempt organization being classified as a private foundation.

ANS: FJust the opposite is the correct statement. That is, receiving too much of its support from gross investment income and unrelated business taxable income can result in an exempt organization being classified as a private foundation.

PTS: 1 REF: p. 23-11 | p. 23-12

20. The excise taxes such as the tax on self-dealing and the tax on excess business holdings are imposed only on exempt organizations classified as private foundations.

ANS: T REF: p. 23-13 | Concept Summary 23-3

21. Some of the excise taxes which may be imposed on private foundations may be imposed on both the private foundation and the foundation manager.

ANS: T REF: p. 23-12 | p. 23-13 | Concept Summary 23-3

22. The purpose of the excise tax imposed on a private foundation for failure to distribute sufficient levels of income is to motivate the foundation to distribute more of its income for application to exempt purposes and thus be classified as a feeder organization.

ANS: FThe purpose is to motivate the private foundation to distribute more of its income to be used for exempt purposes. However, this excise tax has nothing to do with feeder organizations.

PTS: 1 REF: p. 23-9 | Concept Summary 23-3

23. The excise tax imposed on a private foundation’s investment income can be imposed both as an initial (first-level) tax and an additional (second-level) tax.

ANS: FSince the basic purpose of the tax effectively is an audit fee to defray IRS expenses, it is imposed only as an initial tax.


24. The excise tax imposed on private foundations for excess business holdings is imposed on investments that enable the private foundation to control publicly-held rather than privately-held businesses.

ANS: FThe excise tax imposed on private foundations for excess business holdings is imposed on investments that enable the private foundation to control unrelated businesses. There is no distinction between publicly-held and privately-held businesses.



25. The excise tax that is imposed on private foundations for making jeopardizing investments is imposed because the foundation has made speculative investments that put the foundation’s income at risk.

ANS: FThe excise tax that is imposed on private foundations for making jeopardizing investments is imposed because the foundation has made speculative investments that put the foundation’s assets at risk.


26. The unrelated business income tax (UBIT) is calculated by multiplying unrelated business taxable income by the highest corporate tax rate.

ANS: FUBIT is calculated by multiplying unrelated business taxable income by the corporate tax rates (i.e., not by just the highest corporate tax rate).


27. Federal agencies exempt from Federal income tax under § 501(c)(1) are not subject to the unrelated business income tax (UBIT).

ANS: T REF: p. 23-15

28. For purposes of the unrelated business income tax (UBIT), a trade or business consists of any activity conducted for the production of income through the sale of merchandise or the performance of services for which profits have been earned during at least two of the five previous years.

ANS: FAn activity need not generate a profit to be classified as a trade or business.

PTS: 1 REF: p. 23-16

29. The trade or business of selling merchandise where substantially all of the merchandise has been received as contributions or gifts is not subject to the unrelated business income tax, but is subject to the tax on feeder organizations.

ANS: FNeither the unrelated business income tax nor the tax on feeder organizations applies in this case.

PTS: 1 REF: p. 23-9 | p. 23-16

30. A profit-related activity of an exempt organization avoids the unrelated business income tax if at least 80% of the merchandise sold had been received as a contribution.

ANS: FA profit-related activity of an exempt organization avoids the unrelated business income tax if the merchandise sold by the exempt organization has been received as a contribution.

PTS: 1 REF: p. 23-16


31. An exempt organization will not have any tax liability associated with the unrelated business income tax if the unrelated business income is $25,000 or less.

ANS: FThere is the materiality exception, but the amount is $1,000.

PTS: 1 REF: p. 23-15

32. For an exempt organization to be subject to the unrelated business income tax, the trade or business must not be substantially related to the exempt purpose of the organization.


33. A corporate sponsorship payment that is contingent on attendance at a sporting event increases the amount of unrelated business income.

ANS: TSuch a sponsorship payment is not exempt from the UBIT. Since the payment is not a “qualified sponsorship payment” because of the contingency, it is included (i.e., increases) in calculating unrelated business income.

PTS: 1 REF: p. 23-17

34. The income from a bingo game is not unrelated business income if the bingo game is legal under both state and local law, and commercial bingo games ordinarily are not permitted in the jurisdiction.

ANS: TIf the bingo game is a qualified bingo game, the income is not unrelated business income. To be a qualified bingo game, the bingo game must be legal under both state and local law and commercial bingo games must ordinarily not be permitted in the jurisdiction. If the bingo game is not a qualified bingo game, the resulting income is unrelated business income.

PTS: 1 REF: p. 23-18

35. The key factor in determining whether an exempt entity’s income from a bingo game is unrelated trade or business income is whether substantially all the work is performed by volunteers.

ANS: FFor a bingo game, a special rule applies in making this determination. The bingo game is not treated as an unrelated trade or business if:

the game is legal under both state and local law and

commercial bingo games (conducted with a profit motive) ordinarily are not permitted in the jurisdiction.

PTS: 1 REF: p. 23-18


36. The income of an exempt organization from bingo games and other casino-type games is not unrelated business income if it is legal for tax-exempt organizations to conduct such games in the jurisdiction, and it is not legal for for-profit entities to do so.

ANS: FThis exception to UBIT treatment applies only to bingo games, and not to other casino-type games.

PTS: 1 REF: p. 23-18

37. Revenue generated by an exempt organization from the distribution of low-cost items is not income from an unrelated trade or business.

ANS: TUnder certain circumstances (i.e., the distribution is considered to be incidental), the distribution of low-cost articles is not considered an unrelated trade or business.

PTS: 1 REF: p. 23-18

38. If an exempt organization conducts a trade or business that consists of either exchanging or renting to other exempt organizations the organization’s donor or membership list, such trade or business is an unrelated trade or business.

ANS: FSuch trade or business is not an unrelated trade or business under these circumstances.

PTS: 1 REF: p. 23-18

39. For an activity to be considered as regularly carried on for purposes of the unrelated business income tax, the activity must be conducted during the work week (i.e., activities performed on the weekend are not considered in determining if the activity is regularly carried on).

ANS: FThere is no such provision in making the determination. Factors to be considered in applying the regularly carried on test include the frequency of the activity, the continuity of the activity, and the manner in which the activity is pursued.

PTS: 1 REF: p. 23-18 | p. 23-19

40. In calculating unrelated business taxable income, the exempt organization is permitted to deduct only the charitable contributions associated with the unrelated trade or business.

ANS: FThe exempt organization, subject to the 10% ceiling, can deduct charitable contributions without regard to whether the charitable contributions are associated with the unrelated trade or business.

PTS: 1 REF: p. 23-20 | p. 23-21

41. Unrelated debt-financed income, net of the unrelated debt-financed deductions, is subject to the unrelated business income tax only if the exempt organization is a private foundation.

ANS: FUnrelated debt-financed income, net of the unrelated debt-financed deductions, is subject to the unrelated business income tax. This applies to exempt organizations that are and are not classified as private foundations.

PTS: 1 REF: p. 23-21


42. Personal property rental income is subject to and real property rental income is not subject to the unrelated business income tax.

ANS: FUnder certain circumstances, personal property rental income is not subject to the unrelated business income tax, and under certain circumstances, real property rental income is subject to the unrelated business income tax.

PTS: 1 REF: p. 23-20

43. If personal property is leased with real property and more than 50% of the rent income under the lease is from personal property, all of the rent income is subject to the unrelated business income tax.

ANS: TAll of the lease income in this case is subject to the unrelated business income tax.

PTS: 1 REF: p. 23-20

44. If the unrelated business income of an exempt organization is $25,000 or less, the unrelated business income tax (UBIT) will be $0.

ANS: FOnly a specific deduction of $1,000 is provided by statute in calculating unrelated business taxable income.

PTS: 1 REF: p. 23-21


45. Debt-financed property consists of all real property of a tax-exempt organization on which there is a mortgage.

ANS: FThe definition of debt-financed property is more restrictive than this. Debt-financed property includes all property of the exempt organization that is held to produce income and on which there is acquisition indebtedness except for the following.

Property where substantially all (at least 85%) of the use is for the achievement of the exempt purpose of the exempt organization.

Property whose gross income is otherwise treated as unrelated business income.

Property whose gross income is from the following sources and is not otherwise treated as unrelated business income.

Income from research performed for the United States or a Federal governmental agency, or a state or a political subdivision thereof.

For a college, university, or hospital, income from research.

For an organization that performs fundamental (i.e., not applied) research for the benefit of the general public, income from research.

Property used in an activity that is not an unrelated trade or business.

PTS: 1 REF: p. 23-21 | p. 23-22

46. Only certain exempt organizations must obtain IRS approval to obtain exempt status.

ANS: TOnly certain exempt organizations are required to obtain IRS approval for their exempt status. However, even when not required to obtain such approval, it is a good idea to do so.

PTS: 1 REF: p. 23-24

47. Exempt organizations which are required to file an annual information return, except for Private Foundations, use Form 990 (Return of Organization Exempt from Income Tax).


48. The due date for the Exempt Organization Business Income Tax Return (Form 990-T) is the fifteenth day of the third month after the end of the taxable year.

ANS: FThe due date for the return is the fifteenth day of the fifth month after the end of the taxable year.

PTS: 1 REF: p. 23-25


49. Unless the “widely available” provision is satisfied, a § 501(c)(3) exempt organization (excluding churches and private foundations) must make copies of the following available to the general public: Form 990 (Return of Organization Exempt from Income Tax) and Form 1023 [Application for Recognition of Exemption under § 501(c)(3)] or Form 1024 [Application for Recognition of Exemption under § 501(a)].


MULTIPLE CHOICE

1. Which of the following qualify as exempt organizations?a. Federal and related agencies.b. Religious, charitable, and educational organizations.c. Civic leagues.d. Social clubs.e. All of the above can be exempt from tax.

ANS: E REF: Exhibit 23-1

2. Which of the following are exempt organizations?a. National Collegiate Athletic Association (NCAA).b. American Bankers Association (ABA).c. Professional Golfers Association (PGA).d. Only a and ce. a, b, and c

ANS: E REF: Exhibit 23-1

3. Which of the following is not an example of an exempt organization?a. Religious, charitable, or educational organization.b. Voluntary employees’ beneficiary association.c. Labor, agricultural, or horticultural organization.d. Stock exchange.e. All of the above can be exempt from tax.

ANS: D REF: Exhibit 23-1

4. Which of the following are organizations exempt under § 501(c)(3)?a. Girl Scouts of America.b. Washington and Lee University.c. League of Women Voters.d. Only a and b are § 501(c)(3) organizations.e. All of the above are § 501(c)(3) organizations.

ANS: DThe League of Women Voters is exempt under § 501(c)(4) (i.e., a civic league).



5. Which of the following attributes are associated with exempt organizations?a. Organization serves some type of common good.b. Organization is not a for profit entity.c. Net earnings do not benefit the members of the organization.d. Organization does not exert political influence.e. All of the statements are true.

ANS: EThese characteristics tend to permeate the definitional requirements of many types of exempt organizations.

PTS: 1 REF: p. 23-5

6. Garden, Inc., a qualifying § 501(c)(3) organization, incurs lobbying expenditures of $210,000 during the taxable year. Exempt purpose expenditures are $900,000. If Garden makes the election under § 501(h) to make lobbying expenditures on a limited basis, its tax liability resulting from the lobbying expenditures is:a. $0.b. $12,500.c. $50,000.d. $60,000.e. None of the above.

ANS: BThe lobbying nontaxable amount is $160,000 [($500,000 20%) + ($400,000 15%)]. Therefore, the ceiling on lobbying expenditures is $240,000 ($160,000 150%). Since Garden did not exceed the ceiling, the tax imposed is only on the amount of the lobbying expenditures in excess of $160,000 ($210,000 – $160,000 = $50,000). The tax is imposed at a rate of 25%. Thus, the tax liability is $12,500 ($50,000 25%).

PTS: 1 REF: p. 23-8 | p. 23-9 | Figure 23-1

7. Which of the following statements is correct?a. Exempt organizations cannot engage in significant levels of lobbying activities.b. Certain exempt organizations can elect to engage in lobbying activities on a limited basis.c. Churches can engage in lobbying activities on an unlimited basis because of the separation

of church and state provision.d. Only a and b are correct.e. Only a and c are correct.

ANS: DChurches are not permitted to engage in lobbying activities.

PTS: 1 REF: p. 23-8 | p. 23-9


8. Which of the following are available options for the IRS in dealing with an exempt organization entering into prohibited transactions?a. Attempt to subject all or part of the organization’s income to Federal income tax.b. Revoke the exempt status of the organization.c. Impose intermediate sanctions in the form of excise taxes.d. Only a and be. a, b, and c

ANS: EAll three of these options are available to the IRS in dealing with exempt organizations and prohibited transactions.

PTS: 1 REF: p. 23-9

9. Which of the following statements regarding intermediate sanctions is correct?a. Intermediate sanctions are self-assessing (i.e., calculated and paid by the taxpayer rather

than being imposed by the IRS).b. The tax is imposed on the exempt organization.c. Both a first-level tax and a second-level tax may apply.d. The corporate tax rates apply in calculating the amount of the tax liability.e. None of the above is correct.

ANS: CIntermediate sanctions are imposed by the IRS (a.). The tax is imposed on the disqualified persons and the exempt organization managers (b.). For the excise tax on the disqualified person, the tax rate is 25% for the first-level tax and 200% for the second-level tax. For the excise tax on the exempt organization manager, the tax rate is 10% with a statutory ceiling of $10,000 of the excess benefit (d.).

PTS: 1 REF: p. 23-9

10. Which of the following statements is correct?a. A feeder organization is a division of a tax-exempt organization and it is not subject to the

Federal income tax.b. A feeder organization is a tax-exempt organization whose purpose is to provide food to

underprivileged children.c. A feeder organization is a taxable organization whose purpose is to provide reduced cost

meals to its employees that are excluded from the employee’s gross income.d. Only a and b are correct.e. None of the above are correct.

ANS: EA feeder organization carries on a trade or business for the benefit of an exempt organization and remits its profits to the exempt organization. It is not exempt from Federal income taxation.

PTS: 1 REF: p. 23-9 | 23-10


11. Which of the following § 501(c)(3) exempt organizations is appropriately classified as a private foundation?a. Cincinnati Memorial Hospital.b. University of Arizona.c. Bill and Melinda Gates Foundation.d. United Fund.e. All of the above.

ANS: COnly § 501(c)(3) organizations can be classified as private foundations. However, certain § 501(c)(3) organization such as hospitals (option a.) and educational institutions (option b.) are statutorily excluded from being classified as a private foundation. In addition, exempt organizations that are broadly supported by the general public are excluded from the classification (option d.).

PTS: 1 REF: p. 23-10 | p. 23-11

12. A § 501(c)(3) organization that otherwise would be classified as a private foundation can avoid such classification if it satisfies:a. Only an external support test.b. Only an internal support test.c. Both an external support test and an internal support test.d. An external support test, an internal support test, and good faith test.e. None of the above.

ANS: CThe intent of the external support test and the internal support test is to exclude from private foundation status those § 501(c)(3) organizations that are responsive to the general public, rather than to the private interests of a limited number of donors or other persons.

PTS: 1 REF: p. 23-11 | p. 23-12


13. Blue, Inc., receives its support from the following sources.

Governmental unit A, for services rendered $18,000General public, for services rendered 25,000Gross investment income 8,000Contributions from individual substantial contributors (disqualified persons) 19,000

Which of the following statements is correct?a. Blue, Inc., is a private foundation because it satisfies the external support test and fails the

internal support test.b. Blue, Inc., is not a private foundation because it fails both the internal and external support

tests.c. Blue, Inc., is a private foundation because it satisfies both the external support test and the

internal support test.d. Blue, Inc., is not a private foundation because it satisfies both the external support test and

the internal support test.e. None of the statements is true.

ANS: DBlue, Inc., would prefer not to be labeled a private foundation. Therefore, the entity needs to receive broad public support. To meet this requirement, it must receive more than one-third of its support in this case from governmental unit A and the general public. However, for this purpose, only $5,000 of the amount received from governmental unit A is counted. Therefore, of the $70,000 support received by Blue, $30,000 ($5,000 + $25,000) is from qualifying sources. So the external support test is satisfied (1/3 $70,000 = $23,333).

In addition, Blue, Inc., must not receive greater than one-third of its support from gross investment income and net unrelated business taxable income. The internal support test is also satisfied, because only $8,000 of the $70,000 (11%) support is from these sources.

PTS: 1 REF: p. 23-11 | p. 23-12 | Example 2

14. Which of the following statements is correct?a. A private foundation is, in general, exempt from Federal income tax.b. A private foundation may be subject to certain types of Federal income tax.c. If a broad public support test is satisfied, an exempt organization that otherwise would be

classified as a private foundation is not classified as a private foundation.d. Only b and c are correct.e. a, b, and c are correct.

ANS: E REF: p. 23-11 | 23-12

15. Which of the following taxes are imposed on private foundations?a. Tax on failure to distribute income.b. Tax on excess business holdings.c. Tax on excess charitable contributions.d. Only a. and b.e. a., b., and c.

ANS: DThere is no tax levied on private foundations labeled a “tax on excess charitable contributions.”

PTS: 1 REF: p. 23-12 | p. 23-13 | Concept Summary 23-3


16. Which of the following is not an excise tax that may be imposed on a private foundation?a. Tax on jeopardizing investments.b. Tax on self-dealing.c. Tax on excessive foundation manager compensation.d. Tax on excess business holdings.e. All of these taxes may be imposed on a private foundation.

ANS: CThere is no such excise tax imposed on private foundations.


17. Which of the following excise taxes are imposed on the private foundation because it engages in prohibited transactions?a. Tax on investment income.b. Tax on self-dealing.c. Tax on failure to distribute income.d. Only b and ce. a, b, and c

ANS: DThe tax based on investment income effectively is an audit fee used to defray IRS expenses.


18. Teal, Inc., is a private foundation which failed to distribute an adequate amount of income for the exempt purpose of Teal. Which of the following statements is correct?a. An excise tax in the form of an initial tax at the rate of 5% may be imposed on Teal.b. An excise tax in the form of an initial tax at the rate of 2.5% may be imposed on the

foundation manager.c. An excise tax in the form of an additional tax at the rate of 100% may be imposed on Teal.d. An excise tax in the form of an additional tax at the rate of 50% may be imposed on the

foundation manager.e. None of the statements is correct.

ANS: CThe initial tax on Teal is at a rate of 15% and the additional tax on Teal is at the rate of 100%. Neither an initial tax nor an additional tax is imposed on the foundation manager.

PTS: 1 REF: Concept Summary 23-3


19. Which of the following statements regarding the unrelated business income tax is not correct?a. Unrelated business income is income from activities not related to the exempt purpose of

the exempt organization.b. The unrelated business income tax is levied because the exempt organization is engaging

in substantial commercial activities.c. If the unrelated business income tax were not levied, nonexempt organizations would be

placed at a substantial disadvantage when trying to compete with the exempt organization.d. The tax rate that is applied to unrelated business taxable income is the highest corporate

tax rate.e. All of the statements are correct.

ANS: DAll of the regular corporate income tax rates apply rather than only the highest corporate income tax rate.

PTS: 1 REF: p. 23-15 | 23-16

20. Which of the following statements is correct regarding the unrelated business income tax (UBIT)?a. To be subject to the UBIT, the exempt organization must conduct a trade or business, the

trade or business is not substantially related to the exempt purpose of the organization, and the trade or business is regularly carried on by the organization.

b. To be subject to the UBIT, the exempt organization must conduct a trade or business, the trade or business must be substantially related to the exempt purpose of the organization, and the trade or business must be regularly carried on by the organization.

c. To be subject to the UBIT, the exempt organization must conduct a trade or business, the trade or business is not substantially related to the exempt purpose of the organization, and the trade or business is carried on during more than half the year.

d. An exempt entity that conducts a business that competes with for-profit businesses automatically is subject to the UBIT.

e. None of the above.

ANS: A REF: p. 23-15 | p. 23-16

21. Third Church operates a gift shop in its parish house. The total income of the church is $800,000. Of this amount, $300,000 comes from offerings and $500,000 comes from the net income of the gift shop. The gift shop operations are conducted by five full-time employees. Which of the following statements is correct?a. The $800,000 is unrelated business income.b. The $500,000 of gift shop net income is unrelated business income.c. The $300,000 is unrelated business income because the gift shop is a feeder organization.d. None of the $800,000 is unrelated business income.e. The unrelated business income tax does not apply to churches.

ANS: BThe gift shop net income of $500,000 is subject to the unrelated business income tax. For the $500,000 not to be classified as unrelated business income, the individuals performing substantially all of the work of the gift shop would need to do so without compensation. This is not the case for Third Church’s gift shop, in that the work is performed by five employees.

PTS: 1 REF: p. 23-16 | p. 23-17


22. Which of the following statements regarding the unrelated business income tax is correct?a. Private foundations are subject to the unrelated business income tax.b. Bingo games are not subject to the unrelated business income tax if they are conducted by

an exempt organization.c. The exchange or rental of membership lists with other exempt and nonexempt

organizations is not an unrelated trade or business.d. All of the statements are correct.e. None of the statements is correct.

ANS: AResponse a. is correct because private foundations may be subject to the unrelated business income tax. Response b. is appropriate only if the bingo game is a qualified bingo game. Response c. is correct only if the other organization is an exempt organization.

PTS: 1 REF: p. 23-15 | p. 23-18

23. Which of the following statements are correct with respect to the unrelated business income tax?a. Under certain circumstances, a corporate sponsorship payment can be classified as not

being an unrelated trade or business.b. Under certain circumstances, a casino game can be classified as not being an unrelated

trade or business.c. Under certain circumstances, the distribution of low-cost articles can be classified as not

being an unrelated trade or business.d. Only a and c are correct.e. a, b, and c all are correct.

ANS: DThere is no statutory provision permitting such treatment of casino games.

PTS: 1 REF: p. 23-18


24. Tan, Inc., a tax-exempt organization, has $65,000 of net unrelated business income. Total charitable contributions (all associated with the unrelated trade or business) are $7,500. Assuming that the $7,500 was deducted in calculating net unrelated business income, what is Tan’s unrelated business taxable income?a. $57,500.b. $65,250.c. $66,000.d. $72,500.e. Some other amount.

ANS: BThe $7,500 of charitable contributions exceed 10% of unrelated business taxable income (without regard to the charitable contribution deduction). Such excess is treated as a positive adjustment.

Unrelated business taxable income without the charitable contribution deduction ($65,000 + $7,500) $72,500 Statutory maximum 10% Ceiling on charitable contribution $ 7,250 Less: charitable contributions (7,500) Excess $ 250

Therefore, unrelated business taxable income is $65,250 ($65,000 + $250).PTS: 1 REF: p. 23-19 | p. 23-20 | Example 16

25. Maroon, Inc., a tax-exempt organization, leases a building and machinery to Brown Partnership. The rental income from the building is $100,000, with related expenses of $40,000. The rental income from the machinery is $9,000, with related expenses of $4,000. What adjustment must be made to net unrelated business income?a. $0.b. ($60,000).c. ($65,000).d. ($109,000).e. Some other amount.

ANS: CThe net rental income from both the building of $60,000 ($100,000 – $40,000) and the machinery of $5,000 ($9,000 – $4,000) is treated as a negative adjustment ($60,000 + $5,000 = $65,000). The personal property (machinery) is leased with the real property (building), and the personal property rental income ($9,000) is not greater than 10% of the total gross income of $109,000 ($100,000 + $9,000) under the lease.

PTS: 1 REF: p. 23-20


26. For purposes of the unrelated business income tax (UBIT), land that is acquired by the exempt organization for later exempt-use is excluded from the definition of debt-financed property if certain requirements are satisfied. Which of the following is not included in the requirements?a. The principal purpose of acquiring the land is for use (substantially all) in achieving the

organization’s exempt purpose.b. The fair market value of the land is not over 50% of the fair market value of land presently

owned by the exempt organization.c. The use of the land by the exempt organization will begin within ten years of the

acquisition date.d. At the date the land is acquired, it is located in the neighborhood of other property of the

organization for which substantially all the use is for achieving the organization’s exempt purpose.

e. All of the above are requirements.

ANS: BMortgaged land that is acquired by an exempt organization for later exempt use is excluded from debt-financed property only if all of the following requirements are satisfied.

The principal purpose of acquiring the land is for use (substantially all) in achieving the organization’s exempt purpose.

The use will begin within ten years of the acquisition date.

At the date when the land is acquired, it is located in the neighborhood of other property of the organization for which substantially all the use is for achieving the organization’s exempt purpose.

PTS: 1 REF: p. 23-22 | p. 23-23

27. Which of the following statements related to unrelated debt-financed income are not correct?a. Debt-financed income is the gross income generated from debt-financed property by an

exempt organization.b. Debt-financed property does not include property of the exempt organization on which

there is acquisition indebtedness, if substantially all the use of the property is for the achievement of the exempt purpose of the exempt organization.

c. Property of an exempt organization will not be treated as debt-financed property unless there is acquisition indebtedness on the property.

d. All of the statements are correct.e. None of the statements are correct.

ANS: D REF: p. 23-22 | p. 23-23


28. Acquisition indebtedness consists of the unpaid amounts of which of the following for debt-financed property?a. Debt incurred in acquiring or improving the property.b. Debt incurred to enable the organization to carry out its exempt purpose.c. Debt incurred to enable the exempt organization to acquire a feeder organization.d. Only a and be. a, b, and c

ANS: AAcquisition indebtedness consists of the unpaid amounts of the following for debt-financed property.

Debt incurred in acquiring or improving the property.

Debt incurred before the property was acquired or improved, but which would not have been incurred without the acquisition or improvement.

Debt incurred after the property was acquired or improved, but which would not have been incurred without the acquisition or improvement.

PTS: 1 REF: p. 23-22

29. Which of the following statements relating to exempt organizations reporting requirements are correct?a. All exempt organizations are required by statute to apply to the IRS for approval of

exempt organization status.b. All exempt organizations are required to file an annual information return.c. Exempt organizations that are private foundations use a different tax form to file their

annual information returns from that used by exempt organizations that are not private foundations.

d. All of the statements are correct.e. None of the statements is correct.

ANS: CThe annual information return for an exempt organization that is not a private foundation is Form 990 (Return of Organization Exempt from Income Tax). The annual information return for an exempt organization that is a private foundation is Form 990-PF (Return of Private Foundation).

PTS: 1 REF: p. 23-25

30. Which of the following exempt organizations are required to file Form 990 (Return of Organization Exempt from Income Tax)?a. Federal agencies.b. Churches.c. Exempt organizations whose annual gross receipts do not exceed $25,000.d. Private foundations.e. None of these entities must file Form 990.

ANS: E REF: p. 23-25


31. Which of the following statements are correct?a. If an exempt organization has annual gross receipts of less than $25,000, it need not file

Form 990 (Return of Organization Exempt from Federal Income Tax).b. Private foundations must file Form 990-PF (Return of Private Foundation).c. If the gross income from an unrelated trade or business is less than $1,000, it is not

necessary to file a return associated with the unrelated business income tax.d. Only a and c are correct.e. a, b, and c are all correct.

ANS: E REF: p. 23-25 | p. 23-26

32. Which of the following statements regarding the disclosure Regulations is correct?a. Posting the required tax forms on the Internet is an acceptable technique for satisfying the

“widely available requirement.”b. Forms 990 and 1023 must be readily available to the general public.c. If an individual requests a copy of the required tax forms in writing, the exempt entity

must provide a copy within 30 days.d. Only a and b are correct.e. a, b, and c are all correct.

ANS: E REF: p. 23-26

MATCHING

Give an example of the indicated types of exempt organizations.a. League of Women Voters.b. Teachers’ association.c. American Plywood Association.d. Six Flags over Texas theme park.e. Salvation Army.

1. § 501(c)(3) organization2. § 501(c)(4) civic league3. § 501(c)(5) labor organization4. § 501(c)(6) business league5. Not an exempt organization

1. ANS: E REF: Exhibit 23-12. ANS: A REF: Exhibit 23-13. ANS: B REF: Exhibit 23-14. ANS: C REF: Exhibit 23-15. ANS: D REF: Exhibit 23-1


Match the following statements with the correct description.a. Exempt organization under § 501(c)(3).b. May not be subject to Federal income tax.c. Permits limited lobbying activities.d. Exempt organization under § 501(c)(7).e. Carries on a trade or business for the benefit of an exempt organization and remits its

profits to the exempt organization.

6. Exempt organization7. Feeder organization8. University of Virginia9. Kentwood Rodeo Club10. § 501(h)

6. ANS: BREF: p. 23-2 | p. 23-7 | p. 23-9 | Footnote 14 | Exhibit 23-1

7. ANS: EREF: p. 23-2 | p. 23-7 | p. 23-9 | Footnote 14 | Exhibit 23-1

8. ANS: AREF: p. 23-2 | p. 23-7 | p. 23-9 | Footnote 14 | Exhibit 23-1

9. ANS: DREF: p. 23-2 | p. 23-7 | p. 23-9 | Footnote 14 | Exhibit 23-1

10. ANS: CREF: p. 23-2 | p. 23-7 | p. 23-9 | Footnote 14 | Exhibit 23-1

For each of the following taxes which are imposed on private foundations, match the appropriate initial tax or additional tax.

a. 5% initial tax and 25% additional tax on private foundation.b. 15% initial tax and 100% additional tax on private foundation.c. 100% additional tax on private foundation and 50% additional tax on foundation manager.d. 5% initial tax and 200% additional tax on private foundation.e. 5% initial tax and 200% additional tax on the disqualified person.

11. Tax on self-dealing12. Tax on failure to distribute13. Tax on excess business holdings14. Tax on jeopardizing investments15. Tax on taxable expenditures

11. ANS: E REF: Concept Summary 23-312. ANS: B REF: Concept Summary 23-313. ANS: D REF: Concept Summary 23-314. ANS: A REF: Concept Summary 23-315. ANS: C REF: Concept Summary 23-3


Match the following statements.a. Carries on a trade or business for the benefit of an exempt organization, remits its profits

to the exempt organization, and is not exempt from Federal income tax.b. May be subject to some Federal income taxation and classification may adversely affect

amount of charitable contributions received.c. Tax imposed for engaging in transactions with disqualified persons.d. Enables certain exempt organizations to engage in lobbying activities on a limited basis.e. Tax imposed on investments that enable a private foundation to control unrelated

businesses.

16. Private foundation17. Feeder organization18. § 501(h) election19. Tax on self-dealing20. Tax on excess business holdings

16. ANS: BREF: p. 23-7 | p. 23-9 | Footnote 14 | Concept Summary 23-3

17. ANS: AREF: p. 23-7 | p. 23-9 | Footnote 14 | Concept Summary 23-3

18. ANS: DREF: p. 23-7 | p. 23-9 | Footnote 14 | Concept Summary 23-3

19. ANS: CREF: p. 23-7 | p. 23-9 | Footnote 14 | Concept Summary 23-3

20. ANS: EREF: p. 23-7 | p. 23-9 | Footnote 14 | Concept Summary 23-3


Match the following statements.a. Exempt from tax on unrelated business.b. Inappropriate definition.c. Exempt organization may be subject to the tax on unrelated business income.d. Annual information return of an exempt organization which is not a private foundation.e. Appropriate definition.f. Annual information return of a private foundation.

21. The trade or business is not substantially related to the exempt purpose of the organization.22. The trade or business consists of selling merchandise, and substantially all of the merchandise has been

received as gifts or contributions.23. Unrelated business income is generally that derived from the unrelated trade or business, reduced by the

deductions directly connected with the conduct of the unrelated trade or business.24. Debt-financed income is the net income from debt financed property.25. Form 990.26. Form 990-PF.

21. ANS: C REF: p. 23-14 to 23-17 | p. 23-22 | p. 23-25 | Figure 23-222. ANS: A REF: p. 23-14 to 23-17 | p. 23-22 | p. 23-25 | Figure 23-223. ANS: E REF: p. 23-14 to 23-17 | p. 23-22 | p. 23-25 | Figure 23-224. ANS: B REF: p. 23-14 to 23-17 | p. 23-22 | p. 23-25 | Figure 23-225. ANS: D REF: p. 23-14 to 23-17 | p. 23-22 | p. 23-25 | Figure 23-226. ANS: F REF: p. 23-14 to 23-17 | p. 23-22 | p. 23-25 | Figure 23-2

Match the following tax forms.a. Return of Private Foundation.b. Application for Recognition of Exemption under § 501(c)(3).c. Return of Organization Exempt from Income Tax.d. Return of Certain Excise Taxes on Charities and Other Persons.e. Application for Recognition of Exemption under § 501(a).f. Application for Extension of Time.

27. Form 99028. Form 990-PF29. Form 102330. Form 102431. Form 275832. Form 4720

27. ANS: C REF: p. 23-25 | p. 23-2628. ANS: A REF: p. 23-25 | p. 23-2629. ANS: B REF: p. 23-25 | p. 23-2630. ANS: E REF: p. 23-25 | p. 23-2631. ANS: F REF: p. 23-25 | p. 23-2632. ANS: D REF: p. 23-25 | p. 23-26


Match the following statements.a. Distribution of such items is not considered an unrelated trade or business if the value

does not exceed $8.60 in 2006.b. Is considered an unrelated trade or business if the amount received is contingent upon the

level of attendance at one or more events, broadcast ratings, or other factors indicating the degree of public exposure to one or more events.

c. Is considered an unrelated trade or business if can be conducted by commercial (for-profit) entities.

d. A trade or business that consists of either renting or exchanging these with another exempt organization is not an unrelated trade or business.

33. Bingo games34. Corporate sponsorship payments35. Low cost articles36. Membership lists

33. ANS: C REF: p. 23-17 | p. 23-1834. ANS: B REF: p. 23-17 | p. 23-1835. ANS: A REF: p. 23-17 | p. 23-1836. ANS: D REF: p. 23-17 | p. 23-18

ESSAY

1. Why are some organizations exempt from Federal income tax?

ANS:The Code’s treatment of exempt organizations is based on a variety of objectives. While the major objective is to raise revenue, social, economic, and political objectives also are present. Social objectives are served by the provision of exempt status for organizations who serve the general welfare, and by so doing, may reduce the financial burden required of the Federal government.

PTS: 1 REF: p. 23-3

2. Under what part of § 501(c) are most organizations exempt from Federal income taxation?

ANS:Most organizations that are exempt from Federal income tax qualify for exempt status under § 501(c)(3). Among the types of organizations exempt under § 501(c)(3) are religious, charitable, educational, scientific, and literary organizations. Examples include the Boy Scouts of America, Red Cross, Salvation Army, Episcopal Church, United Fund, and the University of Richmond.

PTS: 1 REF: p. 23-4 | Exhibit 23-1


3. What are the common characteristics of organizations that receive exempt status?

ANS:Many organizations that qualify for exempt status share the following characteristics.

The organization serves some type of common goal.

The organization is not a for-profit entity.

Net earnings of the organization do not benefit the members of the organization.

The organization does not exert political influence.

PTS: 1 REF: p. 23-5

4. Discuss benefits for which an exempt organization may be eligible, other than exemption from Federal income tax.

ANS:In addition to being exempt from Federal income tax, an exempt organization may be eligible for the following benefits.

Exemption from state income tax, state franchise tax, sales tax, and property tax.

Receive discounts on postage rates.

Donors of property to the exempt organization may qualify for charitable contribution deductions on their Federal or state income tax returns.


5. Describe how an exempt organization can be eligible to lobby.

ANS:Certain exempt organizations are permitted to lobby on a limited basis by making the § 501(h) election. Such lobbying expenses are subject to a ceiling. Exceeding the ceiling can lead to the forfeiture of exempt status. Churches, their integrated auxiliaries, and private foundations are not eligible to make the § 501(h) election. Instead, no substantial part of the organization’s activities can include lobbying.

PTS: 1 REF: p. 23-7


6. What are intermediate sanctions and to what types of exempt organizations do they apply?

ANS:Intermediate sanctions apply to so-called public charities (i.e., not to private foundations). They are excise taxes imposed on disqualified persons (i.e., any individuals who are in a position to exercise substantial influence over the affairs of the exempt organization) who engage in excess benefit transactions, and on exempt organization managers who participate in such a transaction knowing that it is improper. Intermediate sanctions provide the IRS with another option in dealing with such exempt organizations who engage in prohibited transactions. Prior to the legislative enactment of intermediate sanctions in 1996, the IRS had only the following two options.

Could attempt to subject part or all of the exempt organization’s income to Federal income tax.

Could revoke the exempt status of the organization.

PTS: 1 REF: p. 23-9 | p. 23-10

7. What is a feeder organization? How is it taxed?

ANS:A feeder organization is a taxable entity that carries on a trade or business for the benefit of an exempt organization and remits its profits to the exempt organization. A feeder organization is taxed using the corporate tax rates.

PTS: 1 REF: p. 23-9

8. Define a private foundation.

ANS:The following § 501(c)(3) organizations are not private foundations.

a. Churches; educational institutions; hospitals and medical research organizations; charitable organizations receiving a major portion of their support from the general public or the United States, a state, or a political subdivision thereof that is operated for the benefit of a college or university; and governmental units (favored activities category).

b. Organizations that are broadly supported by the general public (excluding disqualified persons), by governmental units, or by organizations described in (a) above.

c. Entities organized and operated exclusively for the benefit of organizations described in (a) or (b) [a supporting organization].

d. Entities organized and operated exclusively for testing for public safety.

PTS: 1 REF: p. 23-11


9. How can an exempt organization, otherwise classified as a private foundation, avoid private foundation status?

ANS:An exempt organization that otherwise would be classified as a private foundation can avoid private foundation status if it receives broad public support. To meet the broadly supported requirement, the exempt organization must satisfy both an external support test and an internal support test.

PTS: 1 REF: p. 23-11 | p. 23-12

10. Discuss any negative tax consequences that result from an exempt organization being classified as a private foundation.

ANS:Two potential negative tax consequences can result from an exempt organization being classified as a private foundation. First, the classification may have an adverse impact on the amount of contributions received by the donee exempt organization. This occurs because the tax consequences for donors may not be as favorable as those for entities not classified as private foundations. Second, the classification may result in certain excise taxes being imposed on the exempt organization.

PTS: 1 REF: p. 23-12 | p. 23-13 | Exhibit 23-2

11. What are the excise taxes imposed on private foundations, and why are they imposed?

ANS:The excise taxes imposed on private foundations include the following.

Tax based on investment income.

Tax on self-dealing.

Tax on failure to distribute income.

Tax on excess business holdings.

Tax on investments that jeopardize charitable purposes.

Tax on taxable expenditures.

The tax based on investment income effectively is an audit fee, where the chief purpose is to defray IRS expenses. The other taxes restrict the permitted activities of private foundations. By its nature, a private foundation envisions a more narrow definition of the common good (and therefore less broad public support) than other exempt organization.

PTS: 1 REF: p. 23-12 | p. 23-13 | Concept Summary 23-3


12. What is the purpose of the unrelated business income tax?

ANS:The unrelated business income tax is designed to treat the exempt entity as if it were subject to the corporate income tax with respect to its unrelated business income. Without such a tax, nonexempt organizations (regular taxable business entities) would be at a substantial disadvantage when trying to compete with the exempt organization. Thus, the UBIT is intended to neutralize the exempt entity’s tax advantage.

PTS: 1 REF: p. 23-14

13. What characteristics must be present for an exempt organization to be subject to the unrelated business income tax (UBIT)?

ANS:An exempt organization may be subject to the UBIT in the following circumstances.

The organization conducts a trade or business.

The trade or business is not substantially related to the exempt purpose of the organization.

The trade or business is regularly carried on by the organization.

PTS: 1 REF: p. 23-15

14. Define “trade or business” for purposes of the unrelated business income tax (UBIT).

ANS:Trade or business, for purposes of the UBIT, is broadly defined. It includes any activity conducted for the production of income through the sale of merchandise or the performance of services. An activity need not generate a profit to be treated as a trade or business. The activity may be part of a larger set of activities conducted by the organization, some of which may be related to the exempt purpose. Being included in a larger set does not cause the activity to lose its identity as an unrelated trade or business.

PTS: 1 REF: p. 23-16

15. Identify the components of the tax model for unrelated business taxable income.

ANS:The tax model for unrelated business taxable income is as follows.

Gross unrelated business income– Deductions= Net unrelated business income

Modifications= Unrelated business taxable income

PTS: 1 REF: Figure 23-2


16. Define a qualified corporate sponsorship payment.

ANS:A payment qualifies as a qualified sponsorship payment if it meets the following requirements.

There is no arrangement or expectation that the trade or business making the payment will receive any substantial benefit other than the use or acknowledgement of its name, logo, or product lines in connection with the activities of the exempt organization.

Such use or acknowledgment does not include advertising the payor’s products or services.

The payment does not include any payment for which the amount is contingent upon the level of attendance at one or more events, broadcast ratings, or other factors indicating the degree of public exposure to one or more events.

PTS: 1 REF: p. 23-17

17. Robin, Inc., an exempt organization, acquired a building for $400,000 which it will lease to XYZ, Inc., for $40,000 annually. To finance the acquisition of the building, Robin secures a mortgage on it of $250,000. Advise Robin as to whether it has any unrelated debt-financed income or deductions.

ANS:The building is appropriately classified as debt-financed property. Therefore, Robin, Inc, calculates the debt/basis percentage as follows.

Average acquisition indebtedness Average adjusted basis

Once the debt/basis percentage for the year is calculated, it is multiplied by the lease rental income of $40,000 and the related deductions including depreciation. The resulting amounts constitute the unrelated debt financed income and deductions.

PTS: 1 REF: p. 23-22 to 23-24

18. What tax forms are used to apply for exempt status?

ANS:An organization that is exempt under § 501(c)(3) uses Form 1023 [Application for Recognition of Exemption Under § 501(c)(3)] to apply. Form 1024 [Application for Recognition of Exemption Under § 501(a)] is used by most other types of exempt organizations.

PTS: 1 REF: p. 23-25

19. If an exempt organization is required to file an annual information return, on what form is it filed?

ANS:Exempt organizations that are not private foundations file Form 990 (Return of Organization Exempt from Income Tax). Private foundations file Form 990-PF (Return of Private Foundation).

PTS: 1 REF: p. 23-25


20. Which exempt organizations are not required to file Form 990 (Return of Organization Exempt from Income Tax)?

ANS:The following exempt organizations need not file Form 990:

Federal agencies.

Churches.

Organizations whose annual gross receipts do not exceed $25,000.

Private foundations.

Private foundations are required to file Form 990-PF (Return of Private Foundation).PTS: 1 REF: p. 23-25

Documents

Chapter 23 Review Questions