UBI and Higher Ed

Larry ClarkClover Park Technical

College

BARMay 29,

2015

UBI and Higher EdAgenda

Summary

Elements of UBI

Common activities that could trigger UBI

Exclusions from UBI

Recent Focus

Summary

Tax-Exempt status does not shield colleges from all taxes:

(UBI) Unrelated Business Income is subject to a special tax (UBIT) at normal corporate income tax rates on net income generated on unrelated activities.

The intent is to even the playing field between for-profit businesses and tax-exempt organizations who might conduct a trade or business in competition with taxable entities. (Mueller Macaroni v. Commissioner 1950.)

The tax is paid when filing Form 990-T.

UBI and Higher Ed

Elements of UBI

Trade or Business

Regularly Carried On

Not Substantially

Related

Three requirements must be present to be a UBI Activity:

IRC Section 513

• Intent to profit from the activity

• Regularity of activities and income production which are different than in a hobby

• An activity does not lose its identity as a trade or business merely because it is conducted within a larger group of similar activities

Trade or Business Requirement

• Show a frequency and continuity

• Pursued in a manner similar to nonexempt organizations

Regularly Carried On

To determine whether an activity is regularly carried on, the IRS considers the frequency and continuity with which the activities producing income are conducted and the manner in which they are pursued. First, consider the normal time span of the activity, then determine whether the length of time alone suggests that the activity is regularly carried on, or only intermittently carried on.Treasury regulations describe a sandwich stand operated by an exempt organization at a state fair for two weeks as not regularly carried on, but the operation of a commercial parking lot every Saturday is a regularly-carried-on activity.If the activity is of a seasonal nature but conducted during a significant portion of the season, it is considered to be regularly carried on. Summer sports camps are an example of this type of activity.

Regularly Carried On

• To the organization’s exempt purpose

• Production of funds alone doesn’t count

• Consider the size and extent of the activity

To avoid UBIT, an activity must have a substantial causal relationship to the achievement of the college’s fundamental exempt purpose.

Not Substantially Related

Treasury regulations describe “substantially related” this way:

Where income is realized by an exempt organization from activities which are in part related to the performance of its exempt functions, but which are conducted on a larger scale than is reasonably necessary for performance of such functions, the gross income attributable to that portion of the activities in excess of the needs of the exempt functions constitutes gross income from the conduct of unrelated trade or business.

Not Substantially Related

Common Activities that could Trigger UBIT

• Advertising• Rental or sales of mailing lists• Online stores linked to college web sites• Renting equipment or debt-financed

property to non-college personnel• Leasing athletic or conference venues

to private interests• Parking revenues generated from public

attendance at non-college events• Travel tours

UBI and Higher Ed

Common Activities that could Trigger UBIT

AdvertisingAdvertising revenue is generally considered UBI.It is rarely substantially related to the exempt purpose of the college.Although the publication may seem exempt as not regularly carried on, the solicitation for advertising is.Readership costs (expense directly connected with production and distribution) must be less than 4 times gross advertising revenue received.

UBI and Higher Ed

• Dividends, interest, investment income• Research• Gains and losses from disposition of

property• Rents from real property not debt

financed and when additional services are not rendered

• Volunteer labor• Qualified sponsorship payments• Selling donated merchandise• For the convenience of

employees/students (cafeteria, logo clothing)

Exclusions from UBI

For the convenience of employees/students (cafeteria, logo clothing)

IRS Private Letter Ruling 802522 states that while the sales of books, supplies, and accessories is a related activity, the sale of clothing and plants are taxable.Selling food or gifts primarily for the convenience of student and staff is generally not taxable (IRC Section 513(a)(2).

Exclusions from UBI

UBI and Higher EdRecent Activity

IRS Compliance Project

Camp Tax Proposal

ACT Report

IRS Colleges and Universities Compliance Project

Launched in 2008, the IRS distributed questionnaires to 400 randomly-selected colleges and universities. Based on the answers, 34 institutions were selected for examinations.

Examination Findings• Increases to UBTI for 90%, totaling $90

million• Over 180 changes to the amounts of UBTI

reported• Disallowance of more than $179 million

(70%) in NOL amounted to more than $60 million in taxes

The main reasons for increases to UBTI were:• Disallowing expenses that were not

connected to unrelated business activities• Lack of profit motive• Improper expense allocation• Errors in computation or substantiation• Reclassifying exempt activities as unrelated

UBI and Higher Ed

Improper Expense Allocation• Expense Allocation must be

reasonable• “Dual use expenses” allowed if

they have a “proximate and primary relationship” to the activity

• Document and check consistency to current tax court rulings

Lack of Profit Motive• No formal business plan or

contracts for the activity• Expenses almost always

exceed any income from the activity

• Many years of losses• No adjustments to cost,

expenses or pricing to lower the losses.

UBI and Higher Ed

Camp Tax Reform Act

Proposed by House Ways and Means Chairman Dave Camp in February 2014. The full proposal is 979 pages long, but it included some changes to the treatment of UBI.

The overall proposal seems to be dead, but some of the recommendations are worth noting:• Compute UBIT separately for each line

of business• Exclusion of research income limited to

publicly available research• Would eliminates safe harbor for

managers who rely on professional advice

UBI and Higher Ed

ACT Report

Recommendations released last summer by the Advisory Committee on Tax Exempt and Government Entities (ACT) point out the lack of guidance from the IRS regarding UBI

The report blames lack of guidance for noncompliance and recommends that:• Standard expense allocation methods

be developed for dual use facilities• Clear examples of UBI be published• Preparatory time not be included in the

consideration of whether an activity is considered to be regularly carried on• Regulations protecting the

organization’s tax-exempt status despite substantial commercial activity• The 990-T be redesigned

UBI and Higher Ed

Ask your AAG when in doubt.This presentation is a summary only which cannot substitute for legal advice.

Questions? Discussion?

http://www.irs.gov/pub/irs-pdf/p598.pdffhttp://www.irs.gov/pub/irs-tege/CUCP_FinalRpt_042513.pdfhttp://cacubo.org/files/docs/resources/Session_103_Tax_Update.pdfhttp://nonprofitblog.bdo.com/index.php/2013/07/31/dont-let-this-happen-to-you-disallowed-losses-on-form-990-t/https://clarknuber.com/articles/act-recommendations-regarding-unrelated-business-income-tax-part-iii-proposed-revenue-ruling/http://www.hurwitassociates.com/l_unrelated_income.php

References