Event Recap: Does Your Nonprofit Organization Have UBTI?
On Thursday, October 24, 2019, Klatzkin Manager, Michelle Martin, CPA, presented “Does Your Nonprofit Organization Have UBTI (Unrelated Business Taxable Income)?” at an in-house breakfast briefing to discuss the complex income rules. Michelle outlined five key areas:
What You Need to Know About Your Organization before Considering UBTI – Before considering whether your organization is subject to UBTI, it is important to identify which code section your organization is exempt under. There are different rules for each type of organization, and the same rules cannot be applied to all 501(c) nonprofit organizations. The rules discussed below apply to 501(c)(3), (4), (5), and (6) organizations. Additionally, it is essential to be aware of your mission statement, as reported to the IRS.
The Basic Three-Part Test – A three-part test should be applied to determine if your organization may have UBTI. The test involves determining if: first, the income is from an activity that is regularly carried on; second, it is from a trade or business; and third, it is not substantially related to the organization’s exempt purpose. Always keep your mission statement in mind when applying the three-part test. The income must have all three of these characteristics to be UBTI. However, there are “special considerations” that may exclude organizations that meet all three parts of the test from taxation. Examples were provided to identify the differences. The IRS considers whether an organization’s nonprofit status gives them an unfair advantage over for-profit or commercial entities. Organizations that have frequent and/or recurrent activities that are pursued in a manner comparable to similar commercial activities need to be carefully reviewed. A common misconception is that if you use the money that you earned to further your organization’s mission, then it is a nontaxable income. That is not the case when you earn money doing something that is outside of your organization’s mission. There are lots of gray areas with UBTI, and it is best to consult your tax professional for advice.
Areas Requiring Special Consideration – Once it is determined that the income could be UBTI under the three-part test, it is necessary to look at items requiring special consideration. Generally, income excluded from UBTI cannot be debt-financed. Some of the most common types of income that can be excluded from UBTI are investment income, royalties, rent from real property, gains/losses on disposition of most property, convention/trade show revenue, and activities for the members’ convenience. Other areas requiring special consideration are advertising, qualified sponsorship income, mailing list income, and rental income. It is prudent to review areas requiring special consideration BEFORE a new income stream begins.
Importance of Planning – In this section, participants were provided with several examples and asked to determine if an organization has UBTI. Participants utilized the information from the previous sections to support their answers. One example was more complicated since it involved both taxable and tax-exempt income. Using this example, the importance of planning with your tax professional was emphasized, as the rules are complex and impact each organization differently.
New Rules with the Tax Cuts and Jobs Act (TCJA) – The TCJA affected nonprofits by making certain parking fringe benefits subject to UBTI. It also required organizations to compute UBTI for each trade or business activity separately and prohibited the netting of taxable income from one trade or business with losses from another. In addition, the corporate tax rate was changed to a flat 21% tax, which may increase an organization’s tax on UBTI.
Al Mueller, CPA, is a Supervisor in Klatzkin’s Newtown office, where he provides tax-related services to small and medium-sized businesses and their owners.