Unrelated Business Income Tax (Portfolio 462)

Tax Management Portfolio, Unrelated Business Income Tax, No. 462, describes and analyzes basic principles of §§511 through 513 pertaining to the tax on unrelated business taxable income of charities and other exempt organizations. 

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Tax Management Portfolio, Unrelated Business Income Tax, No. 462, describes and analyzes basic principles of §§511 through 513 pertaining to the tax on unrelated business taxable income of charities and other exempt organizations. The purpose of the tax is to alleviate unfair competition by exempt organizations with taxable enterprises engaged in similar business endeavors. While most exempt organizations are subject to the tax, not all business income is taxed. Thus, in providing tax representation to an exempt organization, the key determinations are whether the organization derived income subject to the tax and, if so, whether any exceptions or exclusions apply under which the income may escape taxation. From a planning perspective, the tax practitioner should consider whether an organization's business activities can be structured either so that gross income from the activity is not subject to the tax or so that an exception or exclusion applies.
Gross income of an exempt organization is subject to the unrelated business income tax if: (1) the income is derived from the conduct of a trade or business; (2) the business is regularly carried on; and (3) the conduct of the business activity is not substantially related (other than through the production of funds) to the exercise or performance of the organization's exempt function. Certain businesses are expressly excepted from the scope of the tax, including businesses carried on by volunteers, businesses conducted by charities primarily for the convenience of their members, students, patients, and others, and businesses consisting of the sale of donated merchandise. Other exceptions pertain to entertainment events at fairs, trade shows, certain hospital services, bingo games, rental of space on telephone and electric poles, low-cost articles distributed incident to the solicitation of charitable contributions, the exchange or rental of mailing lists, and sponsorship payments.
The tax is imposed on an organization's unrelated business taxable income, which consists of the gross income subject to the tax, reduced by the deductions directly connected with the production of such income, and computed with certain modifications. The modifications exclude from the scope of the tax income from various passive sources, such as dividends, interest, royalties, and rents, and authorize additional deductions, such as the deductions for charitable contributions and net operating losses and a specific deduction. The modifications require the inclusion of certain receipts from controlled entities and insurance income from controlled foreign corporations. The unrelated business income tax is also imposed on certain debt-financed income of exempt organizations. This aspect of the tax is addressed in a companion Portfolio, 465 T.M., Debt-Financed Income (Section 514).
This Portfolio may be cited as Freitag, 462 T.M., Unrelated Business Income Tax.

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Carla Neeley Freitag, B.A., Duke University (magna cum laude, 1974); J.D., University of Florida College of Law (with high honors, 1976); LL.M. (Taxation), University of Miami School of Law (1988); admitted to practice in Florida, Texas, and Georgia; member, American Bar Association; author, The Funding of Living Trusts (ABA Section of Real Property, Probate and Trust Law, 2004); contributor to Tax Practice Series; author of 465 T.M., Debt-Financed Income (Section 514), 539 T.M., Net Operating Losses — Concepts and Computations, 607 T.M., Farm and Ranch Expenses and Credits, 744 T.M., Taxation of Cooperatives and Their Patrons; co-author of 863 and 521 T.M., Charitable Contributions: Income Tax Aspects, 517 T.M., Educational Expenses and Credits; Tax Management Distinguished Author.


Detailed Analysis

I. Introduction

A. Background of the Tax

1. Prior to 1950 Act

2. Revenue Act of 1950

3. Tax Reform Act of 1969

4. Post-1969 Act

B. General Scope of the Tax

C. Limitation of Discussion

II. Organizations Subject to Tax

A. Introduction

B. Exempt Organizations Subject to Tax

1. Organizations Described in § 501(c)

a. Single-Parent Title Holding Corporations

b. Charitable Organizations

c. Social Welfare Organizations

d. Local Associations of Employees

e. Labor, Agricultural, and Horticultural Organizations

f. Business Leagues

g. Social Clubs

h. Fraternal Beneficiary Societies

i. Voluntary Employees’ Beneficiary Associations

j. Domestic Fraternal Societies

k. Teachers’ Retirement Fund Associations

l. Benevolent Life Insurance Companies and Mutual or Cooperative Ditch, Irrigation, Telephone, or Electric Companies

m. Cemetery Companies

n. Mutual Credit Unions and Reserve Funds

o. Small Insurance Companies

p. Cooperative Crop Financing Corporations

q. Supplemental Unemployment Compensation Benefits Trusts

r. Employee-Funded Pension Benefit Trusts

s. Veterans Organizations

t. Group Legal Services Plan Organizations

u. Black Lung Benefit Trusts

v. Withdrawal Liability Payment Funds

w. Veterans Benefits Associations

x. Termination Liability Payment Trusts

y. Multiple-Parent Title Holding Organizations

z. State-Sponsored High-Risk Health Care Organizations

aa. State-Sponsored Workmen's Compensation Insurance Organizations

2. Religious and Apostolic Organizations

3. Qualified Pension, Profit-Sharing, and Stock Bonus Plans

4. State Colleges and Universities

5. Qualified Tuition Programs

6. Coverdell Education Savings Accounts

7. Health Savings Accounts

8. Individual Retirement Accounts

C. Exempt Organizations Not Subject to Tax

1. U.S. Instrumentalities Described in § 501(c)(1)

2. Farmers’ Cooperatives

3. Shipowners’ Protection and Indemnity Associations

4. Political Organizations

5. Homeowners Associations

6. Charitable Remainder Trusts

D. Nonexempt Organizations

1. Feeder Organizations

2. Subsidiaries of Exempt Organizations

III. Gross Income Subject to Tax

Introductory Material

A. Gross Income

B. Three Criteria for Taxation

1. “Trade or Business” Requirement

a. “Trade or Business” Defined

(1) In General

(2) Profit Motive

(3) Policy Considerations in Determining Whether an Activity Is a Trade or Business

b. Fragmentation of Integrated Business Aggregates into Component Trades or Businesses

c. Trade or Business Versus Gift

(1) In General

(2) Items Distributed in Connection with Solicitations

(3) Sponsorship Payments

d. Trade or Business Versus Investment

2. “Regularly Carried On” Requirement

a. General Principles

b. Determining the Duration of an Unrelated Business Activity

c. Special Rules

(1) Normal Time Span of Activities

(2) Intermittent Activities in General

(3) Infrequent Intermittent Activities

3. “Not Substantially Related” Requirement

a. Nature of Relationship Required to Avoid Taxation

b. Special Rules

(1) Income from Performance of Exempt Function

(2) Disposition of Product of Exempt Function

(3) Dual Use of Assets or Facilities

(4) Exploitation of Exempt Functions

(a) In General

(b) Sale of Advertising

(5) Travel Tours

c. Examples

(1) Charitable Organizations

(2) Other Exempt Organizations

d. Title Holding Corporations

C. Exceptions

1. Volunteer Exception

a. “Work” in Conducting a Trade or Business

b. “Substantially All” of the Work

c. “Without Compensation”

d. Labor as a Material Income-Producing Factor

2. Convenience Exception

a. Charitable Organizations and State Colleges and Universities

(1) Eligible Organizations

(2) “Primarily for the Convenience of”

(3) Designated Relationships

b. Local Associations of Employees

3. Donations Exception

4. Entertainment Events at Fairs

a. Qualified Public Entertainment Activities

b. Qualifying Organizations

5. Trade Shows

a. Qualified Convention and Trade Show Activities

b. Qualifying Organizations

6. Hospital Services

7. Bingo Games

a. Nature of Excepted Bingo Games

b. Noncompetitive Requirement

c. No Violation of Law

d. Coordination with Volunteer Exception

8. Pole Rentals

9. Low Cost Articles

a. Regs. § 1.513-1(b)

b. Statutory Exception

10. Mailing Lists

11. Sponsorship Payments

D. Special Rules

1. Insurance Activities

a. Charitable Organizations and Social Welfare Organizations

b. Other Exempt Organizations

2. Qualified Pension, Profit-Sharing, and Stock Bonus Plans, Supplemental Unemployment Compensation Benefits Trusts, and Certain Nonexempt Trusts

3. Businesses Conducted by Partnerships

4. Associate Membership Dues Paid to § 501(c)(5) and § 501(c)(6) Organizations

5. Exempt Organizations as S Corporation Shareholders

IV. Unrelated Business Taxable Income

A. Definition

B. Deductions

1. In General

2. Dual Use of Assets or Personnel

3. Unrelated Businesses That Exploit Exempt Activities

a. General Rule

b. Special Rule

c. Application of Special Rule to Advertising in Exempt Periodicals

(1) Terminology

(a) Income Attributable to Exempt Organization Periodicals

(b) Deductions Attributable to Exempt Organization Periodicals

(2) Computation of Unrelated Business Taxable Income Attributable to the Sale of Advertising

(a) Excess Advertising Costs

(b) Excess Advertising Income

(3) Example

(4) Consolidation of Multiple Periodicals

C. Modifications

1. Passive Income and Related Deductions

a. Dividends

(1) In General

(2) Dividends Received by § 401(a) Qualified Trusts from Real Estate Investment Trusts

b. Interest

c. Annuities

d. Payments with Respect to Securities Loans

e. Loan Commitment Fees

f. Royalties

g. Rent

(1) Excluded Rents

(2) Exceptions to Rental Exclusion

(a) Excessive Personal Property Rents

(b) Rent Determined by Income or Profits

(c) Rendering of Services

(3) Time for Determining if Personal Property Rents Are Incidental or Excessive

(a) Original Determination

(b) Recomputation

(4) Treatment of Separate Leases of Real and Personal Property

h. Gains and Losses from the Sale of Property

(1) General Rule

(2) Lapse or Termination of Options

(3) Cutting of Timber

(4) Real Property Acquired from Financial Institutions in Conservatorship or Receivership

2. Debt-Financed Income and Deductions

3. Net Operating Loss Deduction

4. Research Income and Related Deductions

5. Charitable Contributions Deduction

6. Specific Deduction

7. Income from Controlled Entities and Related Deductions

a. Tax Years Beginning on or Before August 5, 1997

(1) “Control” Defined

(2) Exempt Controlled Organizations

(3) Nonexempt Controlled Organizations

b. Tax Years Beginning after August 5, 1997

(1) “Control” Defined

(2) Amount Includible

8. Special Exclusion for Services Provided Under Federal License by Religious Order

9. Insurance Income from Controlled Foreign Corporations and Related Deductions

D. Special Rules for Certain Exempt Organizations

1. Social Clubs, Voluntary Employees’ Beneficiary Associations, and Supplemental Unemployment Compensation Benefit Trusts

a. Special Definition of Unrelated Business Taxable Income

(1) Exempt Function Income

(2) Gross Income Excluding Exempt Function Income

(3) Allowable Deductions

(4) Modifications

b. Nonrecognition of Gain

2. Veterans Organizations

3. Foreign Organizations

V. Computation and Payment of the Tax

A. Imposition and Rates of Tax

B. Accounting Periods and Methods

C. Tax Returns

D. Penalties and Interest

VI. Alternative Minimum Tax


Working Papers

Table of Worksheets

Worksheet 1 Form 990–T, Exempt Organization Business Income Tax Return, and Instructions

Worksheet 2 Form 990–W, Estimated Tax on Unrelated Business Taxable Income for Tax–Exempt Organizations

Worksheet 3 Publication 598, Tax on Unrelated Business Income of Exempt Organizations

Worksheet 4 H.R. Rep. No. 495, 100th Cong., 1st Sess. 953–57 (1987) (Conference Report)

Worksheet 5 Sen. Rep. No. 445, 100th Cong., 2d Sess. 426–29 (1988)

Worksheet 6 Announcement 92-83, 1992-22 I.R.B. 59 Examination Guidelines for Hospitals

Worksheet 7 Announcement 94-112, 1994-37 I.R.B. 36 Examination Guidelines for Colleges and Universities

Worksheet 8 Internal Revenue Manual Excerpts

Worksheet 9 Unrelated Business Income Tax Issues Checklist





Public Laws:

Congressional Reports:

Treasury Rulings: