Unrelated Business Income Tax (Portfolio 462)

Description

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.

Table of Contents

I. Introduction
II. Organizations Subject to Tax
III. Gross Income Subject to Tax
IV. Unrelated Business Taxable Income
V. Computation and Payment of the Tax
VI. Alternative Minimum Tax