for live program only state tax treatment of ubti for...

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State Tax Treatment of UBTI for Exempt Organizations:

Calculations, Conformance and Apportionment Navigating States' Partial- or Non-Conformance With Federal Treatment; Multi-State Apportionment Rules

TUESDAY, SEPTEMBER 19, 2017, 1:00-2:50 pm Eastern

FOR LIVE PROGRAM ONLY

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FOR LIVE PROGRAM ONLY

mailto:[email protected]

Sept. 19, 2017

State Tax Treatment of UBTI for Exempt Organizations

Brenda A. Blunt, CPA, CGMA, Tax Partner

Eide Bailly, Phoenix

[email protected]

Dr. Laura Robichaud, DBA, MBA, State and Local Tax Senior Manager

Eide Bailly, Phoenix

[email protected]

mailto:[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

w w w . e i d e b a i l l y . c o m

Brenda A. Blunt, CPA, CGMA, Exempt Organizations Tax Partner [email protected]

602-264-8607 Laura Robichaud, State and Local Tax Senior Manager

[email protected] 602.264.8038

State Tax Treatment of UBTI for

Exempt Organizations: Calculations,

Conformance and Apportionment

5

Federal Treatment of Unrelated

Business Taxable Income

6


Identifying UBTI

Activity must be:

•Unrelated

•Business and must

•Generate Income

Note: §§501(c)(7), (9) or (17) organizations do not follow the

same rules for identifying UBTI.

7


Identifying UBTI

Unrelated

•Activity will generate UBIT unless it

contributes importantly to the primary

exempt purpose

Example: Retail sales

8


Identifying UBTI

Trade or Business

•Profit Motive

• Incidental activities

•Regularly carried on

• Investment v. business

9


Identifying UBTI

Activity Exclusions

• Volunteer exceptions (85%) • Convenience • Donated goods (85%) • Conventions & Trade Shows • Bingo • Public Entertainment at fairs • Low cost articles • Mailing list rentals to other (c)(3)’s

10


Identifying UBTI

Income Exclusions

• Investment income

• Royalties

• Rental income • Real estate v. personal property

• Gain/Loss on sale of organization’s property

11


Identifying UBTI

Income Exclusions

• Debt Financed Income • Reverses the benefit of the Income Exclusions

• Applies when Income Exclusion items stem from

assets that were debt financed • Securities purchased on margin

• Debt financed real estate

• Partnership–level debt

12


Identifying UBTI

Income Exclusions

• Debt Financed Income • Income is taxable to the extent the asset is

leveraged

• Numerous exceptions • Research activities

• Substantially all is used for exempt purpose

• Neighborhood Land Rule

• Property acquired by gift

13


Identifying UBTI

Special Areas

• Partnership K-1

• S-corporation income

• Sponsorships

• Advertising

• Fragmentation Rule • PLR 9720035 – golf course fees

• Gift Shop

14


Form 990-T Filing Thresholds

Organizations required to file form 990-T: • The following organizations with gross UBI of $1,000 or

more: • Exempt organizations under §501(a); • Qualified Tuition Programs under §529; • Colleges and universities of states and other governmental

units (but not instrumentalities of the United States organized and exempt from tax by an Act of Congress);

• Trustees of IRA, SEP IRA, SIMPLE IRA, Roth IRA, Coverdell education savings accounts, Archer medical savings accounts and Health savings accounts trusts

• Applicable reinsurance entities under the ACA §1341(c)(1) Gross income = Gross receipts less Cost of Goods Sold

15


Tax Computation

Unrelated Business Income Tax (“UBTI”) is based on the net

Unrelated Business Taxable Income (“UBTI”) times the

applicable income tax rate.

In other words, organizations will pay tax on the gross

income from UBI activities, less expenses directly connected

with generating that income, less charitable contributions, less

net operating losses carrying from other years, less the

“specific deduction”.

16


Tax Computation

The “specific deduction” is $1,000 per tax return.

There is an exception for a diocese, province of a religious

order, or a convention or association of churches. They may

take a specific deduction of $1,000 per each parish,

individual church, district, or local unit (“component units”)

that regularly conducts unrelated trade or business up to the

gross UBI generated by each component unit and only if such

components are not separate legal entities.

17


Tax Computation

A charitable contribution is allowed for contributions made to

other governmental units and organizations (other than itself)

as described in §170(c).

The charitable contribution deduction does not need to be

directly connected to the activity that generated the UBI.

18


Tax Computation

Beyond that, the limitations and definitions that apply to the charitable contribution deduction follow the rules for corporations or trusts, depending on the organizational structure of the filing entity. Example One An accrual corporation may deduct accrued contributions actually paid within two and ½ months following the year end, if the contributions are authorized by the board and the required statements are attached to the return. This rule is not available to trusts.

19


Tax Computation

Example Two Corporations are limited to a deduction equal to 10% of taxable income before any deduction for contributions, the DPAD, NOL’s an any capital loss carrybacks. Trust contributions are limited to 50% of UBTI before the deduction for charitable contributions for contributions to §170(b)(1)(A) organizations. And limited to the smaller of 30% of UBTI before this deduction or the amount by which 50% of the UBTI is more than the deduction for 50% charitable contributions for contributions to other qualified charities.

20


Tax Computation

Having arrived at taxable income, you must apply the applicable tax rate. Organizations taxed as corporations, which include incorporated exempt organizations, unincorporated associations and limited liability corporations who elected to be taxed as corporations, use the “C” corporation tax rates and rules. Trusts follow the trust rates and rules. Alternative minimum tax applies to both using the respective rules. 21


Tax Computation

Corporate Tax Rates Trust Tax Rates

22


Tax Computation – Credits allowed

23


Allocation of Expense Deductions

Expenses can be deducted against UBI to the extent the expenses are “directly connected with the carrying on of such trade or business” (Reg. §1.512(a)-1) To be “directly connected, a “deduction must have a proximate and primary relationship to carrying on of that business”. Expenses must also be “ordinary and necessary” under §162 and other normal tax limitations – for example, meals and entertainment expenses are normally limited to 50%, UNICAP and tax depreciation rules – apply.

25



Dual use of personnel and facilities

Many times people and facilities are directly used in both

related and unrelated activities. In this case, the expense

may be allocated to the unrelated business activity using a

reasonable method consistently applied.

26




Example One

Unrelated business income is 10% of the organization’s

overall revenues. The organization does not have records to

show how much time and facilities are dedicated to the

unrelated business activity so the organization allocates 10%

of all expenses to UBI.

This would NOT be considered a “reasonable” method.

27




Example Two

Unrelated business income is 10% of the organization’s

overall revenues. Through the use of time cards or a time

study, the organization can show the executive directors

spends 5% of her time on the unrelated business activity.

It would be reasonable to allocate 5% of her salary and

benefits to the UBI activity. It may also be reasonable to

allocate 5% of her office space and related expenses.

28


Rent Income – Sch C

Most organizations should use Schedule C to report:

1. Personal Property rentals that are rented with real estate

if the personal property rents are more than 10% of the

rental contract.

2. Rents from Real and Personal Property contracts if more

than 50% of the contract is for the rental of personal

property or the rent depends on the income or profits

derived by the person renting the property (except

amounts that are a fixed percentage of sales).

29


Rent Income – Sch C

Schedule C does not apply to 501(c)(7), (9) or (17)

organizations. They should report Rent income on Part I and

expenses on Part II.

Debt-financed real estate rentals not meeting the description

in item 2 from the previous screen should be reported on

Schedule E.

Personal Property rented separately from Real Estate should

be reported on Part I, line 12.

30


Unrelated Debt Financed Income – Sch E

Debt-Financed Property – Property held to produce income when such property has acquisition indebtedness at any time during the year, or, if the property was disposed of, at any time during the 12 months prior to the disposition. Includes real estate rentals, interest, royalties, dividends, investment capital gains and similar other investment/passive income. There are numerous exceptions.

31



Acquisition Indebtedness

• Debt incurred to acquire or improve the property

• Debt incurred before acquiring or improving the property

if the debt would not have been incurred but for the

acquisition or improvement

• Debt incurred after acquiring or improving the property if

the debt would not have been incurred but for the

acquisition or improvement and the need was reasonably

foreseeable

32



Acquisition Indebtedness

• Property acquired is subject to a mortgage, the debt secured by the mortgage is acquisition indebtedness even if the organization does not assume or agree to pay the debt.

• If property acquired by bequest or gift is subject to a mortgage, the debt is not acquisition indebtedness for the first 10 years. • Includes bequest of a partnership interest with debt financed

income inside the partnership (Ltr. Rul. 2000011051) • This exception does not apply if the organization assumes,

agrees to pay, or makes payments on the debt.

33



Report on Sch E:

Gross Rents (Col 2)

Directly Connected Expenses (Col 3a and 3b)

Note: Depreciation must use straight line method

34



Average Acquisition Indebtedness (Col. 4)

• Outstanding debt on the first day of each month

• Add together

• Divide by the total number of months the organization held

the property (including any months the property is owned

after pay-off)

• In the year of disposition, use the highest debt balance

during the preceding 12 months.

35



Average Adjusted Basis (Col. 5)

Adjusted Basis – Cost, plus additions less depreciation,

(allowed or allowable) since acquisition. Use depreciation

for all years the property was owned, not just subject to UBI.

Average Adjusted Basis – Adjusted Basis at the beginning

and end of the year divided by 2.

36



Col. 6 (Leverage)

Average Acquisition Indebtedness (Col 4)

Average Adjusted Basis of the Rental Property (Col 5)

37


Interest, Royalties and Rents from Controlled

Organizations – Sch F

General Principle: When the reporting exempt organization has income from interest, annuities, royalties and rents that it received from a controlled organization subject to income tax, the income is UBI to the reporting exempt organization, if it reduces unrelated taxable income of the controlled organization. (IRC §512(b)(13)) Only UBI if amounts exceed FMV (Transfer Pricing rules) and paid pursuant to a written binding contract in place at 8/17/06

38




The controlled organization could be either an exempt

organization or an nonexempt organization.

Either way, the “net unrelated taxable income” is the income

of the controlled organization that would be unrelated

(subject to UBIT) if it were an exempt organization AND had

the same exempt purpose as the controlling organization.

39




An entity is a “Controlled Organization” if the reporting entity owns: • By vote OR by value more than 50% of a corporation’s

stock; • More than 50% of a partnership’s profits OR capital

interest; or • More than 50% of the beneficial interest in an

organization. • Ability to control more than 50% of the vote (through the power

of appointment or otherwise) of an exempt organization.

The constructive ownership rules of §318 apply. Use similar principles to determine interests in other organizations.

40




41


Other Schedules

Other Schedules in the Form 990-T include • Investment Income of §§501(c)(7), (9) or (17)

organizations; Schedule G • Exploited Exempt Activity Income, Other Than Advertising

Income; Schedule I • Advertising Income, Schedule J • Compensation of Officers, Directors, and Trustees;

Schedule K Due to the time allotted and the depth of the topics, we will only be covering Schedules G, I and J at an overview level.

42


Other Schedules

Investment Income of §§501(c)(7), (9) or (17) organizations;

Schedule G

§§501(c)(7), (Social Clubs); (9), (Voluntary Employee

Beneficiary Associations (VEBA’s)); and (17) (Supplemental

Unemployment Benefit Trusts (SUBT’s)) fall under a complete

separate structure for UBTI. Generally, these organizations

are taxed on non-member (non-exempt function) income.

43


Other Schedules

Investment Income of §§501(c)(7), (9) or (17) organizations;

Schedule G

These organizations are allowed a deduction against non-

exempt function income for amounts set aside for

1. Religious, charitable, scientific, literary or educational

purposes or for the prevention of cruelty to children or

animals;

2. Payment of life, health or accident insurance or other

benefits by VEBA’s and SUBT’s; and

3. Reasonable administration costs for the above.

44


Other Schedules

Exploited Exempt Activity Income, Other Than Advertising

Schedule I

There are times when an organization’s exempt function

activities generate goodwill or other services and products

that can be exploited commercially. The revenue from the

exploitation is generally UBI. Organizations may offset net

UBI from exploited activities with the net losses of the exempt

activity that generated them, but may not create a UBTI loss.

45


Other Schedules

Exploited Exempt Activity Income, Other Than Advertising

Schedule I

Example:

A photographic equipment manufacturer underwrites a

photography exhibit at a local museum. In return for the

underwriting, the manufacturer gets an advertisement in the

exhibition catalog with also includes educational materials,

pictures of the exhibited works, interviews with

photographers, and other exempt-function content. The

advertising revenue is exploited activity income.

46


Other Schedules

Advertising Income

Schedule J

This is a subset of the Exploited Exempt Activity category

and includes income from advertising sold in periodicals.

Other advertising revenue should be reported on Schedule I.

The general principles applicable to Exploited Exempt

Activities apply here as well.

47


Other Schedules

Advertising Income

Schedule J

Unique aspects include the ability to elect to combine all

periodical advertising as a single activity (Sch I, Part I), or

separately (Sch I, Part II). Also, if there is not a separate

charge for the periodical, known as circulation income, then a

portion of the member revenue is deemed to be circulation

income, to determine the exempt function income from the

periodical, (Rev. Rul. 81-101).

48


Other Schedules

Compensation of Officers, Directors, and Trustees

Schedule K

List here all of the organization’s Officers, Directors and

Trustees where some or all of their compensation was directly

attributable to unrelated business income. If a particular

Officer, Director or Trustee spent 10% of his time (col. 3)

devoted to the unrelated business activity, the deductible

compensation is 10% of the total compensation (col. 4).

This should include total compensation – salary, allowances

and other benefits.

49

UBTI – State Level Issues

51


Learning Objectives

• Understand problem states

• Important reporting differences

• Recognize NOL carry-backs or forward treatments

• Understand state challenges

52


States that do not tax UBTI

Kentucky

New Jersey

Texas (if granted)

Delaware

New Hampshire

Pennsylvania

Ohio

South Dakota

Washington

Wyoming

53


Who conforms with modifications?

Arizona

Arkansas

California

Hawaii

Idaho

Kansas*

Kentucky**

Maine

Missouri

Montana

New Mexico

North Dakota

Oregon

Pennsylvania

Utah

54


Which states require information returns?

Arizona

California

Georgia

Indiana

Oklahoma

55


Net Operating Loss Carryforwards

56


Net Operating Loss Carrybacks

57


Considering Reporting Differences

Connecticut

• Form REG-1

• Obtain a tax registration number

California

• Form 3500A

• Provide copy of IRS 501(c)(3) letter

• Alternative: Form 3500 – pay $25

58


Other State Compliance Considerations

Nonresident Withholding on Nonresident

Partners/Members/Shareholders

Refunds

• Process

• Forms

• Documentation

Withholding Waivers

59


Challenges

• Varying carryforward periods (5 years in some states)

• Electing to forego a carryback

• If you carryback for fed do you HAVE to carryback for

state? (some states would say "yes.")

• NOL deduction limitations

• Example: CO used to have $250K max deduction

carryforward periods (5 years in some states). You c

Electing to forego a carryback

What happens if you have a state that is a carryback state but there is no UBTI in the 2 preceding years?

60


Apportionment

• Three-Factor Formula

• Three-Factor Formula with an extra weighting for sales

• Single-Factor

• Throw-out v. Throwback rules

61


This presentation is presented with the understanding that the information contained does not constitute legal, accounting or other professional advice. It is not intended

to be responsive to any individual situation or concerns, as the contents of this presentation are intended for general informational purposes only. Viewers are urged

not to act upon the information contained in this presentation without first consulting competent legal, accounting or other professional advice regarding implications of

a particular factual situation. Questions and additional information can be submitted to your Eide Bailly representative, or to the presenter of this session.

62


Brenda A. Blunt, Exempt Organizations Tax Partner [email protected]

602.264.8607

Laura Robichaud, State and Local Tax Senior Manager [email protected]

602.264.8038

Thank You!

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