Unrelated Business
Income and Other Tax
Issues
Presented By:
Xiaoyan Luo
Learning Objectives
At the end of this session, you will be able to:
• Recognize unrelated business income
• Understand the basic exclusions from unrelated
business income
• Understanding of worker classification
• Understanding of tax laws regarding cell
phone/auto reimbursement or allowances
What is UBI?
• UBI = Unrelated Business Income
• Unrelated business taxable income = gross
income derived by any organization from:
– Unrelated
– Trade or business
– Regularly carried on by it (IRC § 512(a)(1)).
Unrelated Business Income
• What Sort of Activities Generate Unrelated
Business Income?
• Three Prong Test
– Is the activity:
◊ A trade or business?
◊ Regularly carried on?
◊ Not substantially related?
Test 1 - Trade or Business
– Is the activity performed in a commercial manner
similar to a trade or business (within meaning of
§162)?
◊ Does it involve selling goods or performing services?
◊ Is it carried on for the production of income?
◊ Primary objective of UBI tax rules is to eliminate unfair
competition by placing unrelated business activity on same
basis with for profit counterparts.
– If the organization is selling goods or services to
generate income, even if it is conducting the activity
within a larger group of activities related to its exempt
purpose, the activity is a trade or business.
Test 2 - Regularly Carried On
• Frequency and continuity
• Pursued in manner similar to commercial activity
Examples:
- Not regularly carried on
– sandwich stand operated two weeks at the state fair
– fundraising activity lasting a short period of time
- Regularly carried on
– commercial parking lot operation on Saturday all year
Test 3 - Not Substantially Related
– A business activity is not substantially related to an
organization’s exempt purpose if it does not
contribute importantly to accomplishing that purpose.
◊ Must be a causal relationship to achievement of exempt
purpose, AND
◊ Relationship must be a substantial one
◊ Must “contribute importantly” to the accomplishment of the
exempt purpose of the organization
– Examples:
◊ Operation of sports and fitness center is substantially related
to healthcare provider’s exempt purpose, but sales of items
by its pro shop not used at fitness center are not.
Unrelated Business Income
• Exclusions:
– Even where the activity is a regularly carried on trade
or business and is not substantially related, it may be
statutorily excluded.
– Certain types of income are also statutorily excluded.
Exclusions from UBI
• What types of activities are excluded from UBI?
• What types of income are excluded from UBI?
What activities are excluded from UBI?
Must have one of these characteristics:
- Is not regularly carried on
- Substantially all of the work is performed by
volunteers or by the organization without
compensation
- The activity is carried on for the convenience of
its members (for orgs described in 501(c)(3) or 511(a)(2)(B))
- Substantially all of the merchandise being sold
was received as gifts or contributions
What activities are excluded from UBI?
Section 513(d) through 513(i) specifically
excludes:
- Trade Shows / Public Entertainment activities
- Certain qualified sponsorship payments
- Distributions of low-cost articles
- Certain bingo games
- Certain hospital services
- Certain pole rentals
What is Excluded from UBI?
I.R.C. Section 512 specifically excludes:
- Interest / dividends
- Rental income
- Mailing list rentals (between charitable orgs)
- Royalties
- Possibly other types of mailing list rentals
- Gains and losses from asset dispositions
- Research income
Advertising Income
The Sale of Advertising in an organization’s
exempt periodical is a common form of UBI
activity
–
–
–
–
qualitative or comparative language
price information or indication of savings or value
endorsements
inducements to buy
Qualified Sponsorship Payment
• Qualified Sponsorship Payment is not
advertising and not subject to UBI tax
• Payment by a business for which there is no
arrangement or expectation that the business
will receive any “substantial return benefit”
Substantial Return Benefits Do Not Include
• Recognizing sponsor by:
– sponsor’s name/logo
– slogans that are part of the sponsors identity or that
do not contain qualitative or comparative descriptions
– listing of sponsor’s locations, telephone #’s, or
internet addresses
– value-neutral descriptions
– sponsor’s brand or trade names and product listings
– Display or distribution of the sponsor’s product by the
sponsor or exempt org. at the sponsored activity
– Hyperlink on the exempt org. website to the sponsor’s
site – cannot contain any endorsement or promotion
Income from Debt Financed Property
Another complex area – 5 full pages in
Publication 598
Investment income generally excluded from
UBTI must be included to the extent it is derived
from debt-financed property.
 Income included is proportionate to the debt on the
property.
Income from Debt Financed Property
In general, debt-financed property is property held
to produce income (including gain from
disposition) for which there is an acquisition
indebtedness:
o At any time during the tax year or
o During the 12-month period before the date of
the property’s disposal, if disposed of during
the year.
Includes real estate, tangible personal
property, and corporate stock
Income from Debt Financed Property
Computation of Debt-Financed Income
Complex – uses average acquisition
indebtedness, average adjusted basis of
property and gross income from debt financed
property.
Average acquisition indebtedness
Average Adjusted Basis
X
Gross income from debt-financed property
Income from Debt Financed Property
Example:
ABC Inc, an exempt organization, owns an office
building which is debt-financed property. The
building produces $40,000 of gross rental
income. The average adjusted basis of the
building is $200,000, and the average
acquisition indebtedness with respect to the
building is $60,000. Accordingly, the debt/basis
percentage is 30% (the ratio of $60,000 to
$200,000). Therefore, the unrelated debtfinanced income with respect to the building is
$12,000 (30% of $40,000).
Exceptions to Debt-Financed Property
Property related to exempt purposes- If
substantially all (85% or more) of the use of any
property is substantially related to an
organization’s exempt purposes, the property is
not treated as debt-financed property.
Property used in an unrelated trade or business
Property used in research and certain excluded
activities
Related Exempt uses
Medical clinics
Neighborhood land rule
If an organization acquires real property with the
intention of using the land for exempt purposes
within 10 years, it will not be treated as debtfinanced property if it is in the neighborhood of
other property that the organization uses for
exempt purposes.
 This rule applies only if the intent to demolish
any existing structures and use the land for
exempt purposes within 10 years is not
abandoned.
Deductions for Debt-financed property
1.
2.
The allowable deductions are those directly connected with the
debt-financed property or with the income from it (including the
dividends received deduction), except that:
The allowable deductions are subject to the modifications for
computation of the unrelated business taxable income, and
The depreciation deduction, if allowable, is computed only by use
of the straight-line method.
The deductions allowed for each debt-financed property are
determined by applying the debt/ basis percentage to the sum of
allowable deductions.
Capital Loss / Net Operating Loss
Any capital loss on the sale or exchange of debt
financed property can be carried back or carried
forward to another tax year
Any NOL (where deductions exceed the income
related to the debt financed property) can also
be carried back or carried forward to another tax
year.
Unrelated Business Income Tax
• Filing Info
– Organizations that have total gross income from a
regularly carried-on unrelated trade or business of at
least $1,000 are required to file Form 990-T and pay
income tax on the net unrelated business income.
◊ Tax is computed using corporate tax rates.
◊ Estimated quarterly tax payments may be required.
◊ Organization may be subject to alternative minimum tax.
– Form 990T of any other exempt organization must be
filed by the 15th day of the 5th month after the end of
its tax year.
– Filer may request an automatic 6-month extension of
time to file a return by submitting Form 8868.
Worker Classification
– Federal government estimates that up to 30% of
companies misclassify workers, and approximately
3.4 M employees are improperly excluded from
payrolls. www.accountingweb.com)
(
– Both states and the federal government have
announced increased enforcement efforts for 2010.
This is a revenue source for them in a down
economy.
– Potentially misclassified workers are a financial
liability for employers.
Employee vs. Independent Contractor
• Courts have identified three categories of facts
when determining worker classification:
– Behavioral Control
– Financial Control
– Relationship of the Parties
• IRS Publication 1779 (Updated 8/2008)
Behavioral Control
• Facts that show whether there is a right to direct
or control how the worker does the work
• Does not matter if the business actually controls
the way the work is done, as long as they have
the right to do so
• Behavioral control factors include type of
instructions given, degree of instruction,
evaluation systems, & training
Financial Control
• Financial control refers to facts that show
whether or not the business has the right to
control the economic aspects of the worker’s job
• Factors to evaluate include:
• Significant investment
• Unreimbursed expenses
• Opportunity for profit & loss
• Services available to the market
• Method of payment
Type of Relationship
• How do the worker and business perceive their
relationship to each other?
• Facts include
•
•
•
•
Written contracts
Employee benefits
Permanency of relationship
Services provided as key activity of the business
Expense Reimbursements
– An advance, reimbursement or other expense
allowance received under an “accountable
plan” – not taxable
– Accountable plan defined:
• Business Connection
• Substantiation
• Returning amounts in excess of expenses
Listed property
• Section 274(d)(4) of the Code provides that no
deduction shall be allowed with respect to any listed
property (as defined in § 280F(d)(4)), unless the
taxpayer substantiates by adequate records or by
sufficient evidence corroborating the taxpayer’s own
statement:
(A) the amount of such expense or other item,
(B) the use of the property,
(C) the business purpose of the expense or other item,
and
(D) the business relationship to the taxpayer of
persons using the property.
Cell Phones
– Small Business Jobs Act of 2010 signed into law on
Sept. 27th includes a provision that removes cell
phones and similar telecommunications equipment
(Blackberry, but not computers) from the definition
of “listed” property for taxable years beginning after
December 31, 2009.
– Notice 2011-72 – Tax treatment of employerprovided cell phones - issued on September 14,
2011
– The notice addresses the treatment of employerprovided cell phones primarily for noncompensatory
business reasons
Cell Phones
– Excludable from an employee’s income as a
working condition fringe benefit
– If paid by employees, such payment would be
allowable as a deduction under Section 162 for the
employee
– Personal use of an employer-provided cell phone
primarily for noncompensatory business purposes
as excludable from the employee’s income as a de
minimis fringe benefit
Cell Phones
– Interim guidance on reimbursement of employee
personal cell phone usage
– reimbursements for work-related use of personallyowned cell phones are not taxable for substantial
noncompensatory business reasons
– the employee must maintain the type of cell phone
coverage that is reasonably related to the needs of
the employer’s business, and the reimbursement
must be reasonably calculated so as not to exceed
expenses the employee actually incurred in
maintaining the cell phone
Questions?
Xiaoyan Luo, CPA
LarsonAllen LLP
(612)376-4810
xluo@larsonallen.com