«The following is for use by assistive readers and users who prefer a text version of this course. Unrelated Business Income Storyline /Narration ...»
Unrelated Business Income Storyline Wednesday, December 31, 2014
The following is for use by assistive readers and users who prefer a text version of this course.
Unrelated Business Income Storyline /Narration
Leagle – Welcome to the Unrelated Business Income Course.
This course is presented by the Exempt Organizations division of the IRS.
Leagle: Hi. I’m Leagle, the StayExempt Eagle, and I’ll guide you through the courses here at StayExempt.
Before you start, there are a few things to keep in mind. First, if you like to take notes, you might want to print this course first. The printout may make it easier to follow along, especially if you haven’t taken many online courses.
Next, if you have any difficulty navigating the courses here at StayExempt, feel free to take a look at our navigation tutorial.
Also, this course includes questions and activities that test your knowledge. You’ll be instructed to click on the screen to answer the questions and participate in the activities.
Select the Objectives button to begin learning about Unrelated Business Income.
Slide 3 Leagle: In this course we’ll talk about Unrelated Business Income for Section 501(c)(3) organizations or UBI, for short. Section 501(c)(3) organizations may need to report and pay tax on UBI, so it’s important to recognize it.
You’ll also learn the three-part UBI definition, the exceptions and exclusions to UBI, and the deductions available when calculating tax on UBI.
We’ll end this session with information on how and when to report your organization’s UBI and how to pay the income tax due.
First, let’s learn the basics of UBI. Select the Introducing UBI button to continue.
Slide 4 Page 1 of 13 Unrelated Business Income Storyline Wednesday, December 31, 2014 Vernon: Hi, I’m Vernon, I joined the Highland Middle School Parent Teacher Organization to help at my grandson’s school. Now I serve as the treasurer - and prepare the PTO’s tax forms, including Form 990-T for reporting unrelated business income from the school’s fundraising activities.
Problem is, I’m having trouble determining which activities generate UBI and which don’t. I’m never sure if I’m right.
Leagle: Hi Vernon. Yours is a very common problem. First, let me point out that the main benefit of tax-exempt status is that your organization isn’t taxed on income from an activity that furthers its exempt purpose.
Vernon: Exempt purpose? What’s that?
Leagle: Your organization’s “exempt purposes” will be one – or more – of the eight purposes described in Section 501(c)(3) of the Internal Revenue Code. “Charitable,” “Educational” and “Religious” are the big three, but there are five others. To learn more about exempt purposes, take the Applying for Section 501(c)(3) Tax-Exempt Status Overview course. You can always find the list of exempt purposes on the IRS website as well.
The Internal Revenue Code has a three-part definition, or test, describing when income from an activity of an organization might be taxable. Select the Continue button to learn about the UBI definition.
Slide 5 Vernon: So what does our exempt purpose have to do with UBI?
Leagle: Well Vernon, it’s used in the following UBI definition: For income to be considered unrelated business income, it will come from (1) a trade or business that is (2) regularly carried on and (3) is an activity that’s NOT substantially related to accomplishing the organization’s exempt purpose.
Let’s cover each part. Select the Trade or Business button to begin.
Slide 6 Vernon: Like I said, my organization is a PTO. That doesn’t seem like a business at all. How does anything we do qualify as a trade or business?
Leagle: A trade or business generally includes any activity carried on for the production of income from selling goods or performing services.
Vernon: Any activity that produces income?
Leagle: Exactly. Do you sell memberships to the PTO?
Vernon: We sure do.
Leagle: Then that – selling the memberships – is a trade or business activity. But because the memberships are directly related to your organization’s exempt purpose, income from those memberships won’t create unrelated business income.
Remember, the third part of the definition says the income has to be unrelated to your exempt purpose to be considered UBI. We’ll talk more about the third part of the test a little later.
Vernon: So it’s ok to run a trade or business as long as what we’re selling furthers our exempt purpose?
Page 2 of 13 Unrelated Business Income Storyline Wednesday, December 31, 2014 Leagle: Yes, generally that’s right. Sometimes, though, an organization conducts a group of similar activities where some of the activities aren’t related to an exempt purpose. The activities that are not related might generate UBI even though they are similar to the related activities.
Let’s take a look at an example and see if you can tell if it’s a trade or business generating UBI. Select the Case Study button to try it out.
Slide 7 Leagle: Marion works at a tax-exempt hospital pharmacy that furnishes drugs to its patients in accordance with prescriptions written by doctors on the hospital’s staff. If Marion also fills prescriptions for the general public who are not patients of the hospital - is that an unrelated trade or business?
Select an answer, then click the submit button to check it.
Slide 8 Leagle: Let’s try another one: A charity publishes a regular newsletter about the activities that relate directly to its purpose. Additionally, the organization sells advertising space in the newsletter to commercial businesses. Is selling the advertising an unrelated trade or business? Select the best answer, then select the submit button to check it.
Or Let’s try another one: Marion’s tax-exempt hospital publishes a regular newsletter about the activities that relate directly to its purpose. Additionally, she also sells advertising space in the newsletter to commercial businesses. Is selling the advertising an unrelated trade or business? Select the best answer, then select the submit button to check it.
Slide 9 Vernon: Ok, so I think I get the idea of what a business or trade is. But how about the second part of the UBI test – “regularly carried on?” How often does the activity have to happen to meet this part of the test? Every day? Every week?
Leagle: In most cases, if the activity shows frequency and continuity - and is conducted the same way that a non-exempt organization would run a similar business, it’s regularly carried on.
Vernon: Hmmm. OK---do you have an example for me?
Leagle: Sure! Here’s one. See if you can answer this example:
Leagle: A hospital auxiliary operates a health food stand for one week at a preventative health education conference. Is this a regularly conducted activity?
Select the best answer, then select the Submit button to check it.
Slide 11 Vernon: Okay, I understand that an activity must produce income and happen on a regular basis to be considered UBI. You said you were going to talk more about the third part of the test – are we ready for that now?
Leagle: You bet we are, Vern! The third part of the test focuses on whether a regularly-occurring, income-producing activity actually furthers the exempt purpose of the organization. If the activity isn’t closely related your exempt purpose, any income it produces will be UBI.
For example, the exempt purpose of a school is to provide education on a subject. Even if a school publication is for the purpose of educating the students, selling advertisements appearing in the publication would be considered unrelated – and generate UBI.
Any income-producing activity that doesn’t directly further your organization’s exempt purpose, other than by raising funds, could generate UBI.
The key thing here is not the DESTINATION of the income, but the SOURCE of the income This means that even though an organization uses income from a particular activity to further its charitable purposes, that doesn’t make the activity substantially related to its exempt purposes..
Vernon: So anything we sell only for the purpose of raising funds could be generating UBI?
Leagle: That’s right.
Vernon: How do I figure out if an activity is sufficiently related to my exempt purpose?
Leagle: That can depend on the size and extent of the activities in comparison to the nature and extent of the exempt function they intend to serve.
There are several principles that help determine if an activity is substantially related to an organization’s purpose. Let’s go over those next. Select the UBI Principles button.
Slide 12 Vernon: So, what are the principles to determine whether my activity is significantly related to my organization’s exempt purpose?
Leagle: Let me list them first, then I’ll give you more information about each. The principles are: Selling products of exempt functions; Dual use of assets or facilities, and exploitations of exempt functions.
Select the Selling Products button to move forward.
Leagle: Ordinarily, selling products that result from the performance of exempt functions is not an unrelated trade or business if the product is sold in substantially the same state it was in when the exempt functions were completed. An example would be an exempt organization that engaged in rehabilitating handicapped individuals, then sold the items made by the patients as part of their rehabilitation training. This is not considered an unrelated trade or business.
However, if a finished product is used or manipulated after completion, beyond what is reasonably appropriate or necessary to use as it is, the activity is an unrelated trade or business. For example, if an exempt organization maintains an experimental dairy herd for scientific purposes, the sale of milk and cream produced in the ordinary course of operation of the project is not an unrelated trade or business. But, if the organization uses the milk and cream to manufacture items like ice cream or yogurt, the sale of these products is an unrelated trade or business unless the manufacturing activities themselves contribute importantly to the accomplishment of an exempt purpose of the organization.
Sometimes facilities can have more than one function which may affect how the UBI calculations for your organization. Select the Dual Use button to learn more.
Slide 14 Leagle: While some of your assets or facilities may be necessary for your organization to conduct your exempt function, these assets or facilities may have a dual use. Some may be used both for exempt and commercial functions. The use of an asset or facility for exempt functions does not, by itself, make the commercial activities an unrelated trade or business. The test, as discussed earlier, is whether the activities contribute importantly to the accomplishment of your exempt purposes.
For example, a museum has a theater designed to show educational films in connection with its public education in the arts and sciences program.
The theater is a principal feature of the museum and operates continuously while the museum is open to the public. If the organization also operates the theater as a motion picture theater for the public when the museum is closed, that activity would be an unrelated trade or business.
Select the Exploitation button to continue.
Slide 15 Leagle: Exempt activities can sometimes create goodwill or other intangible circumstances that can be exploited in a commercial way. When an organization uses these intangibles in a commercial way, the fact that the income depends upon an exempt function does not automatically make the activity related to their exempt function. It could be considered UBI.
Vernon: Whoa. That sounds like it came right out of an IRS regulation. Can you give me an example?
Leagle: I sure can. Let’s say a tax-exempt scientific organization enjoys an excellent reputation in the field of biological research. It exploits this reputation regularly by selling endorsements of laboratory equipment to manufacturers. Endorsing laboratory equipment does not contribute importantly to accomplishing any purpose the organization may have, so, the sale of endorsements is an unrelated trade or business.
Page 5 of 13 Unrelated Business Income Storyline Wednesday, December 31, 2014 Remember, unless the commercial exploitation contributes importantly to the accomplishment of the exempt purpose, the commercial activities are an unrelated trade or business and may qualify as UBI.
Now, let’s try to put it all together. Select the Case Study button.
Slide 16 L
eagle: Let’s try a scenario to demonstrate all three parts of the UBI test:
Richard’s exempt organization, operated for the prevention of cruelty to animals, offers pet boarding services to the general public year round. Is the income from the pet boarding and grooming services subject to UBI even though the income is used to further the exempt purpose?
Remember the three test to determine if the activity may generate UBI:
1. Is the activity a trade or business?
2. Is it regularly carried on?
3. Is it substantially unrelated to the exempt purpose of the organization?
If the answer to all three questions is yes, the activity may generate taxable unrelated business income.
Select an answer then select the Submit button to check it.
The boarding and grooming services do qualify as regularly-carried-on trade or business because they are offered year round and are offered to the public. In addition, they are not substantially related to the prevention of cruelty to animals even though the income generated is spent on furthering that purpose.
Remember the three tests to determine if an activity may generate UBI: Is the activity a trade or business? Is it regularly carried on? And is it substantially unrelated to the exempt purpose of the organization? If the answer to all three questions is yes, the activity may generate taxable Unrelated Business Income.