Contributions, Gifts, Grants, and Similar Amounts Received.

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1 990 3/ Preparation Pointer: Organizations receiving Form 1099-K reporting a gross amount received from payment card and third party network transactions should report these amounts based on the nature of the payments. Some payments may represent unrelated business income and, therefore, be reported on Form 990-T. Caution: The Financial Accounting Standards Board (FASB) issued new accounting standards for nonprofit entities, revising the financial statement reporting requirements in certain areas. Although the new standards are not required for years beginning before December 15, 2017, early application is permitted. If the organization has adopted these new standards, reporting the organization s income and expenses per books on Form 990 may differ slightly from prior years. For example, investment expenses may be netted against investment income for financial statement reporting and a footnote is no longer required separating the income from expense. However, these expenses should not be netted on Form 990 and additional analysis of investment income may be required. If this occurs, these expenses should be added back when determining an organization s gross receipts. All organizations must complete Form 990, Part VIII, column (A), Total revenue, reporting gross receipts from all sources. Related or exempt function revenue is reported in column (B), unrelated business revenue is reported in column (C), and revenue excluded from tax under Section 512, 513, or 514 is reported in column (D). Section 527 political organizations are exempt from completing columns (B) through (D). (See Key Issue 5B for guidance on analyzing income-producing activities.) Check the box in the heading of Part VIII if Schedule O contains any information pertaining to this part. (See Key Issue 8J for more information on completing Schedule O.) Preparation Pointer: If the organization enters an amount in column (A) for lines 2a 2e or lines 11a 11c, enter a business code for each line from Appendix K (from the Form 990 instructions) or from the NAICS file at that describes the activity (not the organization). If none of the listed codes accurately describe the activity, enter Entering one of these codes does not imply that the business activity is unrelated to the organization s exempt purpose. References Rev. Procs , IRB 707 and , IRB 489. Rev. Ruls , CB 104, amplified by Rev. Proc , CB 471; , CB 104; , CB 148; and , CB 48. Goldman, Douglas And Evelyn, 388 F. 2d 476, 21 AFTR 2d 301 (6th Cir. 1967), aff d 46 TC 136 (1966). Thomas More Law Center v. Kamala Harris, 118 AFTR 2d (DC, CA 2016). KEY ISSUE 5A Contributions, Gifts, Grants, and Similar Amounts Received. Form 990, Part VIII, line 1 reports gifts to the organization where the donor did not receive anything of value in return. A gift is distinguished from a payment in that a payment is an exchange transaction while a gift is not. Gifts to a Section 501(c)(3) organization are generally deductible by the donor as a charitable donation. Noncharitable organizationsmayacceptgiftsaswell,butiftheysolicitsuch gifts, they must notify the donor that the gift is not tax deductible as a charitable donation (see Form 990, Part V, line 6). Preparation Pointer: In addition to completing lines 1a 1g for contributions, Schedule B, Schedule of Contributors, may also need to be completed and filed. (See Key Issue 5J.) Although not controlling for tax purposes, FASB ASC through may be useful in distinguishing between contributions and exchange transactions. Also, membership revenues should be analyzed to determine what portion, if any, is a contribution. The following factors indicate a contribution: Exempt organization (EO) is soliciting funds that will be used to benefit the public. Significant benefits do not inure to the payer. Key Issue 5A

2 /18 Payments are generally irrevocable and nonrefundable. While donors may restrict donations for a specified time or purpose, donors do not typically have a right to demand that a gift be returned. Payer indicates a desire to support the EO s programs. EO has discretionary authority over the delivery of services. Payer determines the amount of the payment. The following factors indicate an exchange transaction: EO is soliciting funds that will be used to provide goods, services, facilities, or products that will physically or economically benefit the payer. Significant benefits inure to the payer. Payments may be refundable if the goods and services are not provided or if the payer is not satisfied with the results. Payer indicates a desire to receive the services or benefits. Payer has discretionary authority over the delivery of services. EO determines the amount of the payment. A payment that is partially a gift and partially an exchange transaction must be segregated. Only the portion of the payment that exceeds the value of goods, services, or any other substantial return benefit to the payer is treated as a gift (see Key Issue 3B for a discussion of quid pro quo contributions and Key Issue 14F for a discussion of substantial return benefit). It is generally the responsibility of the donee organization to provide the donor with an estimate of the fair market value (FMV) of the benefits provided. Token Benefits Certain goods and services provided in return for a charitable donation can be ignored and the entire amount treated as contribution revenue. The FMV of token benefits is limited to 2% or less of the payment (not to exceed $107 in 2017 and $108 in 2018), or low-cost articles with the donee s logo that cost less than $10.70 in 2017 (as long as the total payment is at least $53.50) and $10.80 in 2018 (as long as the total payment is at least $54.00) (Rev. Procs and ). Example 5A-1 Token exception for low-cost items. Mr. Carson contributes $50 to his favorite charity. In return, he receives a coffee mug bearing the charity logo. The mug costs the organization $8, but it sells in the gift shop for $15. Although the mug bears the charity s logo and costs less than $10.70 (for 2017), it does not meet the token exception because the donation is less than $ Therefore, $35 of the payment is a charitable donation and $15 is from the sale of a coffee mug. Variation: Mr. Carson contributes $55 and receives the same coffee mug. Because the mug bears the charity s logo and costs less than $10.70 and the donation is at least $53.50, the token exception applies. Therefore, $55 of the payment is a charitable donation. Example 5A-2 Token exception for benefits of 2% of the payment. Mr. Carson contributes $100 to his favorite charity. In return, he receives a coffee table book that costs the organization $10, but it sells in the gift shop for $25. Because the FMV of the book exceeds 2% of the payment and the book does not bear the charity s logo, it does not meet the token exception. Therefore, $75 of the payment is a charitable donation and $25 is from the sale of a book. Key Issue 5A

3 990 3/ The museum has a total of 1,450 members. Its membership income for the current year is as follows: Basic memberships (800 members $80) $ 64,000 Sustaining memberships (425 $200) 85,000 Associate memberships (175 $500) 87,500 Executive memberships (50 $1,000+) 142,000 Total revenue from membership dues $ 378,500 The $80 of dues paid by each member that approximates the value of the available membership benefits is reported as program service income from membership dues and assessments. Therefore, $116,000 ($80 1,450) is reported on line 2 as program service revenue. The balance of $262,500 ($378,500 $116,000) is reported as contributions on line 1b. Variation: If the Charter Museum lowered its basic membership to $75, the value of the benefits of the membership dues could not be considered insignificant (see discussion of Significant and Insignificant Benefits later in this key issue) because the free admission to special museum events and the admission to lectures offered only for members are significant benefits that cannot be disregarded. The $75 dues is reported on line 2 as program service revenue. Significant and Insignificant Benefits. When annual membership dues are $75 or less, the value of the member benefits can be disregarded and the entire amount reported on line 1b, provided the benefits are insignificant [Reg A-13(f)(8)]. Insignificant benefits include rights and privileges that a member can exercise frequently during the membership period, including free or discounted admission to the organization s facilities or general events, discounts in the gift shop or restaurant, free or discounted parking or stroller rental, newsletters whose primary purpose is to keep members informed about the organization s activities and which are not available to nonmembers by paid subscription or through newsstand sales, or discounts on the purchase of other goods or services. Insignificant benefits also include admission to events open only to members for which the organization reasonably projects that the cost per person (excluding allocable overhead) is within the limits established for low-cost articles within the meaning of IRC Sec. 513(h)(2). The low-cost article amount for 2017 is $10.70 and $10.80 for 2018 (Rev. Procs and ). Significant benefits include rights and privileges that a member cannot exercise frequently during the membership period, including free or discounted admission to specific events and special performances, free private use of the facilities, newsletters or periodicals that contain articles written for compensation and that accept advertising, and items that exceed the low-cost exception. Significant benefits also include admission to events open only to members for which the organization reasonably projects that the cost per person (excluding allocable overhead) exceeds the limits established for low-cost articles. When annual membership dues are greater than $75, the distinction between significant and insignificant benefits is based on whether the organization offers any membership level for $75 or less. If it does, then the insignificant benefits for the membership levels greater than $75 are the same as for the membership levels of $75 or less, while the significant benefits are any additional benefits provided to the membership levels of $75 or more. If it does not, then none of the benefits meet the insignificant benefits exception, and none of the membership benefits can be disregarded. Line 1c Fundraising Events. Fundraising events are those endeavors with a primary purpose of raising funds for the organization by selling goods or services for more than their direct cost. Event refers to the fact that the activity involves more than purely a solicitation of funds, such as an auction, carnival, concert, dinner, or sporting event. Note that gaming is not considered a fundraising event (see Key Issue 5G). For a discussion of the written substantiation requirements, see Disclosure Required for Quid Pro Quo Contributions in Key Issue 34A. Example 5A-6 Contributions received from a fundraising event. United Charities, Inc. (United), annually sponsors a concert to raise funds for its charitable programs. United contracts with the local symphony to provide the performance. Tickets are $100 for the orchestra circle Key Issue 5A

4 /18 seating and $75 for the balcony. They contain a notation that the concert is sponsored by and for the benefit of United. (Tickets for normal symphony concert performances are $50 and $25, respectively.) The $50 per ticket difference ($100 $50 and $75 $25) between the ticket price and the retail value of the performance is reported as a contribution on Part VIII, line 1c and again on line 8a (within the parentheses of the description)(rev. Rul ). The balance of the revenue from each ticket and United s payment to the symphony for out-of-pocket expenses are reported on Part VII, lines 8a and 8b, respectively. (See Key Issue 5F.) Preparation Pointer: Organizations that report more than $15,000 of gross receipts from fundraising activities must also answer Yes to Part IV, line 18, and complete Part II of Schedule G (Form 990 or 990-EZ), Supplemental Information Regarding Fundraising Activities. (See Key Issue 5L.) Line 1d Related Organizations. Report contributions by a related organization (see Glossary at Resource R505 for definition). For example, include voluntary contributions by members of a professional society (remitted with their membership dues payments) for the benefit of the related filing organization, and payments from Type I and Type II supporting organizations described in IRC Sec. 509(a)(3). Do not include contributions received from federated funding agencies reportable on line 1a. Example 5A-7 Donations from a related organization. Mercy Hospital Foundation is the fundraising affiliate of Mercy Hospital. Dave contributes $10,000 to the Foundation, but earmarks the funds for the Hospital. Mike contributes $10,000 to the Foundation without any designation, but the Foundation gives the funds to the Hospital anyway. Mike made a contribution to the Foundation, and the Foundation chose to expend its own funds by making a grant to the Hospital. The Foundation reports the $10,000 contribution from Mike on Part VIII, line 1f and Schedule B, and the $10,000 grant to the Hospital on Part IX, line 1 and Schedule I. In contrast, the Foundation had no discretionary authority over Dave s contribution; the Foundation was merely acting as a pass-through agent. The $10,000 donation from Dave should not appear on the Foundation s Form 990. The Hospital reports the $10,000 from Dave on Part VIII, line 1f and the $10,000 from the Foundation on Part VIII, line 1c. Both Dave and the Foundation should be disclosed on Schedule B. Preparation Pointer: Proper reporting of pass-through donations is particularly important for calculating the public support test. Two organizations cannot claim public support for a single donation if only one of the organizations had discretionary authority over the funds. Line 1e Government Grants. Payments from local, state, or federal government sources, foreign governments, and U.S. possessions are included here if the funds are provided primarily to benefit the general public. However, if the funds are provided primarily for benefits to the governmental unit, then they should be included on Part VIII, line 2 as an exchange transaction [Reg (a)-3(g)]. One way to determine whether the government grant should be classified as a gift or an exchange transaction is to consider whether a commercial organization would provide funds to the nonprofit organization for the same goods and services. If a commercial organization would engage the nonprofit to provide the goods and services, that indicates an exchange transaction. If a commercial organization would not be likely to engage the nonprofit to provide the goods and services, then the funds are likely meant to benefit the general public. Examples of governmental grants that benefit the general public and should be reported on line 1e include amounts for 1. the construction or maintenance of library or museum facilities open to the public, 2. nursing homes to provide care to their residents (however, Medicare/Medicaid or similar payments made on behalf of specific residents are reportable on Part VIII, line 2), and Key Issue 5A

5 990 3/ Sec. 6033(e)(1)(B)] and others are excluded pursuant to Rev. Proc The following organizations are also exempt from the notification requirements: 1. Organizations that meet the de minimis exception (as discussed later in this key issue under the The De Minimis Rule. 2. Section 501(c)(4) and 501(c)(5) organizations who receive more than 90% of their dues from persons, families, or entities who each paid annual dues of $113 (for 2017) or less ($115 for 2018) (Rev. Procs and ). Note that this amount is indexed for inflation (Rev. Proc ). 3. Local associations of employees and veterans organizations as described in Section 501(c)(4) but not Section 501(c)(4) social welfare organizations. 4. Labor unions and other labor organizations as described in Section 501(c)(5) but not Section 501(c)(5) agricultural and horticultural organizations. 5. Organizations that are not a membership organization. 6. Organizations with an IRS private letter ruling stating that the organization meets the Section 6033(e)(3) exception (i.e., 90% or more of its dues are paid by members who cannot claim a tax deduction for their dues whether or not the payments are allocated to nondeductible lobbying expenses). 7. Any organization that keeps records to substantiate that 90% or more of its members cannot deduct their dues (or similar amounts) as business expenses whether or not any part of their dues are used for lobbying purposes. Note: For guidance on how to meet this standard, or on requesting a ruling on whether the organization meets it, see Rev. Proc , Sec Preparation Pointer: Schedule C (Form 990 or 990-EZ), Part III, deals with the notification issues discussed previously. (See Key Issue 9G for detailed guidance in completing Part III.) Example 9F-1 Social welfare entity s exemption from the disclosure rules. The Gotham City Association (GCA), a Section 501(c)(4) organization, carries out several exempt function activities to promote public safety, crime prevention, more affordable housing, and better community services in Gotham City. As part of its activities, GCA lobbies the state legislature on proposed bills that could affect its exempt functions. Membership in GCA is open to any interested person or business enterprise in the community, although the benefits of its activities extend to both members and nonmembers equally. Membership dues are $10 annually for individuals and $25, $50, or $125 annually for businesses, depending on their sales volume. GCA received the following dues during the current year: Individual memberships ($10 2,500) $ 25,000 Business memberships ($25 1,000) 25,000 ($50 600) 30,000 ($125 50) 6,250 $ 86,250 When its dues are assessed or paid, GCA need not notify its members of the amount of their dues estimated to relate to nondeductible lobbying and political activities. Although Section 501(c)(4) organizations generally are required to provide such notice, GCA is exempted from doing so because less than 10% of its annual dues come from members who pay $113 (2017 amount) or more in annual dues (i.e., $6,250 is less than 10% of $86,250). (See Ltr. Rul ) Affiliated Organizations. Organizations that share a name, charter, historic affiliation, or similar characteristics and coordinate their activities are treated as a single organization for purposes of the dues test (Sec of Rev. Key Issue 9F

6 /18 Proc ; see Ltr. Rul for an example of this provision applied to agricultural organizations). Annual dues are defined as the amount an organization requires a person to pay to be recognized by the organization as a member for an annual period. The term similar amounts includes (but is not limited to) voluntary payments made by members, assessments made by the organization to cover basic operating costs, and special assessments imposed by the organization to conduct lobbying activities (Rev. Proc , Sec. 5.01). The De Minimis Rule No notification is required by an organization that must otherwise notify its members of the portion of their dues related to nondeductible lobbying or political expenditures if the organization did not make any political expenditures or foreign lobbying expenditures during the year, and the lobbying expenditures made consisted solely of de minimis (up to $2,000 per tax year) in-house direct lobbying expenses (disregarding any allocable overhead expenses or any direct lobbying expenses related to legislation of a local council or similar governing body). For this purpose, in-house expenses include labor and material costs and include expenses incurred to influence legislation at the state or federal level and the costs of contacting high-level federal officials (i.e., the first and fourth activities discussed under Notifying Members about Political Expenditures earlier in this key issue). However, the de minimis rule does not apply to expenses paid to persons engaged in the trade or business of lobbying or as dues to an organization that engages in lobbying or other political activities [IRC Secs. 6033(e)(1)(B) and 162(e)(5)(B)(ii)(I)]. Preparation Pointer: If in-house lobbying expenses exceed $2,000 for the year, all of the expenses, not just the amount over $2,000, are subject to the disclosure rule or proxy tax [IRC Sec. 6033(e)(1)(B)(ii)]. Example 9F-2 The de minimis lobbying rule. Plumbers Trade Association s (PTA s), a Section 501(c)(6) organization, only lobbying activity in the coming year will involve its executive director meeting with various state legislators during a two-day period while a proposed bill of interest to PTA is discussed. PTA s expenses for this activity (not including allocable overhead) are expected to be as follows: Key Issue 9F Allocable portion (based on time) of executive director s salary and benefits $ 530 Executive director s travel expenses 860 $ 1,390 PTA is not required to either pay the proxy tax on these expenses or notify its members that a portion of their dues is nondeductible. The expenses qualify as in-house lobbying expenses; thus, PTA avoids the notification requirement. Variation: PTA hired a professional lobbyist (for $800) to accompany its executive director to the meetings with the legislators. None of the fee paid to the outside lobbyist can be excluded under the de minimis rule even though PTA s other lobbying expenses are less than $2,000. Thus, PTA must either report the $800 of nondeductible expenses to its members or pay a $280 ($800 35%) proxy tax (the corporate rate decreases to 21% beginning January 1, 2018). However, even though PTA s total lobbying expenses now exceed $2,000 [($1,390 + $800) > $2,000], it still may exclude its in-house expenses because those expenses alone are no more than $2,000. The proxy tax is discussed later in this key issue. Preparation Pointer: Whether or not a non-section 501(c)(3) exempt organization is subject to the lobbying notification rules, it may be subject to another notification requirement regarding the nondeductibility of its dues as a charitable contribution. (See Key Issue 3B.) Proxy Tax in Lieu of Notice Instead of providing notice, an organization can pay a proxy tax equal to 35% (for 2017, decreasing to 21% beginning January 1, 2018) of the lesser of (1) its lobbying and political expenditures for the year or (2) the dues and similar payments it received during the year [IRC Secs. 11 and 6033(e)(2)]. See Election E203.

7 990 3/ Variation: If a contributor pays more than $400 for the gala ticket, he or she is making a larger contribution. For example, if $500 was paid for the ticket, the contribution reported on line 1 would be $340 ($500 $160 FMV). If an organization offers goods or services through a special event or distributes free, unordered items of only nominal or insubstantial value to patrons, report the entire amount received for such benefits as a contribution on line 1. Benefits have a nominal or insubstantial value if the organization informs patrons how much of their payment is a deductible contribution, and either: 1. the FMV of all the benefits received for the payment is 2% or less of the payment or $107 (for 2017, $108 for 2018) whichever is less; or 2. the payment is $53.50 (for 2017, $54.00 for 2018) or more and only token benefits are received (e.g., bookmarks, calendars, key chains, mugs, posters, T-shirts) bearing the organization s name or logo. The cost to the organization of all benefits received by the donor must be no more than $10.70 (for 2017, $10.80 for 2018). Alsoincludeonline1thefollowingitems: 1. Grants received to further the organization s exempt programs and purpose. 2. Grants or grant equivalents from a governmental unit (whether the payment is labeled a grant or a contract) that enable the recipient organization to provide a service to, or maintain a facility for, the direct public benefit. 3. Membership dues and assessments to the extent they are contributions and are not payments for benefits received (see line 3 discussion following). 4. Contributions received indirectly from the public through solicitation campaigns of federated fundraising agencies (e.g., the United Way). 5. Contributions received from closely associated organizations (i.e., a parent, subordinate, or brother/sister organization). 6. Contributions received from a commercial co-venture by the organization for allowing the donor to use the recipient organization s name in a sales promotion campaign (e.g., 2% of the sales proceeds are contributed to the organization). 7. Contributions of conservation easements and other qualified conservation contributions consistently with how reported in the books and financial statements. 8. Assets contributed by another entity in the course of the entity s liquidation, dissolution, or termination. Schedule B is generally required to be filed by organizations that receive more than $5,000 in money, securities, or other property during the year from a single contributor. See Key Issue 5J for guidance on completing Schedule B. Line 2. Program services are those activities that primarily form the basis of an organization s exempt status. Program service revenue includes admissions to a concert or other performing arts event, charges by a clinic for medical services, or tuition received by a school. It also includes income earned on program-related investments (i.e., investments made primarily to accomplish an exempt purpose of the investing organization). Examples include scholarship loans and low-interest loans to charitable organizations, indigents, or victims of disaster; and below-market rental income received from housing leased to low-income persons. Some unrelated business activities that generate fees for services may also be program service activities. For example, a social club should report on this line the fees it charges both members and nonmembers for the use of its tennis courts and golf courses. Program service revenue can also include income earned by the organization for providing a government agency with a service, facility, or product that benefited that agency directly and not the general public. (See Key Issue 5C for a discussion of program service revenue.) Key Issue 10B

8 /18 Line 3. Enter members and affiliates dues and assessments that are not contributions. Dues and assessments that are not contributions are those that compare reasonably with the benefits of membership or that generally match dues and benefits [i.e., typically Section 501(c)(5), (6), or (7) organizations]. Membership benefits may include subscriptions to publications, newsletters, free or reduced-rate admission to organization-sponsored events, and other discounts. Dues or assessments received that exceed the FMV of available membership benefits (whether or not they are used) are a contribution reported on line 1. However, if a college fraternity or sorority charges membership initiation fees, but not annual dues, report the amount of the fees on this line. Such fees are included in gross receipts, even though initiation fees are generally excluded. Line 4. Report as investment income interest earned on savings and temporary cash investments (i.e., checking and money market accounts, certificates of deposit, and U.S. Treasury bills). In addition, report dividends and interest from stocks and bonds, mutual savings banks, and mutual funds as investment income. Also report gross rental income received from investment property and any other real property rented by the organization (other than program-related investments reported on line 2) on this line. Include the organization s share of investment income from a joint venture, limited liability company, or other entity treated as a partnership for federal tax purposes. Also include royalties received by the organization from licensing the use of property to others (but not royalties generated as part of the organization s exempt function reported on line 2). Do not report capital gains dividends (reported on line 5) or unrealized gains and losses on investments carried at market value as investment income. In addition, exempt function (i.e., program service) rental income is reported on line 2 rather than on line 4. Examples of exempt function rental income include the rent received by an organization whose exempt purpose is to provide low-rental housing to qualified individuals and rent charged to a tenant organization whose activities are related to the filing organization s exempt purpose. Line 5a. Report all sales of securities and other types of investments (i.e., real estate, royalty interests, or partnership interests). Also, report the sales of all other noninventory assets (i.e., program-related investments and fixed assets used in related and unrelated activities). In addition, report capital gains dividends, the organization s share of capital gains and losses from a joint venture, limited liability company, or other entity treated as a partnership for federal tax purposes, and capital gain distributions from trusts. Line 5b. Report the cost basis or other basis (less depreciation) and selling expenses. For reporting sales of securities on Form 990-EZ (but not the Form 990-T), the organization may use the more convenient average-cost basis method for calculating basis of the particular security sold. Line 5c. Report the net gain (or loss) from the sale of assets other than inventory (line 5a line 5b). Details of other assets sold are not required to be attached to Form 990-EZ. Preparation Pointer: The organization should maintain books and records supporting the sale or exchange of securities or other assets sold for which market quotations were not published or otherwise readily available. For all assets, show (1) a description of the asset, (2) the date and how acquired, (3) the date sold and to whom sold, (4) the gross sales price, (5) the cost or other basis (if donated, the value at the time acquired), (6) any expense of sale and cost of improvements made after acquisition, and (7) any depreciation since acquisition. A worksheet for the organization s internal use is provided at Worksheet W601. Line 6a. Report the gross income from gaming activities (e.g., raffles, bingo, or other gaming). If the organization reports income from gaming on line 6a of more than $15,000, Part III of Schedule G (Supplemental Information Regarding Fundraising or Gaming Activities) must be completed. (See Key Issue 5L for examples of gaming and information on completing Schedule G.) Preparation Pointer: Proceeds of fundraising campaigns where the donors names are entered into a sweepstakes, raffle, or lottery normally are treated as contributions and reported on line 1. However, if the prizes to be awarded have more than a nominal value and a donor pays a minimum amount to be entered in the event, the resulting income is treated as revenue from gaming and is reported on line 6a. Note: Many gaming activities are taxable and subject to unrelated business income tax. (See Key Issue 5G, as well as, the discussion of Games of Chance and Bingo in Key Issue 12E for exclusions.) Key Issue 10B

9 990 3/ incidental to the solicitation of charitable contributions if the soliciting organization is described in IRC Sec. 170(c)(2) or (3) [IRC Sec. 513(h)(1)(A)]. An incidental distribution isonemadewithouttherequestorexpress consent of the distributee and accompanied by a request for a donation and a statement that the item distributed need not be returned, regardless of whether a contribution is made [IRC Sec. 513(h)(3)]. Organizations described in IRC Sec. 170(c)(2) or (3) include most tax-exempt veterans organizations and all Section 501(c)(3) organizations, other than those involved in testing for public safety. Preparation Pointer: For this purpose, the term low cost item means any article with a cost of no more than $10.70 for 2017 and $10.80 for 2018 [IRC Sec. 513(h)(2); Rev. Procs and ]. Example 12B-3 Incidental activity is not a trade or business. Save Our Trees, Inc. (Trees) is a public charity whose tax-exempt purpose is to educate the public on the need to preserve and replant trees. It raises funds by mail solicitations. Trees sends a box of greeting cards printed on recycled paper with its appeals for donations. The cards cost Trees $2.50 per box. The cards attract contributions and promote the use of recycled paper products. They are of the same quality and content as cards sold commercially. The distribution of the cards is not a trade or business because [IRC Sec. 513(h)(1)(A) and (3)]: (a) the cards are low-cost items, (b) the potential donor did not request or expressly consent to receiving them, and (c) each distribution is accompanied by a donation request and a statement indicating the cards may be kept, regardless of whether a contribution is sent. Activity Carried on within a Larger Activity An activity that produces or distributes goods or performs services for the production of income does not lose its identity as a trade or business merely because it is carried on within a larger group of similar activities or within a larger complex of other functions of the organization. This is true even if these other activities or functions are related to the organization s exempt purpose [Reg (b)]. Example 12B-4 Trade or business activity within a program service activity. The Tri-County Hospital pharmacy fills drug prescriptions for the hospital s patients. The pharmacy also regularly sells pharmaceutical supplies to the general public. The regular sale of pharmaceutical supplies to the general public is a trade or business, even though the pharmacy also furnishes supplies to the hospital and hospital patients in accordance with its exempt purpose. Although this activity is partially related to an exempt function (the sales to hospital patients), it is conducted on a larger scale than is reasonably necessary for the performance of that function. Thus, to the extent it exceeds the needs of the exempt function (i.e., to the extent of the sales to the general public), the activity is an unrelated trade or business [Reg (d)(3)]. (For the IRS s definition of patient, as distinguished from the general public, see the discussion of Members Convenience in Key Issue 12E.) Commerciality Test An activity that is carried on in a manner similar to a commercial business may be considered a trade or business (American Bar Endowment). This is sometimes referred to as the commerciality doctrine or test, which focuses on the type of operation being conducted by the organization. An activity is likely to be considered a trade or business if a for-profit entity would want to, and could, conduct it. Generally, the IRS applies the commerciality test in determining whether an organization qualifies for tax-exempt status. (See Key Issue 32C.) However, the test means that an activity that could be substantially related to an organization s exempt purpose may become an unrelated activity if conducted in a commercial fashion (Ltr. Rul ). Example 12B-5 Denial of exempt status under commerciality doctrine. Give a Hand-Up Not a Hand-Out (GHUNHO) is formed with a mission to equip small businesses, entrepreneurs, and nonprofit organizations with capacity-building strategies for growth, effectiveness, and Key Issue 12B

10 /18 sustainability. GHUNHO will provide software tools, tutorials, online instruction, networking, workshops on business strategies, and assistance in developing business-related documents. The services are offered using the software and consulting services of a for-profit entity that is owned by the executive director of GHUNHO. GHUNHO s activities further the private interests of both the executive director and the customers purchasing the services. It advertises and sells products and services provided by specific private interests. GHUNHO is not operating exclusively for an educational or charitable purpose. Even when the products are provided at cost solely to nonprofit organizations, the provision of managerial and consulting services on a regular basis for a fee is a commercial activity in direct competition with for-profit businesses providing similar services. At times, the operation of a nonprofit organization may directly benefit a commercial organization. When the directors of the nonprofit organization own or control the commercial organization, tax-exempt status may be denied or revoked even if the payments to the commercial organization are reasonable and at arm s length. In Church by Mail, Inc., the 9th Circuit Court of Appeals wrote that the critical inquiry is not whether particular contractual payments to a related for-profit organization are reasonable or excessive, but whether the entire enterprise is carried on in such a manner that the for-profit organization benefits substantially from the operation of the nonprofit organization. See Key Issue 32C. Example 12B-6 Nonprofit organization operated to increase director s commercial business. Anja Odysseus is an officer and shareholder in Odysseus Travel Agency. Anja also founded and serves on the Board of Directors of the Continuous Education Foundation (CEF), a nonprofit organization. CEF s mission is to organize and sponsor continuing education seminars and symposia in Greece. CEF will use Odysseus Travel Agency for all its travel arrangements, including sightseeing and recreational activities. CEF was formed, at least in part, to obtain customers for the founder s commercial business, and therefore CEF s operations increase the income of Odysseus Travel. Although CEF furthers other exempt purposes, it serves the private interests of its founder, rather than public interests. CEF s tax-exempt status will be denied. KEY ISSUE 12C Meaning of the Term Regularly Carried on. Trade or business activities of exempt organizations are not subject to unrelated business income tax (UBIT) if they are not regularly carried on [IRC Sec. 512(a)(1)]. Business activities ordinarily are regularly carried on if they have a frequency and continuity and are pursued in a manner comparable to similar commercial activities of nonexempt organizations [Reg (c)(1)]. This is consistent with the UBIT s primary purpose of placing an exempt organization s business activities on the same tax basis as the endeavors of nonexempt businesses with which they compete. An exempt organization s activities are more likely to compete with those of a commercial operation if both entities offer their products or services during the same times each year. Thus, the frequency necessary for determining whether an activity is regularly carried on varies with the activity involved. Annual or Infrequent Activities An annual fundraising event will generally not be treated as a regularly carried on business activity, nor will infrequent fundraising events be regarded as regularly carried on merely because they are conducted as often as annually [Reg (c)(2)(iii)]. However, if an event involves significant planning, preparation, and promotion that begins several months prior to the actual event, the activity can be considered to be regularly carried on. Example 12C-1 Infrequent activity regularly carried on. A charitable organization has an annual directory prepared and distributed to its entire membership. An independent commercial firm under contract throughout the year sells advertising space and collects advertising fees. Although the directory is only published once a year, the activity is regularly carried on because the organization works on the directory for several months before and after publication (Ltr. Rul ). A troublesome application of the regularly carried on test has involved advertising activities. In National Collegiate Athletic Association (NCAA), the 10th Circuit Court of Appeals reversed the Tax Court and held that advertising Key Issue 12C

11 990 3/ However, Rev. Proc contains no guidance on how to determine whether the associate member category was formed for the principal purpose of furthering the organization s exempt purpose or producing UBI. It says only that the IRS will look to the purposes and activities of the organization rather than its members when making the determination. Ltr. Rul elaborates on the criteria the IRS will consider in such cases, such as whether associate members can participate in the organization s exempt activities and receive equal privileges and treatment, including voting and holding office. If there is real involvement by associate members in policy and decision making, then the principal purpose of an associate member category may not be to generate UBI. Example 12L-1 Income from associate member dues. The Basket Weaving Association, a Section 501(c)(6) trade association, creates a new membership classification for individuals who are not active or retired basket weavers. These Friends of Weavers (Friends) pay dues to the Association to obtain access to the Association s health insurance plan, a quarterly newsletter, group legal services, and the right to participate in the Association s travel, credit card, eyewear, and long-term care insurance programs. Friends are allowed to elect only one member of the nine-member board. The benefits, products, and services are not substantially related to the Association s mission of improving working conditions for basket weavers. The membership dues paid by Friends are UBI. Planning Tip: Organizations that establish an associate member category that does not grant privileges to vote orholdofficemaybetaxedontheincomeifotherdeterminativefactorsarenotpresent.thefactorslistedinltr. Rul help identify steps that Section 501(c)(5) and (6) organizations can take to minimize the risk of tax related to associate member dues. Rev. Proc retroactively applies the principles of Rev. Proc to Section 501(c)(6) entities. It also confirms that Rev. Proc continues to apply to associate member dues of Section 501(c)(5) organizations not covered by IRC Sec. 512(d) (i.e., agricultural and horticultural organizations whose associate member dues exceed the $100 inflation-adjusted limit and labor organizations, regardless of the size of their dues). Note: Annual dues paid by associate members of a Section 501(c)(5) agricultural or horticultural organization are not to be treated as UBI based on the benefits or privileges received by such members [IRC Sec. 512(d)]. This provision, however, only applies to the extent the required dues do not exceed an annually indexed threshold, and it does not apply at all to Section 501(c)(5) labor organizations. The threshold is $162 for taxable years beginning in 2017 (Rev. Proc ) and $165 for taxable years beginning in 2018 (Rev. Proc ). The definition of dues for IRC Sec. 512(d) includes payments not designated as dues but required to be paid to be recognized by the organization as a member. KEY ISSUE 12M Income from Management and Administrative Services Fees. General Rules Providing services (e.g., management, administrative, consulting, and other) to other exempt organizations for a fee on a regular basis is an unrelated business activity that will generate unrelated business income (UBI) unless the services are insignificant in relation to the performing organization s other activities. Under some circumstances, however, performing services for another exempt organization may further an exempt purpose of the service provider, in which case, the income will not be considered UBI (Ltr. Rul ). Additionally, income from services that are unique and otherwise unavailable commercially will apparently not be UBI (Ltr. Rul ). To demonstrate that furnishing services furthers an exempt purpose of the provider, they must be provided at substantially below cost (Rev. Ruls and ). Simply discounting charges is insufficient to satisfy this test (IHC Health Plans, Inc.). Relationships between Organizations A relationship between the services provider and the services recipient does not per se permit the provider s fee to be excluded from UBI. The services must still accomplish an exempt purpose of the provider. For example, in Ltr. Key Issue 12M

12 /18 Rul , a Section 501(c)(6) business league received income for services to a related Section 501(c)(3) organization. However, the business league s activities should be directed to improving business conditions of one or more lines of business rather than performing particular services for individual persons [Reg (c)(6)-1]. Therefore, these services resulted in UBI even though provided to a related exempt organization because they did not further the business league s exempt purpose. (See also Rev. Rul and Indiana Retail Hardware Association.) Similarly, fees for services to members of a business league or trade association are also UBI. Controlled Groups. Groups of affiliated exempt organizations are common in the health care industry. Often, one of the exempt affiliates provides management and administrative services for its affiliates. The IRS has consistently ruled that services provided by an exempt member of the group to other exempt members will not be UBI because all the members are under the common control of a single member (Ltr. Rul ). Control can apparently be indirect as well as direct (Ltr. Rul ). Example 12M-1 Services for controlled affiliates. Three tax-exempt acute care hospitals and a tax-exempt home health care agency form a tax-exempt supporting organization that will coordinate the delivery of home health care services. The supporting organization will provide management, personnel, purchasing, and administrative services. The organizations are related through common control and are part of an integrated home health care system. Providing services and sharing assets, personnel, facilities, and services among these organizations will increase efficiency in delivering home health care services and thus will not be UBI (Ltr. Ruls and ). Services to a taxable affiliate in a controlled group generally result in UBI. However, incidental services to a taxable affiliate that further an exempt purpose of the service provider do not result in UBI (Ltr. Rul ). KEY ISSUE 12N Income from Travel Tours. General Rule The income derived from a travel tour will not result in unrelated business income (UBI) to the exempt organization if the tour is substantially related to an organization s exempt purpose, not regularly carried on, or conducted with volunteer labor. (See Key Issues 12A and 12E.) Typically, such tours are conducted by an educational organization. GCM lists various factors in determining that an educational tour did not generate UBI, including (1) relationship of the tour to the organization s exempt activities; (2) use of qualified study leaders; (3) existence of organization contacts at the area that enhance the tour s educational value; (4) relationship of present tour to prior tours, lectures, or classes of the organization; and (5) careful structuring of the tour to maximize educational goals and contents. (See also Rev. Rul ; Ltr. Ruls , , and ) Based on seven examples included in Reg (b), the IRS apparently will focus on two key elements in making its determination: the types of activities scheduled during a tour and the time devoted to those activities. The emphasis seems to be on organized study, preparation of reports, lectures, instruction, and oral readings during the tour. Only limited time should be available for social and recreational activities. [See Ltr. Ruls and ; and Reg (b), Ex. 4.] Example 12N-1 Travel tours. State University (SU) is organizing a tour of Eastern Europe to study the conquests of Attila the Hun. SU s History Department will provide educational lectures at each point of interest in the two-week tour. The professors will be tour guides and lecture a minimum of six hours a day at each location. Examinations will be given at the end of the tour to cover the subject matter. A passing grade is required to earn college credit. This income will not be UBI to SU. The educational emphasis of the tour furthers SU s exempt educational purpose [Reg (b), Ex. 2]. If there were limited educational opportunities during the tour with emphasis on social and recreational activities, the income would be UBI. Key Issue 12N

13 990 2/ Example 15B-1 Related party interest. Forney First, Inc. (FFI), an accrual basis organization exempt under IRC Sec. 501(c)(3), provides food and shelter to needy families in Forney. FFI augments its charitable contributions by selling imported merchandise (an unrelated business activity) in its thrift store. To expand these activities, FFI borrows $500,000 for one year at 6% interest from ABC Pawnshop, Inc. (ABC), a wholly owned taxable subsidiary. ABC uses the cash method of accounting. On December 31, there is accrued interest of $22,500 on the loan. FFI cannot deduct any of this interest until it repays the loan in the following year and the interest income is reported by ABC. Note: This general rule does not apply to defer the deduction of otherwise deductible OID or below-market loan interest [Temp. Reg (a)-2T(b), Q&A-2]. Interest Paid to a Partnership. A corporate organization that pays interest to a partnership in which it is a partner, directly or indirectly, may not be able to deduct such interest under certain circumstances [IRC Sec. 163(j)]. Other Rules An organization can deduct foregone interest on a below-market loan that it is deemed to have paid to the lender (IRC Sec. 7872). A below-market loan is 1. a demand loan where interest is payable on the loan at a rate less than the applicable federal rate [IRC Sec. 7872(e)(1)(A)], or 2. a term loan where the amount loaned exceeds the present value of all payments due under the loan [IRC Sec. 7872(e)(1)(B)]. These rules are inapplicable to loans of $10,000 or less [IRC Secs. 7872(c)(2) and (c)(3)], to amounts treated as unstated interest [IRC Sec. 7872(f)(8)], and to certain other loans to qualified continuing care facilities [IRC Sec. 7872(g)]. KEY ISSUE 15C Charitable Contributions. General Rules When calculating unrelated business taxable income (UBTI), organizations are allowed to deduct charitable contributions, regardless of whether the contributions are directly connected with carrying on an unrelated trade or business [IRC Sec. 512(b)(10)]. The term charitable contribution has the same meaning here as it does in the case of for-profit entities [IRC Secs. 512(b)(10) and 170(c)]. For example, a Section 501(c)(3) organization may claim a deduction for a contribution to another charitable organization, but not for payments made in conducting its own charitable programs or for scholarships and similar awards made to individuals [Reg (b)-1(g)(3)]. Although an interfund transfer on an organization s books may qualify as a charitable contribution under state law, such transfer is not equivalent to payment to an outside charity under federal law. (See Women of the Motion Picture Industry.) Deduction Limit A corporate organization s deduction for otherwise allowable charitable contributions is generally limited to 10% of its UBTI, computed without regard to the charitable contribution itself [IRC Sec. 512(b)(10)], any domestic production activities deduction under IRC Sec. 199, any net operating loss carryback under IRC Sec. 172 to the tax year, or any capital loss carryback under IRC Sec. 1212(a)(1) to the tax year. Charitable contributions that exceed the 10% limit may be carried over and deducted against UBTI in the succeeding five tax years (to the extent contributions made in those years, plus carryover contributions from earlier years, do not already exceed the 10% limit for that year) [IRC Sec. 170(d)(2)]. Note: A contribution carryover cannot increase a net operating loss (NOL) carryover (Key Issue 15E). Law Change Alert: The Disaster Tax Relief and Airport and Airway Extension Act of 2017 (The Disaster Act) and The Bipartisan Budget Act of 2018 provide relief to the victims of Hurricanes Harvey, Irma, or Maria, and the Key Issue 15C