Navigating UBIT in Religious Organizations

Transcription

1 Navigating UBIT in Religious Organizations September 28, 2017 Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.

2 Disclaimers The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by CliftonLarsonAllen LLP to the user. The user also is cautioned that this material may not be applicable to, or suitable for, the user s specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The user should contact his or her CliftonLarsonAllen LLP or other tax professional prior to taking any action based upon this information. CliftonLarsonAllen LLP assumes no obligation to inform the user of any changes in tax laws or other factors that could affect the information contained herein. 2

3 Housekeeping If you are experiencing technical difficulties, please dial: Q&A session will be held at the end of the presentation. Your questions can be submitted via the Questions Function at any time during the presentation. The PowerPoint presentation, as well as the webinar recording, will be sent to you within the next 10 business days. For future webinar invitations, subscribe at CLAconnect.com/subscribe. Please complete our online survey. 3

4 About CliftonLarsonAllen A professional services firm with three distinct business lines Wealth Advisory Outsourcing Audit, Tax, and Consulting More than 5,000 employees Offices coast to coast Over 60 years of experience serving more than 6,000 nonprofit clients Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC. 4

5 Speaker Introductions David Trimner Principal, National Nonprofit Tax Leader Focuses on federal and state tax services Assists clients on unrelated business income, IRS examinations, and state solicitation requirements Understands the rules and regulations critical to charitable and tax-exempt entities 5

6 Learning Objectives At the end of this session, you will be able to: Explain what unrelated business income is, and how it impacts your organization Understand the current regulatory environment associated with unrelated business income and why it is important to properly classify the revenue Identify common sources of unrelated business income, including rental activities, parking, sale of merchandise, sponsorships/advertising, and affinity agreements 6

7 Unrelated Business Income What s Wrong with Making a Profit? Unrelated Business Income is corporate rates (avg. 40% blended Fed & State), leaving the organization with roughly 60% of after-tax profits Alternative Revenue Generating Activities, in aggregate, should not become a substantial part of the organization s activity. Understanding the tax consequences of proposed transactions help the organization make sound business decisions

8 Unrelated Business Income IRS Examination Risk Associational Test Evidence of noncompliance particularly with regard to UBIT and expense allocation Organizations often report significant unrelated business income, but usually reported a loss on underlying activities IRS questioned the validity of those losses and whether they were attributable to the unrelated activity IRS stated it plans to implement enforcement as a result of the findings Service has engaged in increased examination activity for organizations that report activities that have three consecutive years of losses

9 Unrelated Business Income IRS Examination Risk Associational Test 1. Distinct legal existence 2. Recognized creed and form of worship 3. Definite and distinct ecclesiastical government 4. Formal code of doctrine and discipline 5. Distinct religious history 6. Membership not associated with any other denomination 7. Organization of ordained ministers 8. Ordained ministers selected after completing prescribed studies 9. Literature of its own 10. Established places of worship 11. Regular congregations 12. Regular religious services 13. Schools for religious instruction of the young 14. Schools for the preparation of its ministers. The IRS also considers any other facts and circumstances which may bear upon the organization's claim for church status.

10 Unrelated Business Income IRS Examination Risk Unrelated Business Income Evidence of noncompliance particularly with regard to UBIT and expense allocation Organizations often report significant unrelated business income, but usually reported a loss on underlying activities IRS questioned the validity of those losses and whether they were attributable to the unrelated activity IRS stated it plans to implement enforcement as a result of the findings Service has engaged in increased examination activity for organizations that report activities that have three consecutive years of losses

11 UBI Defined IRC 512(a)(1) Trade or Business Not Substantially Related To Exempt Purpose Regularly Carried On

12 TRADE OR BUSINESS Reg (b) Activities carried on for the production of income from the sale of goods or the performance of services. Profit Motive Test Reg (b) Manner in which the activity is carried on Expertise of taxpayer and advisors Time and effort expended Expectation that activity assets will appreciate Success experienced in carrying on the activity History of income or losses Amount of profit earned Financial status of the taxpayer Elements of personal pleasure or recreation Unfair Competition Test Commercial Manner Test

13 REGULARLY CARRIED ON Reg (c) Is the activity s frequency, continuity and manner of conduct comparable to commercial operations of similar for-profit organizations? Annually? Quarterly? Intermittently? Sporadically?

14 REGULARLY CARRIED ON Reg (c) A charitable organization with a mission of serving children and giving their issues a voice holds two conferences annually. At each conference a small booth displays & sells t-shirts, mugs, bags and other paraphernalia bearing the organization s name. The conference is attended by employees and other interested parties.

15 NOT SUBSTANTIALLY RELATED Reg (d) What is the relationship of the activity to the accomplishment of the exempt purpose (other than the destination of income)? What is the size and extent of the activity in relation to the nature and extent of the exempt function that they purport to serve? Is it excessive?

16 NOT SUBSTANTIALLY RELATED Reg (d) The Living Hope Church has a large kitchen. It prepares free and low-cost meals for charitable class individuals in the community. The Living Hope Church has a large kitchen. It rents its kitchen to a local catering copy. The catering company provides the meals for the church in exchange for use of the kitchen.

17 NOT SUBSTANTIALLY RELATED Reg (d) Dual-use activities The Victorious Faith Church has a tennis court that it utilizes during Sunday School and Vacation Bible School. When the courts are not in use, the church charges a fee to tennis pros who sell lessons to the community.

18 NOT SUBSTANTIALLY RELATED Reg (d) Exploitation of an exempt activity The Victorious Faith Church has a tennis court that it utilizes during Sunday School and Vacation Bible School. When the courts are not in use, the church charges a fee to tennis pros who sell lessons to the community.

19 UBI Analysis Always begin with Trade or Business Not Substantially Related To Exempt Purpose Regularly Carried On 19

20 UBI Analysis Then look for Exceptions Exclusions Court cases But be aware of Exceptions to the exceptions 20

21 Exceptions The activity is performed by volunteers. Donated merchandise is being sold. The activity is provided for the convenience of the members. The only gaming activity is bingo.

22 Exceptions A church operates a thrift store selling items to the general public. A church operates a thrift store selling items to the general public. All of the individuals carrying on the work are uncompensated. A church operates a thrift store selling items to the general public. Persons desiring to benefit the organization contribute used clothes, books, and furniture to be sold to benefit the church. A church operates a snack bar for the convenience of the congregants.

23 Exceptions A public charity receives passive investment income, including, dividends, interest, and royalty income. An exempt organization sells its mailing/membership list to unrelated entities. An exempt organization sells its mailing/membership list to unrelated entities and provides support services.

24 Rental Income An church rents out a large portion of its office building. It charges rent to tenants whose activities are unrelated the organization s exempt purpose. There is a mortgage on the building. The tenant occupies the first floor of a 12 story building. 24

25 Rental Income When it is taxable Property is debt financed Tenant is a controlled corporation Based on a % of the tenant s net income Includes payment for services >50% is attributable to personal property 25

26 Rental Income Acquisition Indebtedness Acquiring the property Improving the property Incurred prior to acquisition/improvement, but would not have been incurred but for the acquisition/improvement Reasonably foreseeable debt Exception: property subject to mortgage, acquired by gift or bequest 26

27 Rental Income an Example 1. The Live Forever Church is incorporated as a tax-exempt church described in IRC Sec. 170(b)(1)(A)(i). On September 18, the Church purchases a building with $100,000 down and a $300,000 mortgage. Beginning in October, the Church makes monthly payments of $10,000 plus interest, paid on the 15 th of the month. What is the average acquisition debt? 2. The Foundation is allowed to take $4,000 of depreciation during the first year. What is the average adjusted basis of the property? 3. The Foundation earns 10,000 of rental income during the first year. How much of the rental income is subject to tax? 4. The Foundation incurs $7,000 of directly related office expenses during the first year. How much of the expenses may be deducted? Are there any indirect expenses that may be deducted? 27

28 Rental Income Planning Tip Subdivide the property into its exempt purpose portion and its rental portion Apply cash down payment to the rental portion Accelerate payments on the rental portion Exempt purpose portion is generates no taxable income regardless of leverage Exempt Use Portion Highly leveraged Rental Portion No Mortgage 28

29 Rental Income Neighborhood Land Rule Debt financed real property may produce income without generating UBI if: It is contiguous with exempt purpose property (not required for churches) The is a continuous intention to use the land for exempt purposes within 10 years (15 years for a church) Existing structures will need to be demolished The property is not subject to a lease for a term of more than 5 years The IRS is given sufficient notice before the end of the fifth year 29

30 Rental Income Neighborhood Land Rule Using borrowed funds, the church purchases a nearby parcel of land with the intention of demolishing the grocery store on the property and constructing a new worship center. A downturn in the economy has slowed the church's fundraising efforts. Demolition and construction activities have been delayed while the church attempts to raise capital to pay off the debt and begin construction, and the church continues to earn rental income from the owners of the grocery store. Five years after the purchase of the land, the church has secured the services of an architect and obtained preliminary drawings for the worship center. The church expects that demolition and construction will begin within the next seven years, with the new expanded church facilities placed into service before the expiration of the 15-year period. Is the rental income taxable? What additional reporting obligation does it have? 30

31 Parking Facilities A church owns a parking garage used by the general public and charges an hourly fee A church owns a parking garage, used by employees, ministers, congregants, and visitors, and charges an hourly fee The church leases the parking lots during weekdays to local businesses, and charges an hourly fee The church leases the parking garage to a 3 rd party operator 31

32 Retail Shops Pistis, Elpis, and Agápe Coffee House Our mission: Spread the gospel message Promote prayer, Bible study, Christian fellowship, evangelism, and salvation by Christ Provide a forum in which Bible truths can be discussed in a casual, non-confrontational setting Serve light refreshments on a donation basis 100% of profits will be donated to faith-based organizations 32

33 Retail Shops Church Bake Sales On the last Saturday of the month, congregants provide cookies, brownies, and other baked goods for resale. The customers are primarily members of the congregation, but the activity is not held contemporaneously with Sunday worship services. 33

34 Retail Shops Items for Sale 1. T-shirts with spiritual messages 2. T-shirts with spiritual messages and a pamphlet describing the church s efforts to spread scriptural truth 3. Art reproductions 4. Books 5. Postcards Camera film and batteries 6. Newspapers 7. Coffee shop Staff, employees, church members, visitors The general community 8. Sale of items on the website 34

35 Retail Shops 35

36 Retail Shops 36

37 Advertising Reg (c)(2)(v) Advertising Defined Any message or material which promotes or markets any trade, business, service, facility or product using: Qualitative or comparative language Price information or other indications of savings or value Endorsements Inducement to purchase, sell, or use any company, service, facility or product. A single message that contains both advertising and an acknowledgment is advertising. 37

38 Qualified Sponsorship Payment Reg (c)(2)(iv) Permissible QSP Acknowledgment Exclusive Sponsor arrangement Name, Address, Phone number, website, logo General description of the product line ( retailer of fine bathroom fixtures ) Visual depictions of the products and services Taglines ( The Ultimate Driving Machine ) Display or distribution of products

39 Advertising/Sponsorships 39

40 Conventions/Trade Shows Vendors exhibit products and services and promote public interest in the industry Income from such activity is excluded from UBI only when the activity is carried on by a qualifying organization in conjunction with a qualified convention or trade show. The purpose of the activity should be educating members, promoting products and services of the industry, or educating persons attending the show concerning new developments or products and services related to the exempt activities.

41 Conventions/Trade Shows The Live Forever Foundation conducts a trade show. Exhibitors pay $5,000 for a booth, and attendees pay $1,000/person. The Platinum Sponsor pays $50,000 and receives: Link from website Logo on tote bag Free booth at the trade show 6 admission tickets Right to introduce the keynote speaker 2 full page ads in the monthly magazine (FMV of $4,000/each) How should the payment be shown on Form 990?

42 Contractual Obligations Contracts or other agreements that obligate the nonprofit to perform certain acts or services in exchange for payment. For example, in exchange for a large donation, the nonprofit agrees to encourage its members to use the donor s goods and services, send out letters or s to its members, monitor and report on results, etc. Services provided by an exempt organization to a donor can result in a substantial return benefit to the donor without advancing the mission. The organization should make a good-faith estimate of the fair market value of the services it is providing, and consider whether that portion of the payment is exempt-function income or UBI.

43 Contractual Obligations $100,000 License Agreement Trial Balance/Audited Financial Statements Contribution? Sponsorship? Royalty? 43

44 Contractual Obligations The Save the Whales Foundation signs an agreement with Flyover Country Airlines. The Foundation will Grant a license to use its trademarks Provide a quarterly membership list, including physical and addresses Send an to its members, promoting the affinity agreement with Flyover Insert Flyover s promotional material in its membership renewal notices Put Flyover s logo on its homepage, with a hyperlink Identify Flyover as the preferred airline of the Save the Whales Foundation Provide educational content to be featured on Flyover s website 44

45 Contractual Obligations The Save the Whales Foundation signs an agreement with Flyover Country Airlines. The Airline will Obtain written approval of all promotional material using the trademarks Paint the Foundation s logo and a depiction of a humpback whale on the body of 10 planes Pay a sponsorship of $100,000 Pay the Foundation 1% of all tickets purchased by individuals following the hyperlink from the Foundation s website Pay the Foundation 1% of all tickets purchased by members responding to a solicitation from Flyover 45

46 Questions? David Trimner, Principal To receive future webinar invitations, subscribe at CLAconnect.com/subscribe. CLAconnect.com linkedin.com/company/ cliftonlarsonallen facebook.com/ cliftonlarsonallen twitter.com/claconnect 46