RECENT DEVELOPMENTS AFFECTING TAX-EXEMPT ORGANIZATIONS

Transcription

1 BEYOND THE 990 Recent Developments, Unrelated Business Income Tax and Other Taxes Affecting Nonprofit Organizations David S. Rosen, Esq., CPA RS&F MACPA 2012 Government and Not For Profit Conference April 27, 2011 RECENT DEVELOPMENTS AFFECTING TAX-EXEMPT ORGANIZATIONS RS&F: Strategic Thinking for Successful Growth 2

2 IRS INITIATIVES Private Foundations IRS will be examining (i.e., auditing) a selection of the largest private foundations in the country The selection of private foundations will be based on the information provided on Form 990-PF A particular focus will be on private foundations with assets greater than $500 million with international activities The IRS will scrutinize these organization for avoidance of excise taxes RS&F: Strategic Thinking for Successful Growth 3 IRS INITIATIVES (CONT.) Unrelated Business Activities IRS will inquire about organizations that report unrelated business activities on Form 990 but do not file Form 990-T (reporting unrelated business taxable income) An upcoming IRS project (possible for 2013) will be a comprehensive examination of UBIT compliance RS&F: Strategic Thinking for Successful Growth 4

3 IRS INITIATIVES (CONT.) Political Activities IRS will focus its examination resources on serious allegations of impermissible political intervention The IRS has outlined a multitude of situations covering the following areas: Voter Education, Voter Registration and Voter Get Out the Vote Drives Individual Activity by Organization Leaders Candidate Appearances Candidate Appearances Where Speaking or Participating as a Non-Candidate Issue Advocacy vs. Political Campaign Intervention Business Activity RS&F: Strategic Thinking for Successful Growth 5 IRS INITIATIVES (CONT.) Tax-Exempt Hospitals Development of guidance for compliance with I.R.C. 501(r) part of the 2010 health care law Failure to comply with the new reporting requirements may result in excise taxes of up to $50,000 per hospital per year or loss of tax-exempt status Requires creation of Community Health Needs Assessment (CHNA) report RS&F: Strategic Thinking for Successful Growth 6

4 IRS INITIATIVES (CONT.) Colleges and Universities IRS is currently examining a selection of colleges and universities (about 30 nationwide) in its attempt to identify areas requiring additional scrutiny Primary focus appears to be on unrelated business taxable income and executive compensation RS&F: Strategic Thinking for Successful Growth 7 IRS INITIATIVES (CONT.) Employment Taxes IRS has launched initiative to focus on employment tax compliance for tax-exempt organizations IRS has planned 1500 audits for employment tax compliance focusing on: Worker classification (i.e., employee vs. independent contractors) Fringe benefits Officer compensation Employee expense reimbursements RS&F: Strategic Thinking for Successful Growth 8

5 IRS INITIATIVES (CONT.) Upcoming Initiatives Disaster Relief Organizations Mortgage Foreclosure Assistance Social Welfare Organization Labor and Agricultural Organizations Business Leagues RS&F: Strategic Thinking for Successful Growth 9 LEGISLATIVE DEVELOPMENTS Charitable Deduction Changes If the repeal of the 2001 limitation on charitable contributions is not extended, the provision will return with the expiration of the Bush tax cuts in 2013 President s budget proposes a cap on charitable contributions for individuals making more than $200,000 (single) or $250,000 (joint) RS&F: Strategic Thinking for Successful Growth 10

6 LEGISLATIVE DEVELOPMENTS (CONT.) Private Foundation Excise Tax President s budget proposes a single 1.35% rate to replace the existing two-tiered excise tax structure House and Senate proposals would replace the existing structure with a 1.39% excise tax RS&F: Strategic Thinking for Successful Growth 11 LEGISLATIVE DEVELOPMENTS (CONT.) Private Foundation Excise Tax President s budget proposes a single 1.35% rate to replace the existing two-tiered excise tax structure House and Senate proposals would replace the existing structure with a 1.39% excise tax RS&F: Strategic Thinking for Successful Growth 12

7 LEGISLATIVE DEVELOPMENTS (CONT.) Expiring Tax Provisions Contribution of IRA distributions to charitable organizations This provision will likely be extended or made permanent Enhanced Charitable Contribution Deductions Contributions of conservation property Contributions of food and book inventory Contributions of computer technology equipment RS&F: Strategic Thinking for Successful Growth 13 LEGISLATIVE DEVELOPMENTS (CONT.) Postal Reform Proposed Senate bill to reform the US Postal Service (S. 1625) would reduce the discount that nonprofits receive on postage rates from 40% to 20% over several years Unknown whether this bill will be considered by the House RS&F: Strategic Thinking for Successful Growth 14

8 UNRELATED BUSINESS INCOME TAX (UBIT) RS&F: Strategic Thinking for Successful Growth 15 UNRELATED BUSINESS INCOME TAX (UBIT) The primary objective of the adoption of unrelated business income tax (UBIT) was to eliminate a source of unfair competition by placing the unrelated business activities of certain exempt organizations upon the same tax basis as nonexempt business endeavors with which they compete RS&F: Strategic Thinking for Successful Growth 16

9 COMPUTATION OF UBIT Gross Income from unrelated trade or business regularly carried on less less and Allowable deductions that are directly connected with the carrying on of the trade or business Income excluded under the statutory exceptions Computed with the modifications described in I.R.C. 512(b) RS&F: Strategic Thinking for Successful Growth 17 UNRELATED BUSINESS INCOME TAX (UBIT) Tax is imposed on the gross income of a taxexempt organization if such income: Is income from a trade or business Such trade or business is regularly carried on The conduct of the trade or business is not substantially related to the organization s performance of its exempt functions RS&F: Strategic Thinking for Successful Growth 18

10 TRADE OR BUSINESS REQUIREMENT The following factors will determine whether an activity constitutes a trade or business: Profit Motive: Whether the activity is engaged in for the primary purpose of generating income or profit Unfair Competition: Whether the failure to tax the activity would result in unfair competition with for-profit entities Investment Income: Investment income is not income from a trade or business RS&F: Strategic Thinking for Successful Growth 19 TRADE OR BUSINESS REQUIREMENT (CONT.) Trade or Business activities include: Providing and Sponsoring Insurance Plans Administrative Services Professional Services Sale of Advertising and Publications Leasing and Rental of Debt-Financed Property RS&F: Strategic Thinking for Successful Growth 20

11 REGULARLY CARRIED ON REQUIREMENT In order to be regularly carried on, the activity must be: Conducted with frequency and continuity similar to commercial activities of non-exempt organizations; and Pursued in a manner similar to non-exempt organizations RS&F: Strategic Thinking for Successful Growth 21 REGULARLY CARRIED ON REQUIREMENT Regularly Carried On Intermittent Activities Conducted in Same Manner as Commercial Enterprises Not Regularly Carried On Infrequent Intermittent Activities and Intermittent Activities Relating to Exempt Purpose Transactional Activities Engaged in Regularly Activities Conducted in Same Time Span as Commercial Enterprises One Time or Infrequent Transactions Activities Conducted over a Short Time Span Relative to Commercial Enterprises RS&F: Strategic Thinking for Successful Growth 22

12 NOT SUBSTANTIALLY RELATED Trade or business income that is substantially related to an organization s exempt purpose is not subject to UBIT A trade or business is substantially related if it has a substantial causal relationship to the organization s exempt purpose An activity that contributes importantly to the organization s exempt purpose will usually be substantially related Facts and circumstances are also considered RS&F: Strategic Thinking for Successful Growth 23 RELATED GROSS INCOME Gross income from a related trade or business is not subject to UBIT: Income from performance of an exempt function Income from disposition of the product of an exempt function Dual use property is nontaxable when used for exempt purposes and subject to UBIT otherwise Sale of advertising is usually subject to UBIT and is highly scrutinized by the IRS RS&F: Strategic Thinking for Successful Growth 24

13 ALLOWABLE DEDUCTIONS Deductions allowable against unrelated trade or business income are determined in the same manner as deductions are computed for regular income tax purposes To be allowed as a deduction, the deduction must be directly connected with the unrelated trade or business RS&F: Strategic Thinking for Successful Growth 25 STATUTORY EXCEPTIONS Unrelated trade or business income is not subject to UBIT if it comes under the statutory exceptions: Work Performed Without Compensation (the Volunteer Exception ) Work Performed for the Convenience of the Organization s Constituents Income is from the Sale of Donated Merchandise (the Thrift Shop Exception ) Other Statutory Exceptions of I.R.C. 513 RS&F: Strategic Thinking for Successful Growth 26

14 STATUTORY MODIFICATIONS Dividends Interest Annuities Payments with respect to Securities Loans Loan Commitment Fees Royalties Certain Rents Gains and losses from disposition of property RS&F: Strategic Thinking for Successful Growth 27 EXCLUDED RENTAL INCOME Rents from real property and from personal property rented with real property will be excluded from UBIT unless: Rents for personal property exceed 50% of total rents due under a lease Rental amount is determined by income with respect to the rented property Rental amount includes payment for the rendering of services Rental income from debt financed property RS&F: Strategic Thinking for Successful Growth 28

15 DEBT-FINANCED PROPERTY Income derived from debt-financed property is subject to UBIT The debt-financed property rules apply to rental, dividend, royalty and other types of income, as well as gains and losses, if the underlying property is considered debt financed property Debt financed property means property with respect to which there is acquisition indebtedness at any time during the taxable year RS&F: Strategic Thinking for Successful Growth 29 DEBT-FINANCED PROPERTY (CONT.) Property is not considered debt financed property if: The property is substantially used by the organization in performing its exempt function (i.e., more than 85% of the property is used for exempt purposes) The property is used to derive research income The property is acquired for prospective exempt use RS&F: Strategic Thinking for Successful Growth 30

16 PARTNERSHIPS AND S CORPORATIONS Income of a partnership is classified as subject to UBIT or exempt using the normal UBIT rules (i.e., unrelated trade or business income is taxable and passive-type income is exempt) All income from S corporations, including flowthrough income to its shareholders and gains and losses form the sale of S corporation stock is subject to UBIT RS&F: Strategic Thinking for Successful Growth 31 EXCISE TAXES AND SIMILAR TAXES ON TAX-EXEMPT ORGANIZATIONS RS&F: Strategic Thinking for Successful Growth 32

17 OVERVIEW OF TAX-EXEMPT ORGANIZATIONS An organization qualifies as a tax exempt organization if: The organization is operated exclusively for exempt purposes permitted under I.R.C. 501(c) None of its net earnings inure to the benefit any private shareholders or individuals It is approved for tax exemption by filing Form 1023 or Form 1024 RS&F: Strategic Thinking for Successful Growth 33 TYPES OF TAX-EXEMPT ORGANIZATIONS Organizations Other Than Private Foundations: Form 990 Traditional Public Charities Supporting Organizations Donor Advised Funds Other organizations exempt under I.R.C. 501(c) Private Foundations: Form 990-PF Operating Private Foundations Non-operating Private Foundations RS&F: Strategic Thinking for Successful Growth 34

18 TAXES IMPOSED ON TAX-EXEMPT ORGANIZATIONS Income Tax on Feeder Organizations Excise Tax on Net Investment Income Excise Tax on Undistributed Income Excise Tax on Excess Business Holdings Excise Taxes on Prohibited Activities Unrelated Business Income Tax RS&F: Strategic Thinking for Successful Growth 35 FEEDER ORGANIZATIONS A feeder organization is an organization operated for the primary purpose of carrying on a trade or business for profit even if all the profits are payable to a tax-exempt organization A trade or business will not include: Rental income that would otherwise be excluded Substantially all the work is performed without compensation The trade or business consists of the sale of donated merchandise RS&F: Strategic Thinking for Successful Growth 36

19 EXCISE TAX ON NET INVESTMENT INCOME The tax imposed is equal to 2% of a private foundation s net investment income Net investment income is defined as the amount by which gross investment income plus capital gain exceeds ordinary and necessary expenses The tax is reduced to 1% if the qualifying distributions for the year exceed the foundation s average distributions Exempt Operating Foundations are exempt RS&F: Strategic Thinking for Successful Growth 37 EXCISE TAX ON UNDISTRIBUTED INCOME A private non-operating foundation must distribute 5% of its net assets each year An excise tax equal to 30% of any undistributed income that was required to be distributed will be assessed on the foundation Operating private foundations are exempt from this excise tax RS&F: Strategic Thinking for Successful Growth 38

20 EXCISE TAX ON EXCESS BUSINESS HOLDINGS An excise tax is imposed for private foundations and donor advised funds owning 20% or more of a business enterprise The permissible ownership is 35% if the business is controlled by a third party The tax imposed is equal to 10% of the value of the excess business holdings (200% if not corrected) Special rules apply to permit dispositions of gifts and bequests RS&F: Strategic Thinking for Successful Growth 39 POLITICAL AND LOBBYING ACTIVITIES Certain political and lobbying activities conducted by tax-exempt organizations will be subject to excise taxes A private foundation and its foundation manager will be subject to taxes for amounts paid to influence legislation or influence public elections A public charity and its foundation manager are subject to excise taxes for certain lobbying expenditures and political expenditures of the organization RS&F: Strategic Thinking for Successful Growth 40

21 PRIVATE BENEFIT TRANSACTIONS Additional excise taxes are imposed for the following prohibited activities: Private foundations and disqualified persons are subject to excise taxes for self-dealing transactions Donor advised funds are subject to excise taxes for distributions for the benefit of an individual or made for a non-exempt purpose, and for distributions that result in a donor or donor advisor receiving more than an incidental benefit All tax-exempt organizations are subject to tax on excess benefit transactions RS&F: Strategic Thinking for Successful Growth 41 Questions? Contact: David S. Rosen, Esq., CPA RS&F Business Consultants and Certified Public Accountants 300 Red Brook Blvd., Ste. 200 Owings Mills, MD (410) davidr@rsfchart.com RS&F: Strategic Thinking for Successful Growth 42

22 ABOUT RS&F RS&F is a regional business consulting and accounting firm that caters to middle-market businesses, nonprofit organizations and high net worth individuals throughout the Mid-Atlantic region RS&F provides a wide array of services through its various practice groups: Strategic Business Advisory Business Consulting High Net Worth Services Accounting Tax Valuation and Litigation RS&F: Strategic Thinking for Successful Growth 43