Monday, September 8, 2014
Unrelated Business Income: Tax-Exempt Revenue Can Hang By a Thread
Posted by Armanino Nonprofit Team
The term ‘unrelated business income’ sounds innocuous on the surface, a kind of catchall for items accountants can’t categorize. For the nonprofit community, however, nothing could be further from the truth.
A miscalculation that moves tax-exempt revenue into the taxable realm of unrelated business income (UBI) can be devastating. The nuances are so granular, only a CPA can explain the ins, outs and ramifications. This is why my recent webinar presented more than a dozen case studies to explain the subtleties nonprofits need to master to stay on the right side of IRS rules.
The whole area of UBI stems from concerns raised more than 50 years ago by for-profit entities over what they characterized as unfair competition from tax-exempt entities. To level the playing field, Congress moved from considering the use of the revenue to considering the source.
The test for falling out of tax-exempt status involves three elements, all of which must be present:
- The activity must not be substantially related to the tax-exempt purpose
- It must be a trade or business
- And it must be regularly carried on
Is a hospital cafeteria substantially related to the mission of the hospital? How about a college that leases unused land for a cell phone tower? How about a fundraising gala or that Christmas tree lot on the corner?
These are tricky issues, with lots of variables. In addition, these nuances often have to be sorted out by the courts, resulting in a complex set of exceptions and modifications.
Nonprofits can slip into UBI territory without even knowing it. Watch those hyperlinks. The IRS is on the lookout for links that lead to pages that can be classified as advertising or political content. That’s enough to poison a whole partnership and make any revenues taxable. And that can really hurt at a time when nonprofits are watching every penny.
To hear some additional scenarios and learn more about UBI, click here to access my recent webinar presentation and recording.
Nonprofit organizations have specialized audit, tax and operational needs that require specialized service. Armanino has been committed to the nonprofit sector since 1953, and we now work with more than 500 nonprofit clients. This hands-on experience gives our staff of CPAs and former CFOs a deeper understanding of the issues nonprofits face, so we’re able to meet their needs and help them fulfill their missions in the most efficient, cost-effective way possible.