{"id":16395,"date":"2019-07-25T08:00:06","date_gmt":"2019-07-25T13:00:06","guid":{"rendered":"https:\/\/taxprocenter.proconnect.intuit.com\/?p=16395"},"modified":"2019-07-23T07:34:44","modified_gmt":"2019-07-23T12:34:44","slug":"taxing-nonprofits-changes-in-unrelated-business-income","status":"publish","type":"post","link":"https:\/\/accountants.intuit.com\/taxprocenter\/tax-law-and-news\/taxing-nonprofits-changes-in-unrelated-business-income\/","title":{"rendered":"Taxing Nonprofits: Changes in Unrelated Business Income"},"content":{"rendered":"

When the Tax Cuts and Jobs Act<\/a> (TCJA) was signed into law, most of the coverage revolved around changes in deductions and massive tax rate changes that affected almost every for-profit business and individual in America. Few noticed, at least initially, the changes made to the law affecting nonprofits. However, it turns out that seemingly small changes are having a huge impact; thousands of nonprofits that have never worried about taxation may now owe unrelated business income tax (UBIT) and must file Form 990-T<\/a>, Exempt Organization Business Income Tax Return<\/i>.<\/p>\n

While several TCJA changes impact nonprofits, the following are receiving significant attention:<\/p>\n

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  1. Nonprofits with more than one unrelated trade or business activity can no longer net activities when computing taxable income. This means that nonprofits cannot use a loss in one unrelated trade or business activity to lower taxable income in another. While this will affect some larger nonprofits, it is the second change that is causing a stir in the nonprofit community and will be the focus of this article.<\/li>\n
  2. Nonprofits are now required to pay tax on certain fringe benefits, including parking, given to employees. In a study<\/a> by The Urban Institute in November 2018, 40 percent of responding nonprofits reported they provided transportation fringe benefits in some form to their employees. Under TCJA, these nonprofits may now need to file a 990-T and may well owe taxes for the first time.<\/li>\n<\/ol>\n

    Whether you specialize in nonprofit tax, sit on a board or only have a handful of clients, you\u2019ll want to understand UBIT before and after these changes. In addition, the amount of tax your clients owe really depends on the nonprofit’s home state.<\/p>\n

    Upset About UBIT? Blame Pasta!<\/b><\/p>\n

    Before 1950, tax-exempt organizations could earn tax-free income on all activities, even commercial enterprises, as long as the funds raised were used for tax-exempt purposes. Enter C.F. Mueller Company, the pasta maker. In 1947, a group of alumni donated the company to New York University Law School. The company\u2019s earnings were to be solely for the benefit of the school; in turn, the company stopped paying income tax, claiming it was now a tax-exempt organization. The IRS challenged the company in court, but it won, and because its profits were used to further the school\u2019s tax-exempt purpose, no tax was owed.<\/p>\n

    For-profit entities cried foul, claiming this gave nonprofits the ability to compete directly with for-profit businesses with the unfair advantage of not being taxed on the income. In response, Congress enacted a law in 1950<\/a> to begin taxing nonprofits engaging in commercial activities unrelated to the organizations\u2019 tax-exempt purpose. Since then, additional legislation was enacted and guidance issued to ensure nonprofit compliance.<\/p>\n

    The UBIT law applies to mostly any entity that is exempt from tax. In addition to organizations excluded under IRC Sec. 501(a) — charities, religious organizations, state and municipal colleges and universities, and scientific organizations — certain tax-favored vehicles, including pensions, IRAs, SEPs, 529 plans, medical savings accounts and Coverdell Savings Accounts, are also included.<\/p>\n

    The Traditional Part of UBIT: Unrelated Trade or Business Activity<\/b><\/p>\n

    As with most of tax law, UBIT rules are initially fairly straightforward. Activities considered taxable must meet three conditions:<\/p>\n

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    1. They are considered a \u201ctrade or business\u201d activity.<\/li>\n
    2. They are \u201cregularly conducted.\u201d<\/li>\n
    3. They are not \u201csubstantially related\u201d to an entity\u2019s tax-exempt purpose.<\/li>\n<\/ol>\n

      All three conditions must be true, unless the organization is otherwise specifically exempt (more on that later). Make the argument that even one condition doesn\u2019t apply, and you have avoided UBIT for that activity. Let\u2019s drill down a bit into each of these.<\/p>\n

      Trade or business<\/b>: If a product or service is sold with the intent to make a profit, then you typically have a trade or business for purposes of UBIT; however, this isn\u2019t always the case. Selling t-shirts at an event? As long as the price is roughly the same as the cost, including overhead, it seems logical that a profit motive doesn\u2019t exist. However, just because a specific for-profit activity is part of a larger tax-exempt activity does not make the activity tax-exempt. Selling ads in a periodical that contains articles related to an organization\u2019s tax-exempt purpose does not make the ads tax-exempt.<\/p>\n

      Regularly conducted<\/b>: Here, frequency and continuity of comparable commercial activities are examined. For example, one organization may sell sandwiches at a local state fair for two weeks a year; that\u2019s certainly not what other vendors do that sell food at the same fair — they may sell year-round at other fairs. In this organization\u2019s case, this makes the activity tax-exempt. The idea is to only tax activities that are in direct competition with for-profit entities.<\/p>\n

      Not substantially related<\/b>: If the activity doesn\u2019t contribute in an important way to the organization\u2019s tax-exempt purpose, then it is not substantially related and may be subject to tax. Remember that merely providing funds to the organization is not enough. The activity must further the organization\u2019s exempt purpose.<\/p>\n

      In IRS Publication 598<\/a>, Tax on Unrelated Business Income of Exempt Organizations<\/i>, there is a list of examples of activities that were determined to be (or not to be) unrelated trades or businesses, based on the facts and circumstances of the specific activity. Here are a few examples:<\/p>\n