Charity UBIT Guide: Tax Rules for Unrelated Business Income

Unrelated Business Income
Tax Information for Charities
and Other Nonprofits

Joe Giso, CPA, MST
Director in the Not-for-Profit & Education Tax
Practice

September 24, 2012

Agenda

I. Definition of Unrelated Business Income (UBIT)
A. History
B. Basic Principles
C. Tax Rates, Tax Forms and Organizations Subject to UBIT

II. What Income Is Subject to UBIT?
A. Substantially Related Income
B. Specifically Excluded Income
C. Debt Financed Property
D. Rents From Real Property Based On Net Profit

III. Alternative Revenue Sources
A. Website Activities
B. Acknowledgments or Sponsorship vs. Advertising
C. Digest of Published Rulings
D. Supplemental Information

1

Definition of Unrelated Business Income (UBIT)

I.A. History and Background

• Current State of Events:
 ―As part of an inquiry conducted last year, Grassley and his
colleagues discovered that the Boys and Girls Clubs of America held
more than $50 million in off-shore equity and partnerships, including
hedge funds and limited partnerships. This included funds held in the
Cayman Islands, British Virgin Islands, and Bermuda. When asked why
the money was held off-shore, the organization said the answer was to
avoid paying unrelated business income tax under the Internal Revenue
Code. WRONG ANSWER!

 The IRS is also scrutinizing whether the large endowments held by
universities and colleges are properly paying taxes due on income
related to debt financing.

 IRS ―College and University Compliance Check Questionnaire‖
 The questionnaire solicited detailed information on governance,
executive compensation, endowments, and unrelated business income:
40 percent on UBIT. 2



• Current State of Events:
 The New Champion of Not for Profits! Congressman Charles W.
Boustany Jr., MD (R-LA), Chairman of the Subcommittee on Oversight
of the Committee on Ways and Means.
 Hearings examining operations and oversight of tax-exempt
organizations
 May 16, 2012- First in a series of hearings by the Subcommittee on the
tax-exempt sector and IRS oversight of tax-exempt activities.
 “In my letter to the IRS last October, I asked the IRS about recent
efforts to address certain concerns that have been raised
regarding the operation of tax-exempt organizations, including
corporate governance issues and mishandling of funds by
officers.”
 July, 25, 2012- Second in its series of hearings on tax-exempt
organizations, this time examining the revised Form 990, reasons for
the increasing organizational complexity of public charities, including
unrelated business income tax issues, and their effect on transparency
and tax compliance.
3


 Dual Test: An organization has to be both "organized" and "operated"
exclusively for one or more IRC 501(c)(3) purposes. Fail either and it is not
exempt.

 The organizational test concerns the organization’s articles of organization
or comparable governing document.

 The operational test relates to the entity’s activities. A deficiency in an
entity’s governing document cannot be cured by the entity’s actual
operations. ―Substance over Form.‖

 Outcomes that may arise if an entity conducts a trade or business.
– The entity may be subject to the UBIT.
– The entity may be denied tax-exempt status if the trade or business
constitutes the primary purpose of the entity.
4



 Court cases focused on if the activities are a) incidental in nature; b)
time/resources used in the activities; c) total receipts/expenses; and d) the
importance of the activity to the exempt entity. Fact and Circumstance.

 The principal stumbling block was the "destination of income" test. US
Court in Trinidad v. Sagrada Orden de Predicadores, (1924)
– ―the destination and not the source of the income was the ultimate test
of the right of exemption.‖

 As a subsidiary of the New York University School of Law, the Mueller
Macaroni Company paid no income taxes. (C.F. Mueller Co. v.
Commissioner, 190 F.2d 120 1951). It all began with pasta!

 Why? Eliminate unfair competition between tax exempt
organizations and for profit entities.

5


I.B. Basic Principles

 UBI is income from a regularly-carried-on trade or business that is not
substantially related to the organization’s exempt purpose.

 To find out if an activity of your 501(c)(3) generates UBI, conduct the UBI
test.

 With this three-part test, you’ll determine whether the activity is:
– A trade or business
– Regularly carried on
– Not substantially related

 The IRS will consider each separate line of merchandise in its search for a
nexus between items sold and the exempt purpose. The "fragmentation"
rule.

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 The key issue when assessing liability for UBIT is whether or not it is
substantially related to its exempt purpose.

 There must be causal relationship between the activities of producing or
distributing the goods or performing the services involved and the
accomplishment of the entity’s exempt purpose. What is the primary
purpose of sale?
– ―Merely imprinting an object with the museum's name was insufficient to establish a
substantial causal relationship.‖ (TAM 9550003, 9/18/1995).

Note: most holiday cards, hats, aprons or other objects with entity’s name or
logo only will be considered UBIT. Merchandise sales can mean big
business.

7



 Part 1: Is your activity a trade or business?

 The first part of the UBI test is to determine if your activity is a trade
or business.
1) A trade or business
2) Regularly carried on
3) Not substantially related

 If your organization is selling goods or services to generate income,
even if it is conducting the activity within a larger group of activities
related to its exempt purpose, the activity is a trade or business.

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 The term "trade or business" generally includes any activity carried on for
the production of income from selling goods or performing services.

 Business activities of an exempt entity ordinarily are considered "regularly
carried on" if they show a frequency and continuity, and are pursued in a
manner similar to comparable commercial activities of nonexempt
organizations.

 Trade or business is related to exempt purposes, in the statutory sense,
only when the conduct of the business activities has causal relationship
to achieving exempt purposes (other than through the production of income)
– Important factor to consider is whether a profit motive exists. American Bar Endowment v.
United States, 477 U.S. 105 (1986).

9




 Examples:
– Hospital pharmacy furnishes supplies to the hospital, but it also sells to the
general public. Sales made to the public are treated as an unrelated trade or
business.
– Tax-exempt solicits, sells, and publishes advertisements for commercial vendors
in its publication. Publication contains exempt content, the advertising is still an
unrelated trade or business.
– Tax Court in Veterans of Foreign Wars v. Commissioner, 89 T.C. No. 2 (1987),
found that the organization’s Christmas card program was in direct competition
with Christmas cards marketed by commercial entities.
– In Hope School v. US, the court strongly endorsed the concept of unfair
competition as an essential element in the analysis of unrelated business taxable
income. The court concluded by stating: "We find no problem with unfair
competition in this case." Greeting card business.

10


 Part 2: Is your activity regularly carried on?

 Regs: "specific business activities of an exempt organization will be deemed
to be regularly carried on if they manifest a frequency and a continuity, and
are pursued in a manner, generally similar to comparable commercial
activities of nonexempt organizations."

– Key : Is the frequency in which for-profit operates.

 Regs 1.513–1(c)(2)(i) examples - operation by tax exempt of:
– sandwich stand for only two weeks at a fair, not a trade or business. For
profit generally operates year-round.
– a commercial parking lot on Saturday of each week year-round would
be trade or business. For profit - same basis.

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 Part 3: Is the activity not substantially related?

 The last part of the UBI test is to decide whether the activity is substantially
related to furthering the exempt purpose.

 Sometimes, activities that ARE related to exempt purposes can still
generate UBI if they are conducted on a larger scale than is reasonably
necessary to perform an exempt function.

 The activity engaged in by the organization may be commercial and not be
subject to the UBIT, as long as the activity is substantially related to the
exempt purpose.

12



 Part 3: Is the activity not substantially related?

 Examples:
– Rev. Rul. 73-127, NFP formed to operate a cut-rate retail grocery store in a
poverty area, and to provide job training for unemployed residents. While the
store operation is used in part "as a vehicle for the training program,"
nevertheless, it is "conducted on a scale larger than is reasonably necessary.‖
– Rev. Rul. 75-472, NFP that operated a halfway house and a furniture shop. Any
profits realized from the furniture shop operations were applied toward the cost of
operating the halfway house. The furniture shop's activities were related to the
NFP’s purpose; therefore, the NFP did not have unrelated trade or business
income.
– Rev. Rul. 76-94, held that the operation of a retail grocery store by a NFP, as
part of its therapeutic program for emotionally disturbed adolescents, was not
unrelated trade or business income.

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I.C. Tax Rates, Tax Forms and Organizations Subject to UBIT

 All organizations subject to UBIT are taxable at corporate rates.

 The foreign tax credit is available to organizations filing Form 990–T. If an
exempt organization is eligible for such a credit, it must compute the
limitations upon the credit on the basis of its unrelated business taxable
income.

 An investment credit under IRC 38 is available for property used
predominantly in an unrelated trade or business, the income of which is
subject to tax.

 Various other credits are also available.

14



 What to File
– Report UBI using Form 990-T, Exempt Organization Business Income Tax
Return.
– Form 990-T is required in addition to the regular Form 990, 990-EZ, or 990-PF
(for private foundations).

 Who Must File
– Any tax-exempt organization with a gross income of $1,000 or more for any tax
year from the conduct of unrelated trade or business must file.

 When and Where to File
– File Form 990-T no later than the 15th day of the 5th month following the end of
the organization’s accounting period. For example, a calendar year end of
December 31 would require you to file form 990-T by May 15 of the following
year.
– Where: IRS, Ogden, Utah 84201
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 Interest and Penalties
– Late returns or failure to pay tax when due can result in interest and
penalty charges. Generally, you are not required to include the interest
and penalty charges on Form 990-T.

 The filing of Form 990 by an exempt organization does not start the running
of the statute of limitations for purposes of Form 990–T, unless Form 990
discloses sufficient facts to apprise the Service of the potential existence of
unrelated business taxable income. California Thoroughbred Breeders
Association v. Commissioner, 47 T.C. 335 (1966) and Rev. Rul. 69-247

 Public Disclosure:
– An exempt organization under 501(c)(3) must make available for public
inspection and copying any Form 990-T filed after August 17, 2006.

16

What Income Is Subject to UBIT?

II.A. Substantially Related Income

 Factual question: Is there a relationship between activity and
accomplishment of organization’s exempt purpose? Direct relation to the
NPO’s exempt purpose.
– IRS compares incorporation documents and operations
– New activities should be reviewed to ensure consistency with exempt purpose

 Just because an activity raises needed funds for the NPO does not mean, in
the eyes of the IRS, that the activity is exempt

 Examples of exempt income:
1. Tournaments held by an organization formed to promote such events
2. Operation of a cafeteria, coffee shop, gift shop and parking lots by a hospital
3. Sale by a museum and its gift shop of greeting cards reproducing art works.
– Note: If this unrelated business taxable income (UBTI) becomes ―substantial‖ (a term not
defined by the IRS), the NPO could even lose its exempt status.

17


II.B. Specifically Excluded Income

 Publication 598, Tax on Unrelated Business Income of Exempt
Organizations, lists many of the excluded trade or business
activities such as the ones described below:

1. Volunteer workforce - IRC § 513(a)(1)
2. Convenience of members - IRC § 513(a)(2)
3. Sale of donated merchandise - IRC § 513(a)(3)
4. Distribution of low-cost articles - IRC §513(h)(1)(A)
5. Convention or trade show activity - IRC §513(d)(1), (3); Regs. §1.513-3
6. Sponsorship - IRC § 513(i)(1)
7. Traditional bingo - IRC §513(f); Regs. §1.513-5
8. Mailing lists - IRC 513(h)(1)(B)

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 Volunteer workforce
Income from any trade or business where uncompensated volunteers
perform 85% or more of the work for the NFP is exempt from UBIT.

 Convenience of members
Trades or businesses operated primarily for the convenience of members,
students, patients, employees, or officers are also exempt.
– For example, a college laundry facility used to launder dormitory linens and
students’ clothes is not an unrelated trade or business and therefore not subject
to UBI tax.

 Sale of donated merchandise
When an exempt organization sells merchandise, substantially all of which
was donated as gifts or contributions, the activity is not considered an
unrelated trade or business.
– This exception can apply to national and local thrift stores, as well as to
501(c)(3)s that conduct yard sales in which substantially all merchandise sold
was donated.
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 Distribution of low-cost articles
When soliciting donations through the mail, NFPs include incidental items
like greeting cards to encourage the recipient to make a donation. The
recipient is allowed to keep the item.
– Contributions received in this manner will not be included in the UBI tax
calculation.
– It must be ―low-cost.‖ Adjusted annually. 2012-$9.90

 Convention or trade show activity
Many NFPs regularly conduct activities in conjunction with a convention,
annual meeting, or trade show. The purpose of these activities must be to
either:
– Promote and stimulate interest in the products and services of the exempt
organization or its community, or
– Educate attendees about issues of the organization’s industry.
– An example of income from a qualified activity is the rental fee charged to an
exhibitor for booth space at an annual meeting of the exempt organization.
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 Sponsorship
To qualify as income from sponsorship, payments received:
– Can only buy an acknowledgment of the contributor’s name, logo, or product line.
– Can’t be used to advertise products or services. NO qualitative statement.

 Traditional bingo
To qualify for a special tax exception, it must be:
– Traditional type of bingo, not scratch-off or pull-tab games. In order to qualify as
―traditional bingo,‖ the wagers must be placed, winners must be determined, and
prizes must be awarded in the presence of all persons playing in that game.
– Legal under state and local law.
– Not ordinarily carried out on a commercial basis. If for-profit entities can legally
conduct bingo in a particular jurisdiction (usually the entire state), then bingo
games conducted by NFPs in that jurisdiction would not qualify for the ―bingo
exception.‖

21



 Exclusions
The Code excludes from tax some types of income that might
otherwise meet the UBI test:
– Interests and dividends - IRC § 512(b)(1)
– Rents from real property - IRC § 512(b)(3)
– Royalty income - IRC § 512(b)(2)
– Gains or losses from the sale of property - IRC § 512(b)(5)
– Research - IRC § 512(b)(7)-(9) – ―Not testing‖
 Interests, dividends, and other income from routine
investments:
– Interest from bank accounts,
– Annuities,
– Payments with respect to securities loans, and
– Any other incomes from routine investments which the IRS determines
are largely similar to these types of income.
22



 Royalty income is another allowable exclusion. IRC § 512(b)(2)
– A royalty is the money paid for the use of a right like a trademark, trade
name, or copyright. Similarly, payments for the use of an athlete’s
name, photo, likeness, or facsimile signature are also considered
royalties.

– Right is used by someone other than the owner of that right.

– Be careful not to confuse royalties with payments for services. For
example, payments for interviews or personal appearances with an
athlete cannot be excluded from the UBI tax calculation.

 Gains or losses from the sale of property —like gains on the sale of
stock held by the organization as an investment—can be excluded. No
exclusion for inventory and property held primarily for sale in the course of a
regular trade or business.
23


II.C. Debt Financed Property

 You can normally also exclude rents from real property, including
elevators and escalators, when calculating UBI.
– For example, let’s say your 501(c)(3) rents out an assembly hall for
special events. Provided you wholly own the building and provide no
additional services such as bartending, you can exclude the rental
received from your taxable income.

 However, the exclusion does not apply to:
– Rents from personal property,
– Rents from real property based on net profit,
– Rents from real property when personal services are provided, or
– Rents from debt-financed real property.

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 For each debt-financed property, the unrelated debt-financed income is a
calculation as detailed below:

– The average acquisition indebtedness with respect to the property for the tax year of the
property's average adjusted basis for the year (the debt/basis percentage):

Average acquisition X Gross income from = Unrelated debt
Indebtedness debt-finance property financed income
Average adjusted basis

 Unrelated trade or business decreases as indebtedness decreases.
– X owns an debt-financed office building. The building produces $10,000 of gross
rental income. The average adjusted basis is $100,000, and the average
acquisition indebtedness is $50,000. The debt/basis percentage is 50% (the ratio
of $50,000 to $100,000). The unrelated debt-financed income is $5,000 (50% of
$10,000).

25



 If property is converted to a use which results in treatment as debt-financed
property, the outstanding principal indebtedness with respect to such
property is thereafter treated as ―acquisition indebtedness.‖

 The deductions allowed with respect to each debt-financed property are
determined by applying the debt/basis percentage to the sum of the
deductions allowable.
 To be ―directly connected with‖ debt-financed property or the income there
from, an item of deduction must have proximate or primary relationship to
such property or income.

 Expenses, depreciation, and similar items attributable solely to such
property qualify for deduction, to the extent they meet the above
requirements. Reasonable Allocation Method

26



 Under § 514(c)(9), certain categories of exempt organizations are excused
from the debt-financed property rules with respect to the acquisition and
improvement of real property.

 Specifically, the term ―acquisition indebtedness‖ does not include
indebtedness incurred by a qualified organization in acquiring or improving
real property.

 The following types of exempt organizations (three others not covered) are
qualified organizations for purposes of this exception:

– Educational organizations described in § 170(b)(1)(A)(ii);

– Qualified trusts under § 401

27



 The first category of qualified organizations includes educational
organizations described in § 170(b)(1)(A)(ii).

 Normally maintains a regular faculty and curriculum and normally has a regularly enrolled
body of pupils or students in attendance at the place where its educational activities are
regularly carried on.
 The primary function of an educational organization must be the presentation of formal
instruction.

 Include the traditional educational institutions such as primary and
secondary schools, preparatory schools, high schools, colleges, and
universities

 Other instructional organizations may also qualify, however, if they maintain
a regular faculty, curriculum, and student body.
Note: Rev. Rul. 73-434, 1973-2 C.B. 329-Survival skills school. Rev. Rul. 67-447, 1967-2 C.B. 121
-Ballet school.
28



 The second category of qualified organizations includes any § 401 qualified
trust
 Stock bonus, Pension, or Profit-sharing plan of an employer for the exclusive benefit of
employees and their beneficiaries.

 A qualified plan must satisfy numerous requirements under IRC and ERISA.
Note: PLR 200318076 (qualified plan).

 The application of § 514(c)(9) is restricted by the operation of five
limitations set forth in § 514(c)(9)(B). This special treatment does not apply
if:
– The acquisition price is not fixed;
– The debt is contingent;
– The property is leased back to the seller;
– The real property is acquired from or leased to a related party;
– The seller provides financing; or
– The property is held by a partnership or other pass-through entity that does not allocate items of deductions,
losses, and income in accord with special rules.
29


II.D. Rents From Real Property Based On Net Profit
 IRC 512(b)(3) excludes all passive rents from tax. Not an active business.

 Where the real or personal property rentals are measured by reference to
the net income or profits from the property, the total rent from real and
personal property is taxed.

 However, a lease based on a fixed percentage of the gross receipts or sales
will not be taxed solely by reason of such lease.

 Example: an exempt agricultural society conducted an annual fair and also
rented its fair grounds to a horse sales company. Under a lease agreement, the
exempt organization was paid 10 percent of the first $10,000 of the lessee
organization’s yearly net profits from sales conducted on the premises, 20
percent of the next $10,000, and 25 percent of all net profits in excess of
$20,000. The court held that the rents are based on a percentage of the lessee’s
net profits and, therefore, in accordance with IRC 512(b)(3)(B)(ii), are not
excluded in computing the tax on unrelated business income.

30

Alternative Revenue Sources

“I get this on a daily basis!
And these are legitimate sites…for the most part”.

31


III.A. Website Activities
1) Ensure Accuracy
A. Your website is an open file. Make sure your content is accurate and
corresponds with your traditional hard copy records.
B. Make sure there is a screening process for online content.

2) Register Your Organization
A. Trademark
B. Copyright

3) Various Consumer Privacy Protection Legislation – MA Data Breach Law

4) Backup or Disaster Recovery Policy and Procedures

5) Linking and Liability Issues

32


 IRS personnel have been trained to look at your website for
unrelated business income and other tax and non-tax issues.

 No restrictions on access. Cost-effective way to audit. No
unnecessary field visits. Agents can audit you from virtually
anywhere!

 Internet issues:
– Website ―advertising‖ versus ―corporate sponsorships‖
– Website solicitation of contributors
– Links (such as to a business) and banners
– Merchant affiliate programs
– Lobbying
– Unrelated Business Income Tax
Note: The IRS has stated, “the use of the Internet to accomplish a particular task does not change the
way the tax laws apply to that task. Advertising is still advertising, and fundraising is still
fundraising.” 33


The latest and greatest from the IRS!

 ―Excuse me? You want what?‖

 Whatever happened to the ―Paperwork Reduction Act (44 U.S.C. 3501
et seq.)”?

 The IRS is not “Green Friendly”. You heard it hear first.

34


 Announcement 2000-84, I.R.B. 2000-42, 385: Request for
Comments

 ―Exempt organizations use the Internet to carry on activities that otherwise can
be conducted through other media, such as radio or television broadcasts, print
publications, or direct mailings. The growing use of the Internet by exempt
organizations raises questions regarding whether clarification is needed
concerning the application of the Code to Internet activities.‖

1. General Issues
2. Political and Lobbying Activities
3. Advertising and Other Business Activities
4. Solicitation of Contributions

35


 Announcement 2000-84, I.R.B. 2000-42, 385:

– 3. Advertising and Other Business Activities

 To what extent are business activities conducted on the Internet regularly carried on
under section 512? What facts and circumstances are relevant in determining
whether these activities on the Internet are regularly carried on?

 Are there any circumstances under which the payment of a percentage of sales from
customers referred by the exempt organization to another website would be
substantially related under section 513?

 Are there any circumstances under which an online ―virtual trade show‖ qualifies as
an activity of a kind ―traditionally conducted‖ at trade shows under section 513(d)?

36



 Receive contributions from the state on a repeated and ongoing basis or a
substantial basis through website?

 E-mail messages that promote the website and target persons physically
located in that state?

 The terms ―charitable‖ and ―solicitation‖ are defined very broadly. A letter,
email, phone call, newspaper ad or website posting requesting support
from a state's residents may trigger that state's solicitation law.

 Drop down menu with all 50 states:
– Are they keeping track of where contributions are coming from?
– If a website that can be accessed by individuals in all 50 states: is there an
implied intent to solicit from all 50 states?

37


 Fully describe the organization, location and areas servicing on the web
page containing solicitation for donations.

 Bungee Institute is a Section 501(c)(3) organization fostering scientific
research and testing in the sport of bungee jumping in MA. We are a locally
based organization with our training and testing facility located on The Tobin
Bridge located in Chelsea, MA. Your generous tax-deductible donations will
help keep this sport safe and enjoyable.

 “We jump first so it won’t be your last.” Volunteers are always
welcomed and needed at our testing facility.
38



 Merchant affiliate programs
– A link from the NFP website to a merchant’s web page can be
characterized only by looking at the specific facts and circumstances.

– Some links simply state that "We receive a royalty on ...books
purchased through X bookseller.―
• The exempt organization earns a percentage of sales of exempt books as
well as a lesser commission on other purchases via the link.

– An NFP’s commissions from sales by affiliated merchants can be
analyzed using rules similar to those for merchandise sales.

– Merchandise sales items are looked at from the point of view of whether
they contribute to the NFP’s exempt purpose.

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 Merchant affiliate programs

 Question: UBTI from affiliate commissions? If a tax exempt organization
provides a link to Amazon.com from its website, and receives a commission
when its visitors buy from the store, is the income taxable UBTI?

 Example: JaneDoe.org is the website of a tax-exempt organization devoted
to knitting. It carries on its site links to knitting books that can be purchased
from Amazon.com. If a visitor clicks on one of these links, and buys a
knitting book, the resulting commission to JaneDoe.org will probably not be
UBTI, because the sale of the book is in line with the organization's exempt
purpose. If, however, on the same visit the person also buys a stereo, the
resulting commission will be UBTI. This is because the sale of the stereo is
not in line with the organization's exempt purpose of safe knitting for all
ages.

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 Another way of looking at affiliate programs is to compare them to affinity
programs.
– There are similarities in earning revenues from member use of affinity
cards and earning revenues from member purchases from certain
vendors. This construction would allow NFPs to earn tax-free revenues
from all sales to their members, not just sales of products that are in line
with exempt purposes.
– Courts have found that the fees from affinity card use represent tax-
exempt royalties from the use of an NFP’s intangibles, such as
trademarks and goodwill.

 The IRS does not agree with characterizing receipts from affinity programs
as royalties but has finally relented. IRS Exempt Organizations Division
instructed area managers not to pursue cases challenging tax exempt
organizations' affinity credit card arrangements and rentals of mailing lists.
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III.B. Acknowledgments or Sponsorship vs. Advertising

 Acknowledgements, in order to avoid being characterized as
advertisements, must have the effect of identifying the sponsor without
promoting the sponsor’s products, services or facilities.

 A ―qualified sponsorship payment‖ is a payment in exchange for which the
corporate sponsor neither gets nor expects any return benefit other than:
– Goods or services, or other benefits, the total value of which does not exceed
two percent of the sponsorship payment; or
– Recognition, i.e., use or acknowledgment of the sponsor’s name, logo, or product
lines in connection with the nonprofit’s activities.

 ―Advertising‖ includes any message containing an endorsement, qualitative
or comparative language, price information, other indications of savings or
value, or any inducement to purchase, sell, or use the sponsor’s products or
services.
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 The regs provide six acceptable actions that would avoid the "substantial
benefits realm―:
1. Listing the name or logo or product line of sponsor;
2. Awarding exclusive sponsorship award;
3. Providing logos or slogans that do not contain any qualitative language or
comparative description of the products;
4. Listing of payor's locations, addresses, phone numbers, and internet addresses;
5. Providing value-neutral descriptions of the sponsor’s product displays; and
6. Listing sponsor’s brands or trade names.

 ―Qualified sponsorship payments‖ would also include:
– The sponsor’s logo on signage at an athletic event;
– Describing the corporate partner as ―the exclusive sponsor‖ of an art exhibit or
conference in a brochure; or
– Including the sponsor’s name and logo in newspaper ads about a walkathon and
on T-shirts worn by participants.

43



 There are four items that cannot be done. If any of these items are done,
then you are relegated to traditional UBIT analysis:
1. advertising;
2. designating a sponsor as an exclusive provider;
3. providing facilities, services or other privileges to the sponsor unless they are of
"insubstantial value"; and
4. granting of either exclusive or nonexclusive rights to use sponsor’s intangible
asset (e.g., name or logo).

 Exclusivity arrangements. An arrangement that acknowledges a payer as
the exclusive sponsor of an organization’s activity (or the exclusive sponsor
in a particular trade, business or industry) will not, in and of itself, result in
the payments being taxable as substantial return benefits. However,
exclusive provider arrangements (commonplace for many colleges and
other large exempt organizations) that limit the sale, distribution, availability
or use of competing products or services in connection with an
organization’s activity will generally result in a substantial return benefit and
thus may be taxable.
44


III.C. Digest of Published Rulings
 A corporation that planned on offering consulting services for a fee to nonprofits
engaged in various rural-related activities. The court determined that the taxpayer
had completely failed to show that its own services, or the services performed by its
consultants, would not be in competition with commercial businesses such as
personnel agencies, consulting referral services, real estate agents, housing rental
services, banks, loan companies, trash disposal firms or environmental consulting
companies. B.S.W. Group, Inc., 70 TC 352, Dec. 35,175.

 An organization formed to provide managerial and consulting services for unrelated
tax-exempt organizations for the purpose of improving administration of their
charitable programs did not qualify as a Code Sec. 501(c)(3) organization. The
furnishing of services at cost fell short of the donative element necessary to classify
the activities as charitable. Rev. Rul. 72-369, 1972-2 CB 245.

 An organization controlled by a group of exempt organizations and providing them
investment, management, and other services for a charge substantially less than cost
qualified for charitable organization status under Sec. 501(c)(3). Rev. Rul. 71-529,
1971-2 CB 234.

45



 The Tax Court properly determined that proceeds received by a tax-exempt state
police association from the publication of a magazine constituted UBTI, rather than
nontaxable royalty income. The taxpayer's participation was more than de minimis.
The essence of the agreement between the publisher and the taxpayer was the
imposition of a duty on the publisher to perform on the taxpayer's behalf and under
the taxpayer's control.
– Arkansas State Police Association, Inc., CA-8, 2002-1.

 A tax-exempt organization's income from the sale of periodical and banner
advertising on its website was deemed unrelated business income, and no allocation
between periodical and non-periodical advertising was warranted.
– IRS Letter Ruling 200303062, October 22, 2002.

 An organization composed of state high school athletic and activities associations
had unrelated business income to the extent of income derived from advertising, but
not subscription, in the organization's two periodicals.
– IRS Letter Ruling 9211004, November 7, 1991.
46



 A loss resulting from an exempt organization's provision of food service to a NFP
nursing home was not allowable in computing the organization's UBIT. The food
service activity did not constitute a trade or business. It was not undertaken for the
primary purpose of producing income and was carried on temporarily for the nursing
home's convenience.
– IRS Letter Ruling 9719002, November 27, 1996.

 The investment of an exempt employees' trust as a limited partner in a partnership
carrying on an unrelated trade or business may result in unrelated business taxable
income. No distinction between limited and general partners.
– Rev. Rul. 79-222, 1979-2 CB 236.

 A broadcast tower, which was leased by an EO to a company providing paging
services, was tangible personal property. Therefore, rental income did not qualify for
the exclusion for UBTI derived from real property.
– IRS Letter Ruling 200104031, March 15, 2000.

47



 A tax-exempt educational organization's activity of renting its facilities to corporate
and business patrons for special events constituted an UBIT. The special events
were regular occurrences and did not contribute to the accomplishment of the
organization's exempt purposes.
– IRS Letter Ruling 9702003, August 28, 1996.

 Rents received by a tax-exempt organization from a parking garage did not constitute
unrelated business taxable income because the organization did not render services
to the entity that rented the garage.
– IRS Letter Ruling 8720005, February 20, 1987.

 A EO's activities in providing information about and links to third-party service
providers to its members did not qualify as an UBIT. The income received from
providing links to the third-party service providers was determined to be royalties.
Similarly, links to the Web sites of the organization's sponsors constituted an
acknowledgement and was not UBIT.
– IRS Letter Ruling 200303062, October 22, 2002.
48

Supplemental Information

III.D. Supplemental Information

 Schedule K-1 : Areas to review

49



50



51



52



53


• III.D. Supplemental Information
 Fitness Center
– A health club or fitness center is a facility containing exercise equipment and/or
facilities for activities such as jogging, squash, racquetball and swimming.
– Increasing commercial character of fitness centers operated by exempt
organizations.
– The need for clarity in produced the publication of a TAM, LTR 9803001
– Issues regarding health clubs in the exempt organization context arise in two
ways.
• First, a health club can be a part of a larger system such as a hospital
system or a university.
• Second, operating a health club can be an organization's primary activity.
– In the first instance, the question is whether the health club activity is
substantially related to an exempt purpose or whether the activity is an unrelated
trade or business . UBIT Test
– In the second instance, the question is whether the health club activity furthers
an exempt or non-exempt purpose
54


• III.D. Supplemental Information
 Fitness Center : Exempt or non-exempt purpose

1) Benefiting the Community in General - "significant segment of the local population―
TAM 8505002 and GCM 39327 involve an organization that used three methods to
establish that its health club fees were set at a level within the reach of the community as
a whole. significant percentage of families making under $15,000 were members of the
health club
2) The Promotion of Health as an Exempt Purpose – ―the promotion of health is considered to
be a charitable purpose‖
Activities promoting health are considered beneficial to the general community even
though the class of beneficiaries eligible to receive a direct benefit from such activities
does not include all members of the community, provided that the class is not so small
that its relief is not of benefit to the community. Rev. Rul. 83-157
2) Education as a Charitable Purpose – ―activities with significant instructional content are
educational or may also serve to help prevent delinquency‖
Promoting and protecting the health of high school athletes through uniform interscholastic
competition under the direction and control of school officials, and of cultivating the ideals
of good sportsmanship, loyalty and fair play. Rev. Rul. 55-587
55

Contact Information

Joe Giso, CPA, MST
 Director in CBIZ Tofias’ Not-for-Profit & Education Tax
Practice

 Over 25 years of experience in tax consulting and
compliance issues with a specialization in not-for-
profit organizations in the education, healthcare,
human services, and cultural sectors

 Direct: (617) 761-0623
 JGiso@CBIZtofias.com

56

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