When Investment Income Counts as UBI
Jeff Chiles, CPA, MST
Dividends, interest, rents, annuities and other investment income are generally excluded when calculating unrelated business income tax (UBIT). However, tax law provides two exceptions where such income will be deemed taxable. And, with IRS scrutiny of unrelated business income intensifying these days, not-for-profit organizations need to know about these potential pitfalls.
When a not-for-profit organization incurs debt to acquire an income-producing asset, the portion of the income or gain that’s debt-financed is generally taxable as unrelated business income (UBI). Such assets are usually real estate — for example, an apartment building with income from rents not related to the organization’s mission. However, the assets could also be stocks, tangible personal property or other investments purchased with borrowed funds.
Income-producing property is debt-financed if, at any time during the tax year, it had outstanding “acquisition indebtedness” — debt incurred before, during or shortly after the acquisition (or improvement) of property if the indebtedness would not have been incurred but for the acquisition.
Certain property, however, is exempt from this treatment:
Related to exempt purposes. If 85% or more of the use of the property is substantially related to a not-for-profit organization’s exempt purposes, it is not excluded as debt-financed property. Related use cannot be solely to support the organization’s need for income or its use of the profits.
Used in an unrelated trade or business. To the extent that income from a property is treated as income from an unrelated trade or business, the property is not considered debt-financed, as the income is already UBI.
Used in certain excluded activities. Debt-financed property does not include property used in a manner that is excluded from the definition of “unrelated trade or business” either because it is used in research activities or because the activity has a volunteer workforce, is conducted for the convenience of members, or consists of selling donated merchandise.
Covered by the neighborhood land rule. If a not-for-profit organization acquires real property intending to use it for exempt purposes within 10 years, the property will not be treated as debt-financed property as long as it is in the neighborhood of other property the organization uses for exempt purposes. The latter exception applies only if the intent to demolish any existing structures and use the land for exempt purposes within 10 years is not abandoned.
Income from Controlled Organizations
Interest, rents, annuities and other investment income are not excluded from UBI if they are received from a for-profit subsidiary or controlled not-for-profit organization. The payment is included in the parent organization’s taxable UBI to the extent it reduces the subsidiary organization’s net taxable income or UBI.
The IRS generally considers a corporation to be “controlled” if the other organization owns more than 50% of the “beneficial interest” — either stock in a for-profit or voting board positions in a not-for-profit. For example, if a for-profit leases space from an organization that owns more than 50% of its stock, the lease payments are valid deductions from taxable income. However, when these lease payments are received by the controlling not-for-profit organization, they are not excluded from UBI.
Proceed with Caution
Failing to pay UBIT on debt-financed property or income from controlled organizations could have negative consequences, ranging from taxes, penalties and interest to, in extreme cases, the loss of tax-exempt status.
Newsbits: Summer 2016
Kelly Buchheit, CPA
Microsoft Offers Not-For-Profit Organizations Free Cloud Services
Microsoft’s philanthropic arm has announced that it will donate $1 billion in cloud computing resources over the next three years to not-for-profit organizations and nongovernmental organizations worldwide. The donation is part of an initiative that includes providing a suite of Microsoft cloud services, expanding access to cloud resources for 900 faculty researchers at universities and reaching 20 underserved communities in 15 countries with broadband connectivity and cloud services. Microsoft’s goal is to serve 70,000 not-for-profit organizations through one or more of the offerings in its cloud services suite by the end of 2017. The company will focus on increasing that number in subsequent years. Organizations must work through TechSoup (Microsoft’s partner in the donation program) to satisfy a variety of eligibility requirements to participate.
Report Details Volunteerism Efforts
According to the annual “Volunteering and Civic Life in America” report issued by the Corporation for National and Community Service and the National Conference on Citizenship, approximately one in four Americans, or 25.3%, volunteered with an organization in 2014 — which has remained relatively consistent over the past decade.
In addition, 62.5% of Americans engaged in informal volunteering in their communities. For example, helping neighbors with tasks such as babysitting shopping or house sitting. Notably, the research also found that volunteers are almost twice as likely to donate to charity as non-volunteers. Organizations can use information in this report to help fine-tune your volunteer program. To keep your numbers healthy, you can find out more about your volunteers’ skills and interest, and then assign them to tasks accordingly. You can also offer incentives for volunteering, such as increased visibility and recognition and free admittance to your events.
Not-For-Profit Organizations Warned About E-mail Scam
According to published reports, more than two dozen Virginia organizations, as well as organizations around the country, received e-mails from an individual in England, unknown to the organizations, offering an approximately $30,000 donation.
Here’s how the check-kiting scheme works: After receiving the original e-mail, the not-for-profit organization gets a check for $40,000. Another e-mail arrives concurrently, saying that the overpayment is the result of a clerical error and asking the not-for-profit to return the excess payment. A victim organization might deposit the check and not know for several days that it bounced, during which time it might send a $10,000 “refund,” money that will never be seen again.
You should maintain a healthy level of professional skepticism when responding to any unknown correspondence regarding donations or other business matters. It could happen to anyone.