Summary of Federal Laws
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Miscellaneous Tax Issues
Unrelated Business Income Tax
26 U.S.C. § 511(a)(2); 26 C.F.R. §§ 1.511-1 to 1.513-4
Income from an activity that is a trade or business, regularly carried on, and not substantially related to the conduct of the institution's educational or scientific research purposes will be considered unrelated business income and is taxable. The IRS has opined that income derived by a college or university from fees received by alumni or the general public is unrelated business income. Those items sold by the university to students, faculty and staff that are required or otherwise necessary for courses of instruction or fall under the "convenience exception" will not constitute unrelated business income. With the exception of items that have the university logo affixed, the IRS takes the position that non-educational items with a useful life of more than one year are subject to the unrelated business income tax (UBIT). The IRS holds that an institution must have an accounting system in place to deal with sales that are subject to UBIT and those that are not subject to UBIT.
Use of university facilities in unrelated activities will be subject to UBIT. Mailing list income is not subject to UBIT if the list is sold or exchanged to other exempt organizations. A corporate sponsorship issue arises when a company makes a gift to the school and in return receives certain publicity and exposure beyond a mere acknowledgment of the payment. The IRS will closely examine the relationship between the university and any related entity that has potentially unrelated business activities.
Group operated solely for purpose of travel tours not exempt and tours are UBIT, PLR 201031034; IRS release date 5/10/10
IRS Revenue Ruling 2004-51 (2004-22 IRB June 1, 2004) On UBIT and Joint Ventures with For Profit Entities: This ruling dealt with a joint venture between a university and a for profit and stated that equal ownership of a joint venture would not result in distributions to the university being subject to UBIT. In this fact setting, the university's participation was an insubstantial part of the university's activities.
Notice 2007-45 Interim Guidance on the new requirement (from the Pension Protection Act) for 501(c)(3) organizations to disclose to the public Form 990-T, Exempt Organization Business Income Return (for UBIT).
The public disclosure requirements apply to all 501(c) (3) organizations, and also apply to those state colleges and universities that have dual status as a 501(c) (3) and 115 organization. (For the time being, Form 990-T Public disclosure requirements apply to state colleges and universities that have received determination letters from the IRS granting them 501(c) (3) status, but do not apply to those state colleges than have not received a formal determination letter.) Under 26 CFR §301.6104 (d)-1 an organization that makes the Form 990-T widely available, such as posting it on the internet, does not need to fill individual requests for the return. The exact image of the return must be posted on the internet to meet this exception. Penalties apply to organizations and officers that do not make the return available.
Websites and UBIT: Advertising or Qualified Sponsorship Payments?
The following summary by Sean P. Scally, University Counsel and Tax Attorney, Vanderbilt University, addresses an Oct. 22, 2002 IRS ruling, released Jan. 20, 2003.
In what appears to be the first ruling of the new year pertaining to Unrelated Business Income Tax (UBIT), the IRS has delved into the thorny and complicated area of Internet website "hot" links and banner advertising. Although dated October 22, 2002, the ruling was just released Monday. PLR 200303062, 2002 PRL LEXIS 1607. The ruling involves an exempt organization recognized under IRC 501(c)(5), which is a section covering "labor, agricultural, or horticultural organizations" but such entities must report and pay tax on unrelated business activity as required by IRC 511. In requesting the ruling, the exempt org told the IRS that it was approached by various third-party service providers who wished to provide services as a benefit to members of the exempt org. and, in order to let those members know about those services, the businesses wanted to list the info on the exempt org's website.
The PLR presents three situations for ruling by the IRS. The first scenario simply involved a listing of the service providers and a "hot" link to their respective sites but no payment was being made for this listing to the exempt org. The IRS had no problem saying this is not a "trade or business" so it fails to meet the UBIT definition at all. The second situation has third-party businesses paying the exempt organization a "license fee" to list information about those business and to provide a "hot" link to their website on the exempt org's website. Note: these were not "advertisements" on the website, but rather a description of the businesses, services offered, the website link, etc. The Ruling makes clear that the exempt org does not provide any other "personal" services to the businesses in connection with the licensing agreement and, under these circumstances, the IRS ruled that the payments in exchange for the website listing and link would be treated as nontaxable royalty payments under IRC 512(b)(2).
Finally, the more complicated third scenario pertained to the taxability of payments received for advertisements in periodicals published by the exempt org when payment is also received for "banner advertising" on its website. Payment for ads in periodicals are subject to UBIT under IRC 512(a)(1), but the instant question in this Ruling was whether banner advertising on a website is the equivalent of "periodical advertising" under Treas. Reg.1.512(a)-1(f), a regulation that contains special rules for computing the tax due on advertising in such publications. The general definition of a periodical is: regularly scheduled or printed material published by or on behalf of an exempt organization. The IRS held that the exempt org's sale of banner advertising on its website does not fall within the definition of "periodical advertising" under the regulation so long as such advertising is no part of an on-line version of a periodical. The payment must be allocated between periodical advertising and non-periodical a The IRS observed that if a payment otherwise met the definition of a qualified sponsorship payment and the exempt org provided a "hot" link to the sponsor's website in connection with the acknowledgment, the payment will not be treated as advertising. IRC 513(i)(2)(A), and, in particular, Treas. Reg. 1.513-4(d)(iv), Example 11. The Ruling concludes that such a link would not be taxable advertising but rather falls into the category of a qualified sponsorship acknowledgment, nor would the payment constitute unrelated trade or business activity for UBIT purposes.
Final Regulations on UBIT Treatment of Corporate Sponsorships: 67 Fed. Reg. 20433 (April 25, 2002)
This final rule, effective April 25, 2002, and applicable to all payments solicited or received after Dec. 31, 1997 addresses when corporate sponsorship payments to tax-exempt organizations will be considered unrelated business income. A qualified sponsorship payment is defined in the regulation as follows:
The term qualified sponsorship payment means any payment by any person engaged in a trade or business with respect to which there is no arrangement or expectation that the person will receive any substantial return benefit. In determining whether a payment is a qualified sponsorship payment, it is irrelevant whether the sponsored activity is related or unrelated to the recipient organization's exempt purpose. It is also irrelevant whether the sponsored activity is temporary or permanent. For purposes of this section, payment means the payment of money, transfer of property, or performance of services.(26 CFR § 1.513-4)
While exclusive provider arrangements, advertising, and the provisions of goods, services and activities are examples of substantial return benefits, a simple acknowledgment of the exempt organization's name or logo in a sponsor's trade or business is not a substantial return benefit. The regulations contain examples which can be used to determine whether a substantial benefit exists. Examples in the regulations also address hyperlinks to a sponsor's website. If the link is a simply a hyperlink to a corporate sponsor's web page and nothing more, then the link is most likely a non taxed acknowledgment. On the other hand, if the link to the sponsor's page brings up a web page by the sponsor which contains an endorsement by the exempt organization, then the IRS will conclude that taxable advertising exists.
The regulations also make it clear that in terms of exclusivity contracts, when the nature of goods and services requires the use of a single provider, the organization will not be treated as having entered into an exclusivity contract. Exclusive provider arrangements should be evaluated using standard rules for identifying an unrelated trade or business.
The preamble to the final regulations contains the following on the $79 ceiling on the value of allowable benefits an EO could provide to a sponsor:
While the $79 ceiling (as adjusted for 2002) is an appropriate amount for exempt organizations to thank individual donors, the Treasury Department and IRS agree with the commentators that the $79 ceiling is too low with respect to corporations or persons engaged in a trade or business. In response to these concerns, the final regulations eliminate the $79 ceiling placed on the fair market value of benefits that may be disregarded for purposes of section 513(i).
The regulations retain the language that an allowable benefit cannot be more than 2% of the entire payment.
Changes to the UBIT Rule: The Taxpayer Relief Act of 1997 modified I.R.C. § 512(b)(13) of the UBIT rule for passive income received from a controlled taxable subsidiary corporation, making it more likely that exempt organizations will be taxed on passive income derived from affiliated organizations. The new law also clarified that qualified sponsorship payments received by an exempt organization are exempt from UBIT. The Taxpayer Relief Act defines these as payments made with no expectation of return benefit other the use or acknowledgment of the sponsor's name or logo (or product lines) in connection with the activities of the donee exempt organization. Amounts received for endorsements, inducements to purchase, etc., and not "qualified sponsorship payments" and are therefore taxable.
Final Regulations: See 65 Fed. Reg. 5771 (Feb. 7, 2000) These regulations clarify when the travel and tour activities of tax-exempt organizations are substantially related to the purposes for which exemption was granted. Examples are included, highlighting the question of whether the tours are mainly to generate revenue, or whether they contribute to the educational purpose of the institution.
2014 Report of Recommendations by the Advisory Committee On Tax Exempt and Government Entities (ACT) (June 11, 2014) This report makes recommendation on UBIT compliance by IHEs and is in response to the audits at 34 colleges and universities in 2008. Five recommdations are made. See page 75 forward.
PLR 200625035: IRS new position on UBIT and Hotel and Dormitory Rentals; Nov. 16, 2010
Private dorm rentals to non-students and faculy members should be treated as UBIT. Only students of the school can be be treated as not subject to UBIT.
Private Letter Ruling 200352017 (Oct. 3, 2003) on Participation of Charitable Trusts In Endowment Investments and UBIT. In this case the IRS ruled that the 501(c) (3) non-profit educational organization which serves as trustee for several charitable remainder and lead trusts would not be engaging in a commerical venture subject to UBIT when as trustee of the charitable trusts the 501 (c) (3) purchased investment units in the organization's endowment, and thereby participated indirectly in the return on the organization's endowment.
Questions and Answers on Alumni Magazines, UBIT and Non-Profit Mailing Rates
Question: Can a university alumni magazine accept paid advertising without affecting the magazine's non-profit mailing rates?
Answer: The tax issue first: Advertising that is unrelated to the university's purposes (which probably would be most advertising that would appear) would be subject to the unrelated business income tax ("UBIT"). Technical rules are in place to apply expenses of the publication against its editorial content and against its advertising content. Only the net income from advertising (i.e., gross advertising revenue minus the appropriate portion of expenses attributable to advertising) is subject to UBIT. Frequently, for publications not intended to make a profit, but rather to build relationships, the expenses can eat up a large portion of the revenue; thus net advertising revenue, and the resulting UBIT, can be minimized significantly.
On the mailing issue, there are two kinds of postage for alumni magazines, standard nonprofit and nonprofit periodical (formerly called nonprofit second class). If the university uses "standard nonprofit" for its alumni magazine, there are significant restrictions on advertising in a publication mailed at "standard nonprofit" rates. Those restrictions are extremely complex and this is one issue on which greater detail may be necessary. Suffice it here to say that for "standard nonprofit," the advertising must be related to the purposes of the nonprofit organization, there may be no credit, debit or charge card advertising, and advertising for insurance policies and travel are severely restricted. These restrictions are attributable solely to an historical anomaly. Nonetheless, the advertising restrictions associated with "standard nonprofit" mailings would significantly restrict the advertising that the university could include in its Alumni Magazine.
The second kind of postage that can be used for an alumni magazine is nonprofit periodical class, i.e., the postage rate used for periodicals and magazines. The appeal of nonprofit periodical class is threefold. First, there are no restrictions on advertising. Second, ninety percent of the time, nonprofit periodical class will be less costly than standard nonprofit. Third, nonprofit periodical mail moves more quickly than does standard nonprofit mail. The downside is that the publication must qualify for nonprofit periodical class. Generally it must be published like a magazine with a regular number of issues per year (at least 4), mailed at regular, or agreed upon, intervals, and the publication must be "authorized" by the postal service (not a difficult process).
Question and Answer on Alumni Magazines courtesy of Thomas Arden Roha, Esquire, Roha & Flaherty, Washington, D.C. Attorney Roha serves as tax counsel for The Catholic University of America.
Publication 598 (Rev. March 2012) Tax on Unrelated Business Income
IRS Fact Sheet on Whether Activity is Business or Hobby: Fact Sheet 2007-18, April 2007 One issue in determining UBIT is whether or not the activity was engaged in for profit. This fact sheet may help make this determiniation.
Exclusive Provider Arrangements and UBIT: August 14, 2001 IRS Memo
(The text in this memo is also included in the preamble to the Final Regs at 67 Fed. Reg. 20433, April 25, 2002.)
MLM updated CFR link 7/10/15