Unrelated Business Income and Internal Revenue Code §513
3rd in a Series
This tax tip is the third in a series of tax tips on unrelated business income (“UBI”) and addresses terms associated with UBI including (1) trade or business, (2) regularly carried on and (3) substantially related as they relate to rules and regulations associated with Internal Revenue Code (“IRC”) §513. This tip will also focus on UBI tax rates and reporting issues.
Income will be considered to be UBI and thus subject to Federal income tax if it is:
- Derived from a “trade or business”;
- “Regularly carried on” and;
- “Not substantially related” to the tax-exempt organization’s primary purpose and operations.
IRC §513 sets forth the parameters for determining whether or not a trade or business is regularly carried on.
TRADE OR BUSINESS
The regulations under IRC §513 place heavy reliance on the definition of “trade or business”. A “trade or business”, as defined by the IRC, is generally an activity that is engaged in for the primary purpose of generating an income or profit. In determining whether or not an activity constitutes a trade or business, determining whether or not there is a motive of profit is a major consideration. In defining an activity as unrelated business income, one must first identify the nature, scope and parameters of the activity.
The Internal Revenue Service (“IRS”) fragments a tax-exempt organization’s operations, run as a whole, into component parts. IRC §513 states, “an activity does not lose identity as a trade or business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may, or may not, be related to the exempt purposes of the organization.” IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations, provides a clear example of this. The sale of pharmaceuticals by the pharmacy of a tax-exempt hospital to patients of the hospital is a related activity and not considered UBI; however, the sale of pharmaceuticals to the general public generates UBI; Hi-Plains Hospital v. United States, 670 F.2d 528 (5th Cir. 1982).
REGULARLY CARRIED ON
Treasury Regulation §1.513-1(c)(2)(ii) states, “in determining whether or not intermittently conducted activities are regularly carried on, the manner of conduct of the activities must be compared with the manner in which commercial activities are normally pursued by nonexempt organizations. In general, an exempt organization’s business activities that are engaged in infrequently or periodically will not be considered regularly carried on if they are conducted without competitive and promotional efforts typical of commercial undertakings”. This attribute relates to the frequency and continuity of the activities producing the income.
SUBSTANTIALLY RELATED
In determining whether or not income meets the criteria to be considered UBI, it is necessary to examine the relationship between the business activities that generate the particular income in relation to the corresponding accomplishments of the organization’s exempt purposes. Several factors must be taken into consideration when an organization is making this determination including, but not limited to, the “size” of the activity and the extent to which it is carried on. If the activity is conducted on a larger scale than necessary to perform the function, gross income attributable to that specific portion of the activity in excess of the needs for “reasonableness” may constitute gross income from the conduct of the unrelated trade or business. In addition, if the activity continues for a duration that appears to be excessive in terms of “reasonableness”, the portion deemed excessive may also be subject to federal income tax as UBI.
All tax-exempt organizations must be aware that if UBI generated by the tax-exempt organization represents a more than insubstantial portion of their organization’s total gross income; the organization may potentially jeopardize its tax-exempt status.
All tax-exempt organizations must be aware that if UBI generated by the tax-exempt organization represents a more than insubstantial portion of their organization’s total gross income; the organization may potentially jeopardize its tax-exempt status. As long as a tax-exempt organization has income that meets all three criteria listed above, the IRS mandates a tax rate on that income at either the corporate or trust level.
UBI TAX RATES AND REPORTING
All activities that generate UBI are required to be reported, on an activity by activity basis, on Form 990-T, Exempt Organization Business Income Tax Return, if gross income from the unrelated activity amounts to greater than $1,000. Any tax-exempt organization with gross income of $1,000 or more for any year from the conduct of an unrelated trade or business must prepare and file a Form 990-T. Any net UBI or unrelated business taxable income reported on a Form 990-T is subject to Federal income tax at regular corporate tax rates as prescribed by the IRS.
CONCLUSION
As noted in our previous tax tips, continued IRS interest and scrutiny in this area will continue to subject organizations to questions and examinations with respect to UBI reporting and activities. All organizations should carefully consider reviewing their existing business activities to determine if any may constitute UBI and any new business ventures for UBI reporting.
A complete copy of the 2012 IRS Form 990-T, 2012 Form 990-T instructions and IRS Publication 598 can be accessed at the healthcare services section of our firm’s website.
For more information on the topics discussed or services we can provide, please contact:
Scott Mariani, JD, Partner
Practice Leader
973.898.9494 ? [email protected]
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
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