On November 2, 2017, the U.S. House of Representatives released a proposed tax reform bill. The proposals in the House bill that affect the UBIT are described in Tax Reform 2017: House Proposes Changes to the UBIT. On November 9, 2017, the Senate Finance Committee announced the Senate version of tax reform, which is described by the Joint Committee on Taxation in a document scheduled for markup by the Finance Committee on November 13, 2017. Senate proposals that would affect the UBIT are described in this post.
Sale or Licensing of Exempt Organization’s Name or Logo
Income from passive sources, such as dividends, interest, royalties, certain rents, and gain from the sale of property, is generally excluded from the scope of the UBIT. Under present law, if an exempt organization licenses its name or logo to a for-profit company in return for a fee, the fee is treated as an excluded royalty payment, so long as the organization is not required to render considerable services under the arrangement.
The Senate proposal retains the general exclusion of royalties from the UBIT but eliminates the exclusion for income derived by an exempt organization from selling or licensing its name or logo. Specifically, the Senate version treats the sale or licensing of a name or logo as an unrelated trade or business that is regularly carried on by the organization. Moreover, income from licensing a name or logo is expressly included in an organization’s unrelated business taxable income, regardless of any provisions that exclude various categories of passive income, such as royalties. The Joint Committee description does not state that income from the sale of an organization’s name or logo is expressly included in UBIT, but that would be the logical result of treating the sale of a name or logo as a regularly conducted trade or business.
Many exempt organizations will be adversely affected if income from licensing their names and logos becomes taxable. The taxation of such licensing income seems inconsistent with the underlying structure and purpose of the UBIT. Most passive income is expressly excluded from the scope of the tax. The exclusion covers dividends, interest, royalties, some rents, and gains from the sale of property, so long as the passive income is not derived from debt-financed property. A fee paid for the use of an exempt organization’s name or logo is a classic royalty payment, provided that the organization does not render excessive services under the license agreement.
Moreover, ever if licensing a name or logo were treated as a trade or business, at least some name and logo licensing would be considered a related trade or business not subject to the UBIT. For example, when a university licenses its name and logo to a company that makes apparel, students, alumni, and friends of the university purchase the items to show their loyalty and school spirit. The appearance of the name and logo promotes the university and its programs, which is a purpose that is related to the educational function of the university. In contrast, if an exempt organization licenses its name and logo to an insurance company for the purposes of selling insurance policies to the organization’s members, the relationship between the promotion of the insurance and the organization’s exempt function is likely too tenuous for purposes of the UBIT. Even so, however, the licensing fee continues to be a royalty, which has always been excluded from the scope of the tax.
UBTI of Multiple Unrelated Trades or Businesses Separately Computed
Some exempt organizations carry on more than a single unrelated trade or business. When there are multiple unrelated businesses, UBTI is computed by aggregating the gross income of the organization from all unrelated businesses and subtracting the deductions directly connected with such businesses. Thus, deductions from one unrelated trade or business would be used to offset income from a different unrelated trade or business.
Under the Senate proposal, each of an exempt organization’s unrelated businesses is treated as a separate business for purposes of determining UBTI. Thus, deductions from an unprofitable unrelated business could not be used to reduce taxable income of another unrelated business. An exempt organization may use a single specific deduction of $1,000, however, irrespective of the number of unrelated businesses it conducts. After the net income or loss is calculated for each trade or business separately, the specific deduction applies. Moreover, net operating losses from a particular unrelated trade or business can only be carried forward to offset income of that same unrelated business in future tax years, in accordance with the net operating loss rules of §172.
The Senate proposals are effective for taxable years beginning after December 31, 2017.
Comparison of House and Senate Proposals
Regarding the UBIT, the House and Senate tax reform proposals are different. The House proposal clarifies that state and local tax-exempt entities, such as pension funds of state organizations, are subject to the UBIT. In addition, the House bill seeks to narrow somewhat one of the exclusions for research income. Addressing neither of these topics, the Senate proposal seeks to tax gain or royalties from the sale or licensing of an exempt organization’s name or logo and eliminates the ability of an exempt organization to aggregate the income and deductions of multiple trades or businesses when computing its UBTI.
As the relatively minor proposed changes to the UBIT are taking a back seat to the talk of individual and corporate rate reductions and the elimination of popular deductions, we may not know which, if any, of the proposed changes to the UBIT will become law if and until a new tax law is passed.
Andrew Kreighbaum, “Taxing T-shirt Revenue,” Inside Higher Education (November 13, 2017)