Tax Reform 2017: Senate Passes Final Version of Its Tax Bill

The initial U.S. Senate tax reform bill contained two amendments to the UBIT that would result in additional taxes being imposed on some exempt organizations: the taxation of income from licensing an organization’s name or logo and the prohibition of netting income and losses from multiple trades or businesses. The initial Senate bill is discussed here. The U.S. Senate passed a final version of its tax reform bill on December 2, 2017. The final bill omits the change in licensing income but retains the netting restriction.

Sale or Licensing of Exempt Organization’s Name or Logo

Although royalties are generally excluded from the UBIT as passive income, the initial Senate bill proposed to tax royalty income from the licensing of an exempt organization’s name or logo to a for-profit company. The final bill omits the name and logo licensing provision and allows such licensing income to be excluded as royalty income.

This change comes as particularly good news to colleges and universities, which derive considerable royalty income from the sale of apparel and other items displaying their names and logos.

UBTI of Multiple Unrelated Trades or Businesses Separately Computed

The final Senate tax bill retains the provision that prevents an exempt organization from netting income and losses of multiple trades or businesses. If, for example, an exempt organization conducts Unrelated Business A for a profit and incurs a loss in Unrelated Business B, the present law would allow the organization to net the income and loss. The loss from Business B would reduce the UBIT payable on the income from Business A. Under the Senate proposal, the organization would report UBTI from Business A and would deduct the loss from Business B in accordance with the net operating loss rules.

The anti-netting provision would only affect organizations that carry on two or more unrelated trades or businesses. As a reminder, the IRS may treat what would normally be considered a single trade or business as multiple trades or businesses for purposes of the UBIT. For example, a museum’s gift shop would ordinarily be regarded as a single trade or business. For purposes of the UBIT, however, the IRS may treat the sales of different items as different trades or businesses. For example, assume that an art museum sells art books and history books in its gift store. The IRS would treat the sale of art books as a related business, but the sale of history books would likely be considered an unrelated business. The sale of apparel and toys would also be evaluated as separate trades or businesses. Under the Senate proposal, the museum could not offset a profit from the unrelated business of selling history books with a loss from the unrelated business of selling toys. 

Next Steps

Because there are significant differences between the tax reform bills passed by the House and Senate, it is likely that a reconciliation procedure will be used to come up with a bill that can be passed by both bodies and signed by the president. If the bill becomes law before the end of the year, the provisions affecting the UBIT will take effect for tax years beginning in 2018.

Tax Reform 2017: Senate Proposes Changes to the UBIT

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.

Effective Date

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.

Additional Resource:

Andrew Kreighbaum, “Taxing T-shirt Revenue,” Inside Higher Education (November 13, 2017)

IRS Releases Revised Publication 598

The IRS has released revised Publication 598, Tax on Unrelated Business Income of Exempt Organizations, effective as of March 2012. The publication covers four main topics:

  • Organizations subject to the tax
  • Tax and filing requirements
  • Unrelated trade or business
  • Unrelated business taxable income

 The section entitled “Unrelated Trade or Business” goes over the basic principles from the Code and Regulations concerning the basic requirements for taxatiion under the UBIT.  More importantly, it focuses on the sometimes tricky issue of whether a business is related or unrelated to an organization’s exempt purposes by using examples. The discussion contains numerous common examples of specific businesses and explains why these activities are related or unrelated for purposes of the UBIT. The “Unrelated Trade or Business” section also briefly discusses businesses that are expressly excluded from treatment as unrelated trades or businesses, such as businesses conducted by volunteers, sale of donated items, and the distribution of low cost articles incident to the solicitation of charitable contributions.

 The longest and most detailed section of Publication 598 is entitled “Unrelated Business Taxable Income.” It first discusses the categories of income that are excluded from UBTI. This part covers numerous modifications and special rules, including the treatment of advertising in periodicals, the deductions allowed in computing UBTI, rules for social clubs, VEBAs, and SUBs, income from partnerships and S corporations, and income from controlled organizations. The section concludes with a detailed discussion of the debt-financed property rules with several helpful examples.

 The IRS also maintains a web page on Publication 598. In a Recent Developments section, the IRS will post any changes that occur after the publication date of one revised edition and before the publication date of the following revision. For example, the Publication 598 prior to the current version was revised as of March 2010, applicable beginning with the 2009 tax year. In April of 2011, the IRS alerted taxpayers to the changes for the 2010 tax year. If the next revision of Publication 598 does not come out until March of 2014, an alert on this web page will likely be issued containing the changes for 2012.

 The IRS website has Publication 598 for the following revision dates: 2012, 2010, 2009, 2007, 2005, 2000, 1998, and 1995. If you need to know a UBIT provision applicable for a prior tax year, checking Publication 598 for the appropriate time period may be a good place to start.


Social Welfare Organization Derived UBTI from Members-Only Beach Club and Parking Lots

In Ocean Pines Association, Inc. v. Commissioner, the Court of Appeals for the Fourth Circuit held that a tax-exempt social welfare organization conducted an unrelated business when it operated two parking lots and a beach club limited to members only. The case was not complex, and the outcome was predictable. The court’s opinion, however, illustrates a classic analysis of the distinction between related and unrelated businesses under the UBIT.  Continue reading

Operation of Community Center Raises Various UBIT Issues in IRS Ruling

In PLR 201147035, a charitable organization devoted to disaster relief and general charitable purposes amended its articles to permit ownership and operation of community activity centers throughout country. The proposed community centers would offer a broad range of programs designed to serve all community members and would be accessible to the public through memberships. The organization was controlled by a fraternal beneficiary society described in §501(c)(8).

 In the ruling, the organization proposed to acquire its first community center. The acquisition was financed primarily through the issuance of long-term bonds. The community center would offer the following activities:  Continue reading