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

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)

• 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.

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. 

 Facts. Ocean Pines was exempt from income taxes as a social welfare organization. Its primary activities involved overseeing a 3,500-acre subdivision with over 10,000 residents. Ocean Pines was more than a homeowners association. The organization maintained roadways, bulkheads, and parking lots within the subdivision, enforced zoning regulations, provided police and fire services, and operated numerous recreational facilities. All of the facilities and programs conducted by Ocean Pines were open to members and nonmembers. The organization also owned and operated a ocean-front beach club and two parking lots in a nearby beach location. Most of the club’s facilities and all of the parking spaces could be used only by the association’s members.

 Issue. Ocean Pines derived a profit from the parking lots. The beach club operated at a loss. The IRS sought to tax the net income from the parking lots and beach club as UBTI. To avoid the tax, the organization had to show that the activities constituted a related trade or business. The case is apparently one of first impression in that no prior case has examined potential unrelated business activities of a social welfare organization.

 Law. Whether a business conducted by an exempt organization is an unrelated trade or business depends upon the relationship between the actual conduct of the business and the accomplishment of the organization’s exempt purpose. To avoid the unrelated business income tax, the operation of the business must contribute importantly to the accomplishment of the exempt purpose. The fact that an exempt organization uses income from a business to further its exempt purposes does not make the business related for purposes of the UBIT.

 Analysis. The appellate court first examined the basis underlying the exemption of a social welfare organization from income tax. Social welfare organizations are nonprofit civic leagues or organizations which operate for the promotion of social welfare. The organization must engage primarily in promoting the common good and general welfare of the people of the community. Social welfare organizations are primarily concerned with civic betterments and social improvements.

 Thus, the question presented was whether the operation of the members-only parking lots and beach club contributed importantly to the promotion of social welfare, i.e., was there a community benefit from these activities? Not surprisingly, the Fourth Circuit held that the questioned activities constituted an unrelated trade or business. Unlike the facilities at the residential community, which were open to the general public, the beach facilities could only be used by members. A members only restriction is just not consistent with community benefit and common good.

 One of the association’s arguments pointed to the history of the UBIT, which was enacted primarily to prevent exempt organizations from using their tax exemption to compete unfairly with for-profit enterprises. Ocean Pines argued that its parking lots and club, being restricted to members only, did not compete with taxable businesses providing parking and entertainment to the general public. This argument has been raised, mainly unsuccessfully, in past cases. The court responded that, while the underlying rationale for the UBIT may have been to curb unfair competition, the clear language of the Code applies the tax to businesses which are not related to an organization’s exempt purpose. When the Code is not ambiguous, the use of the legislative history is inappropriate.

 Note: In Ocean Pines, the issue was whether a business carried on by an exempt organization was related or unrelated to its exempt purpose. The legislative history argument is more effective when the issue is whether an exempt organization is conducting a trade or business. If for-profit companies conduct a particular activity, the IRS will argue that an exempt organization conducting a similar activity is engaged in a trade or business. Conversely, an exempt organization may argue that a particular activity is not a trade or business because there are no taxable enterprises conducting a similar activity.

Resources: §513(a), Treas. Reg. §1.501(c)(4)-1(a)(2), Treas. Reg. §1.513-1(d).

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: 

•  Exercise and fitness, with programs and classes to emphasize community health and wellness;
• Youth camps, sports camps, and other educational camps
• Charitable community services, such as meals-on-wheels, food bank drives, and blood drives
• Charity events and disaster relief activities
• Space for community events, community social activities, and school activities, such as swim meets
• After-school and tutoring programs for children
• Sports leagues

 The following uses of the community center were specifically examined:

1. Leasing not more than 10% of the total square footage of the center as office space to employees and independent contractors of the fraternal beneficiary society at fair rental value
2. Providing meeting space to local nonprofit organizations, such as American Red Cross chapters, chambers of commerce, and scouts, at actual cost
3. Leasing the banquet room to individuals and groups for private functions at fair rental value
4. Leasing not more than 15% of the total space in the center to the city to house its recreation department for a one-time unspecified payment

 Here are the issues raised by the facts of PLR 201147035:

 1) Because there is a change in the organization’s articles, the impact of the change on the organization exempt status

2) Because the center provides services, whether any of the services constitute unrelated trades or businesses

3) Because space in the center is leased to third parties, whether the rents received are covered by the rental exclusion to the UBIT

4) Because the property is financed, the application of the debt-financed income rules

 The IRS ruled that the ownership and operation of community centers was within the organization’s general charitable purposes and would not jeopardize its tax exemption. Moreover, all the bulleted activities listed above are substantially related to the organization’s exempt purposes. Income from memberships and other community activities would not generate UBTI, other than under the debt-financed income rules.

 Regarding the numbered activities, the leasing of office space to employees and contractors of the fraternal beneficiary organization was a related use under a special rule. Reg. 1.514(b)-1(c)(2) provides that use of an exempt organization’s property by a related exempt organization constitutes a related use to the extent the property is used by either organization in furtherance of its exempt purposes. Organizations are considered related if one organization controls the other. Thus, use of the organization’s community center by the fraternal beneficiary society constitutes a related use by the organization.

 According to the ruling, however, the other numbered activities were not related uses. Thus, the use of office space by the city recreation department, the use of meeting rooms by local nonprofit organizations, and the use of the banquet hall by private parties were not substantially related to the organization’s exempt purposes and would constitute unrelated trades or businesses. Absent the debt-financed income rules, however, the rental payments for the unrelated uses would be covered by the exclusion of rents for real property under §512(b)(3).

 Notwithstanding the related uses and the rental exclusion for the unrelated uses, the debt-financed income rules require income from debt-financed property to be included in UBTI to the extent the property is debt-financed. The long-term bonds used to finance the center constitute acquisition indebtedness. Thus, unless an exception applies to exclude the property from being treated as debt-financed property, part of the income from the community center is debt-financed income.

 There is a two-part exception under §514(b)(1) under which substantially related use property is not treated as debt-financed property. First, property acquired by an exempt organization is not debt-financed property if substantially all of the use of the property is substantially related to the organization’s exempt purposes. Second, even if substantially all of the use of property is not substantially related to the organization’s exempt purposes, the property is not debt-financed property to the extent that its use is substantially related. To the extent property is not treated as debt-financed property, rents and other income from the property are not debt-financed income subject to taxation under the UBIT.

 The organization in the ruling was able to satisfy the first and most favorable part of the substantially related use exception, with the result that no part of the community center was treated as debt-financed property. Under Reg. §1.514(b)-1(b)(1), property satisfies the first part of the substantially related use test if 85% or more of the property is devoted to a substantially related use. In the ruling, the unrelated uses represent less than 15% of the total use of the community center. Thus, none of the rentals were debt-financed income subject to the UBIT. 

 Because the unrelated uses did not cause any of the property to be treated as debt-financed property, the characterization of the use by the city recreation department and the local nonprofit organizations did not prejudice the exempt organization requesting the ruling. For the sake of discussion, however, there are good arguments that uses of the community center by the city and some of the nonprofit groups were substantially related uses.

Regarding the occupation by the city recreation department, the organization and the city had a written agreement under which the city was responsible for hiring, supervising, and directing all personnel working at the center. The organization had the right to provide input to the city concerning the employment of the center’s manager, programmer, and marketing director. In connection with this agreement, the city relocated the administrative offices of its recreation department to the center. It appears that over half of the activities to be conducted at the center involve community recreation. Having the city recreation department on the premises would contribute importantly to the center’s ability to offer recreation services. Considering that the city also employed the management and staff of the center, it appears that the city purposes were so intertwined with the organization’s charitable purpose in operating the center that the one-time payment from the city could well be considered income from a related trade or business and that use of the center by the city could be a substantially related use.

 There is also a reasonable argument that leasing meeting space to some community nonprofit organizations is also substantially related to the organization’s charitable purposes. Here are the local groups to which the center would lease meeting space: local chapters of the American Red Cross, the United Way and its affiliated agencies, local chambers of commerce, boy scouts, and local historical associations. Allowing the Red Cross to meet at the center is directly related to the organization’s disaster relief purpose and its community benefit purpose. Similarly, scouts groups are community organizations involving children, who are important recipients of the center’s recreational and educational services. In contrast, chambers of commerce benefit the community only in a commercial sense; their use of the facility would not seem to constitute a related use. At a minimum, the leases to the nonprofit groups should be evaluated on an organization-by-organization basis.