Category Archives: Compliance

Colleges and Universities UBIT Compliance Project: IRS Final Report (Part 1)

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In 2008, the IRS commenced a multi-year project to assess UBIT compliance by colleges and universities. The IRS sent out questionnaires to 400 randomly selected institutions and, based on the responses, selected 34 institutions for audit. Released in 2013, the Final Report analyzes the results of the questionnaires and examinations conducted as part of the Compliance Project. In general, the IRS found significant underreporting of UBIT. While the Compliance Project discussed in the Final Report deals exclusively with colleges and universities, the compliance issues uncovered by the audits may be instructive to other exempt organizations as well.

This article summarizes the highlights of the Final Report concerning the UBIT. Succeeding posts will examine in greater detail the most common compliance errors made by colleges and universities in determining UBTI.

Of the 34 institutions selected for audit, a whopping 90% had increases to UBTI, including more than 180 adjustments representing about $90 million in unpaid taxes. More than one half of the adjustments involved the following activities:

  • Fitness and recreation centers and sports camps
  • Advertising
  • Facility rentals
  • Arenas
  • Golf courses

The adjustments related not only to the underreporting of income from unrelated trades or businesses but also to excessive losses and net operating losses. Over $600 million losses and NOLs were disallowed on 75% of the examined returns.

 Note: The colleges and universities were selected for examination because responses to their questionnaires indicated potential noncompliance on UBIT issues. Thus, the institutions audited are not a representative sample of all colleges and universities. The Final Report cautions that the results apply only to the institutions examined and should not be generalized as representative of other colleges and universities.

 The most common adjustments made in the examinations involved the following issues:

  • Misclassification as a trade or business due to lack of profit motive
  • Misallocation of expenses between exempt and nonexempt activities
  • Errors in computation or substantiation of NOLs
  • Misclassification of unrelated activities as related activities
  • Failure to seek professional advice about the treatment of potentially unrelated activities

In Part 2 of this article, we will discuss how an exempt organization might underreport UBTI as a result of misclassifying an activity lacking a profit motive as a business activity subject to the UBIT.

 

Tax Court: An Exempt Organization Subject to the UBIT is Still an Exempt Organization

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To those not accustomed to dealing with subchapter F of the Code (pertaining to exempt organizations) it may seem contradictory that so-called exempt organizations are subject to the unrelated business income tax. And the UBIT is not the only tax that may apply to exempt organizations. Charitable organizations which are private foundations are taxed on their net investment income and are subject to a series of excise taxes designed to curb particular behaviors susceptible to abuse. Thus, exempt organizations, which are not subject to the regular income tax imposed under §§1 and 11, are distinguished from for-profit companies that must pay income taxes. For convenience, we refer to them as exempt organizations, even though we know that they may be liable for the UBIT or other specialized taxes.

 Section 501 expressly recognizes that concept of tax-exempt organizations being subject to taxation. Exemption from taxation is provided under §501(a) for organizations described in §501(c), §501(d), and §401(a). These organizations are charities and 28 other categories of organizations described in §501(c), religious and apostolic organizations described in §501(d), and qualified retirement plans described in §401(a).

 Section 501(b) states that an organization exempt from taxation under §501(a) is subject to tax as provided in parts II (taxes on private foundations), III (the UBIT), and VI (taxes on political organizations) of subchapter F. Notwithstanding parts II, III, and VI of subchapter F, however, such an organization is “considered an organization exempt from income taxes for purposes of any law referring to organizations exempt from income taxes.”

 The Tax Court recently considered this seemingly straightforward Code provision in Research Corporation v. Commissioner, 138 T.C. No. 7 (2012).  Continue reading →

UBIT Compliance Is an IRS Priority for 2012

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It is no surprise that the IRS has identified UBIT compliance as a priority for 2012. With government funding and private donations decreasing during the recession years, exempt organizations reportedly stepped up unrealted business activities to supply needed revenues. Also, the redesigned Form 990, Return of Organization Exempt from Income Tax, effective in 2008, now provides the IRS with information it can use to identify exempt organizations which are engaging in activities that may generate UBTI. Form 990-T, Exempt Organization Business Income Tax Return, is used to report the UBIT.

 In its 2011 Annual Report & 2012 Work Plan, released on February 8, 2012, the Exempt Organizations section of Tax Exempt and Government Entities announced that it would use the information on Form 990 for UBIT compliance to identify organizations that reported unrelated business activities on Form 990 but did not file a Form 990-T. In addition,the IRS proposes to analyze Form 990-T data to develop risk models to identify organizations that consistently report significant gross receipts from unrelated businesses but also report no tax due. Cryptically, the Work Plan also states that the IRS will use its analyses of the Forms 990 and 990-T “in connection with a coming UBIT project.”  Continue reading →

Exempt Organizations: Be Proactive with UBIT Compliance

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Whether large or small, exempt organizations need a plan for UBIT compliance. At a minimum, the plan should include:

  • Education about the UBIT in general
  • Specific direction on business activities the organization already conducts
  • Contact person to consult before engaging in new business activities
  • Policy to notify the organization’s attorney or accountant regarding proposed new business activities that might generate UBTI   Continue reading →