Tax Exemption and Unrelated Business Income Tax (UBIT): The Framework (Part 1 of 3) | law of the free man

This Knowledge blog is part 1 of a 3-part series that provides a focused overview of unrelated business income tax rules for the nonprofit organization that is tax-exempt under section 501 (c)(3) of the Internal Revenue Code (the “Code”).

This Part 1 sets the framework and outlines the organizational and operational tests applicable to tax-exempt organizations and, without going into too much detail (for now), why or when the tax rules Unrelated business income comes into play for the organization.

General tax exemption rule under section 501(c)(3) of the Code.

To be exempt as a 501(c)(3) organization, an organization must be both organized and operated exclusively for one or more of the purposes specified in 501(c)(3) of the Code. See 26 USC § 501(c)(3); 26 CFR § 1.501(c)(3)-1(a)(1). If an organization does not pass the organizational test or the operational test, the organization is not eligible for tax exemption under section 501(c)(3) of the Code.

organizational test.

Section 1.501(c)(3)-(1) of the Treasury Regulations contains the organizational test:

Organizational essay-(1) In general. (i) An organization is organized exclusively for one or more exempt purposes only if its organization statutes (referred to in this section as its articles) as defined in subparagraph (2) of this paragraph: (A) Limit the purposes of this organization to one or more exempt purposes; and (B) do not expressly authorize the organization to engage, other than as an insubstantial part of its business, in activities which by themselves are not in furtherance of one or more purposes. exempted.

26 CFR § 1.501(c)(3)-1(b)(1) (emphasis added).

An organization is organized exclusively for one or more exempt purposes only if it is organization statutes: (A) Limit the purposes of such organization to one or more exempt purposes; and (B) do not expressly authorize the organization to engage, other than as an insubstantial part of its business, in activities which by themselves are not in furtherance of one or more purposes. exempted.

Identifier. at § 1.501(c)(3)-1(b)(1)-(b)(1)(i)(B) (emphasis added).

In In no case should an organization be considered to be organized exclusively for one or more exempt purposes, if, under the terms of its statutesthe purposes for which such an organization is created are wider than the purposes specified in Section 501(c)(3).

Identifier. at § 1.501(c)(3)-1(b)(1)(iv) (emphasis added).

The term “organization bylaws” or “articles” includes the corporate charter or other written instrument “by which an organization is created”. See id. at § 1.501(c)(3)-1(b)(2). The statutes of the organization do not include, for example, the statutes of an organization.

The operating test.

An organization will be considered to be operated exclusively for one or more exempt purposes only if the organization primarily engages in activities that accomplish one or more of the exempt purposes specified in Section 501(c)(3). See 26 CFR § 1.501(c)(3)-1(vs). Under the Treasury Regulations:

[a]An organization may satisfy the requirements of section 501(c)(3) even though it carries on a trade or business as a substantial part of its business, if the carrying on of such trade or business is in pursuit of the exempt purpose or purposes of the organization and whether the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business, as defined in Section 513. To determine the existence or non-existence of such primary purpose, all the circumstances must be taken into account, including the size and scope of the trade or business and the size and scope of the activities which pursue one or more exempt purposes.

See 26 CFR § 1.501(c)(3)-1(e).

“'[T]The presence of a single non-exempt purpose, if substantial in nature, will destroy the exemption, regardless of the number or significance of the actual [exempt] purposes.'” American Ass’n of Christian Schools Voluntary Employees Beneficiary Ass’n Welfare Plan Trust v. United States, 850 F.2d 1510, 1513 (11th Cir.1988) (citing Better Business Bureau c. United States, 326 US 279, 283, 66 S.Ct. 112, 114, 90 L.Ed. 67 (1945)).

In accordance with the authorities cited above, if a tax-exempt organization engages in a non-exempt activity that is not of a substantial nature, the tax-exempt status of the organization cannot be defeated. However, income from such trade or business, even if the activity is not of a substantial nature, may be subject to tax.

Under Section 511 of the Code, a tax-exempt organization must pay tax on income classified as unrelated business income. Generally, gross income from an unrelated trade or business, and any applicable deductions relating to that income, are calculated in the same manner as corporate income tax. See 26 USC §§ 511(a) (corporate rates applicable to unrelated business income), 162 (business or professional expenses), 167 (depreciation). Under Section 513, an unrelated trade or business is a trade or business whose conduct is not substantially related to the exempt purpose of the organization.

Section 512 of the Code contains several exceptions and approximately 20 amendments to the unrelated business income tax rules. For example, Section 512 excludes from the definition of untied business income from passive investments, royalties and rents from real estate and chattels leased with real estate, provided that no more than an amount incidental to the payment of the rent is assigned to the rental of personal property. Special rules also apply to income from debt-financed real estate and income from qualified research activities.

Unrelated business income tax rules are complex, and the applicability of a particular exception or modification will depend on the many facts and circumstances of the organization’s trade or income-producing business. .

Stay tuned for Part 2 of this 3-part series where we’ll dive deeper into the specific unrelated business income tax rules, the exceptions and changes to those rules, and some of the exceptions to the exceptions. See Continuing Life Communities Thousand Oaks LLC v. Comm’r, TC Memo. 2022-31 | April 6, 2022 |Holmes, J. | Dekt. No. 4806-15 (“One way of thinking about tax law is to think of it as a series of general rules with exceptions, and exceptions to those exceptions, and exceptions to those exceptions to those exceptions.”).

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