Associations and Business Leagues – Focus on Unrelated Business Income
Associations and business leagues are resource centers, advocates, and thought leaders of their respective industry membership groups.
However, tax-exempt associations and business leagues often have a surprisingly disproportionate number of complex tax issues to manage. In addition to tax considerations regarding lobbying, compensation, and transactions from their multi-entity structures, many associations also have various types of activities that generate unrelated business income (UBI).
UBI tax issues for associations and business leagues often include:
- Associate memberships;
- Royalties with services;
- Advertising;
- Sponsorship arrangements;
- Management fees;
- Conference rental activities;
- Virtual trade shows; and
- Certain payments from controlled entities.
A key function of the IRS’s exempt organization examination program is to identify any large, unusual, or questionable (LUQ) items — including revenue, expenses, and tax liabilities generated from unrelated business activities.
TIGTA’s Report
The Treasury Inspector General of Tax Administration (TIGTA) recently criticized the IRS Exempt Organization Division for not effectively identifying and auditing key tax areas such as UBI. The TIGTA is the internal audit oversight branch of the IRS. The TIGTA issued a report recommending the IRS improve its examination procedures regarding UBI.
In its February 24, 2021, report, titled “Emphasis on Unrelated Business Income Tax Enforcement Should Be Enhanced,” the TIGTA determined that there are six types of organizations with a higher likelihood of producing UBI to include in this review project.
Based on its analysis, Associations or Business Leagues, exempt under section 501(c)(6) of the Internal Revenue Code (IRC), was one of the six types of exempt organizations the TIGTA chose to review, along with private foundations (IRC §501(c)(3)); private schools (IRC §501(c)(3)), hospitals/other health services (IRC §501(c)(3)); pleasure, recreational, or social clubs (IRC §501(c)(7)); and fraternal beneficiary associations and lodges (IRC §501(c)(8) and §501(c)(10)).
TIGTA made various recommendations to the IRS to:
- Include UBI tax issues in (the IRS’s) future compliance projects to identify issues preventing taxpayers from being compliant with their UBI reporting requirements; and
- Require experienced senior EO classifiers to review claims involving a net operating loss (NOL) prior to accepting the claim as filed and document the review in the case file.
The IRS will challenge tax-exempt organizations when the tax losses reported as UBI either lack the requisite profit motive or have expense allocations that are not deemed to be reasonable.
Long History of Losses
In Losantiville Country Club v. Commissioner, No. 17-2394 (6th Cir. Oct. 15, 2018), the U.S. Court of Appeals for the Sixth Circuit found that the exempt organization, which had a long history of recurring unrelated business losses, provided no evidence that “‘(T)he books and records were kept for the purpose of cutting expenses, increasing profits, and evaluating the overall performance of the operation,’ Golanty v. Comm’r, 72 T.C. 411, 430 (1979), aff’d, 647 F.2d 170 (9th Cir. 1981),” and that the exempt organization “cited no concrete evidence that it adopted any ‘new techniques’ or abandoned ‘unprofitable methods in a manner consistent with an intent to improve profitability.’ Treas. Reg. § 1.183-2(b)(1).”
And as indicated in the preamble of the final regulations for section 512(a)(6) of the IRC regarding Unrelated Business Taxable Income Separately Computed for Each Trade or Business (the UBI “silo” rules), issued at the end of 2020, “In determining the lack of a profit motive, greater weight is given to objective facts than to a taxpayer’s intent.”
Expense Allocations – IRS Guidance Expected
The preamble in these final UBI silo regulations also confirmed that the Treasury Department and the IRS continue to consider and expect to publish additional proposed regulations for UBI regarding reasonable methods of expense allocations.
The new UBI silo rules don’t allow exempt organizations with more than one unrelated business activity to offset the net income from a profitable activity with a loss activity for tax years beginning after December 31, 2017. However, the tax rules do allow organizations to use pre-existing NOL that were generated before 2018 against positive current year UBI. Nevertheless, there is potential tax risk that the IRS will challenge the validity of those pre-2018 NOL if the activity generating those losses is not deemed to have a profit motive or had unreasonable expense allocations.
What does it all mean?
UBI is expected to get more attention in IRS examinations. So, associations, business leagues, and other exempt organizations should review their current year UBI tax positions as well as any existing NOL carryovers before the IRS does.
How we can help
We can assist you assess your UBI tax positions by performing a tax analysis on your UBI activities, as well as assisting your Association or Business League in developing tax planning necessary to mitigate any potential tax risk should you be chosen for examination. Let us help – so you can focus more of your time and attention on what your members need most.
Laura enjoys providing tax services for public charities, higher education institutions, private schools, cultural institutions, associations, foundations and healthcare organizations.
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