Discussion:Tax Exempt Organization

I am preparing form 990 for a tax exempt organization. THis organization has an investment account which earns interest and dividends greater than $1,000.00 per year. I am not sure if this income is taxable and needs to be reported on form 990T.

Below is a portion of instruction from form 990 regarding unrelated business taxable income:

"An exempt organization is subject to a tax on unrelated business taxable income if such income is from a trade or business that is regularly carried on by the organization and is not substantially related to the organization's performance of its exempt purpose or function. Generally, a tax-exempt organization with gross income of $1,000 or more for the year from an unrelated trade or business must file Form 990-T and pay any tax due."

My argument is that this income is

 from a trade or business that is NOT regularly carried on by the organization.

Am I correct with my assumption? When I called the IRS they were unable to answer the question and said a specialist would contact me within 15 days. Just wondering if anyone has encountered this before.

Thanks in advance.

See Pub 598.

I agree with RD1; generally NOT UBTI.

As stated above by Roy and Belle, interest and dividend income are excluded from classification as UBI. Show the amount of interest and dividends on Form 990, Part VII, lines 95 and/or 96, column D. In column C, enter exclusion code 14. These amounts should flow to lines 4 and 5 on page 1 of the 990.

See IRC 512(b)(1)"There shall be excluded all dividends, interest, payments with respect to securities loans defined in 512(a)(5), amounts received or accrued as consideration for entering into agreements to make loans, and annuities, and all deductions directly connected with such income."

Interest and dividends could conceivably be subject to UBIT if securities were purchased on margin, as they would then be considered debt financed income.

My first question is: is my interpretation correct?

If so, I can't reconcile how this interacts with the reporting of investments at FMV on the 990 and running the unrealized gains/losses through page one, line 20. To wit - if they are going to pay capital gains tax on stock sales, why wouldn't (market providing of course) they always do it one the first day of the fiscal year? All the unrealized gain (we're working in a pre-current day economy for purposes of this illustration) goes untaxed as unrealized on line 20, and a minimal amount of "realized gain" gets taxed.

Ugh, all sorts of code cites and verbosity. My apologies.

Don't let the stuff reported on Form 990 confuse you when you are preparing the 990-T.

Dub2131, the unrealized gain shown on line 20 does not increase the basis of the investment assets for purposes of calculating taxable gain/loss on the 990-T. So the strategy you suggest would not work. For securities acquired by purchase, original cost basis is used to determine gain/loss, not the adjusted FMV.

In the past, they have never paid any UBIT. Partner doesn't think they need to, I argue that they do.

They are a fraternity that used to be classified as a 501(c)(10). Supposedly, the IRS sent them a letter and they were reclassified as a 501(c)(7). (Working to find the letters)

So two issues arise...

1. As a 501(c)(7) the IRS has stated that organizations will not be taxed on income set aside for "religious, charitable, scientific, literary or educational purposes." Do you think that a business fraternity can justify that the investment income is set aside for education purposes? As far as I can tell, the income has just been used to pay normal administrative expenses to support its chapters.

2. What would make an organization a 501(c)(7) instead of a 501(c)(10)? A (7) is listed as "clubs organized for pleasure", whereas a (10) is listed as a "domestic fraternal society operating under the lodge system". What would have caused them to be reclassified as a (7)?

I recommend that you read this publication: http://www.irs.gov/pub/irs-tege/eotopicf04.pdf The info on c(10) orgs starts on page 13. After introducing the characteristics of a c(10), it goes on to compare them to c(8)'s and c(7)'s. I think it will shed some light for you.

The main thing for you at this point, it seems to me, is to determine if in fact they really were reclassified as a c(7). Perhaps they ceased to operate under the lodge system. If you can't find the paperwork, get a Power of Attorney and then call the IRS EO division at 877-829-5500 to see if they've managed to retain any historical information about this organization.

That publication really helped.

It looks like we can avoid paying taxes on the 501(c)(7) income investment as long as the income is set aside for charitable purposes. (They have pay more in scholarships than their investment income) So we only need to ensure that they maintain a seperate account to hold their investment income.