Modifications
Net operating loss deduction.
The net operating loss deduction (as provided in section 172) is
allowed in computing unrelated business taxable income. However, the
net operating loss for any tax year, the carrybacks and carryovers of
net operating losses, and the net operating loss deduction are
determined without taking into account any amount of income or
deduction that has been specifically excluded in computing unrelated
business taxable income. For example, a loss from an unrelated trade
or business is not diminished because dividend income was received.
If this were not done, organizations would, in effect, be taxed on
their exempt income, since unrelated business losses then would be
offset by dividends, interest, and other excluded income. This would
reduce the loss that could be applied against unrelated business
income of prior or future tax years. Therefore, to preserve the
immunity of exempt income, all net operating loss computations are
limited to those items of income and deductions that affect the
unrelated business taxable income.
In line with this concept, a net operating loss carryback or
carryover is allowed only from a tax year for which the organization
is subject to tax on unrelated business income.
For example, if an organization just became subject to the tax last
year, its net operating loss for that year is not a carryback to a
prior year when it had no unrelated business taxable income, nor is
its net operating loss carryover to succeeding years reduced by the
related income of those prior years.
However, in determining the span of years for which a net operating
loss may be carried back or forward, the tax years for which the
organization is not subject to the tax on unrelated business income
are counted. For example, if an organization was subject to the tax
for 1996 and had a net operating loss for that year, the last tax year
to which any part of that loss may be carried over is 2011, regardless
of whether the organization was subject to the unrelated business
income tax in any of the intervening years.
Charitable contributions deduction.
An exempt organization is allowed to deduct its charitable
contributions in computing its unrelated business taxable income
whether or not the contributions are directly connected with the
unrelated business.
To be deductible, the contribution must be paid to another
qualified organization. For example, an exempt university that
operates an unrelated business may deduct a contribution made to
another university for educational work, but may not claim a deduction
for contributions of amounts spent for carrying out its own
educational program.
For purposes of the deduction, a distribution by a trust made under
the trust instrument to a beneficiary, which itself is a qualified
organization, is treated the same as a contribution.
Deduction limits.
An exempt organization that is subject to the unrelated business
income tax at corporate rates is allowed a deduction for charitable
contributions up to 10% of its unrelated business taxable income
computed without regard to the deduction for contributions.
An exempt trust that is subject to the unrelated business income
tax at trust rates generally is allowed a deduction for charitable
contributions in the same amounts as allowed for individuals. However,
the limit on the deduction is determined in relation to the trust's
unrelated business taxable income computed without regard to the
deduction, rather than in relation to adjusted gross income.
Contributions in excess of the limits just described may be carried
over to the next 5 tax years. A contribution carryover is not allowed,
however, to the extent that it increases a net operating loss
carryover.
Specific deduction.
In computing unrelated business taxable income, a specific
deduction of $1,000 is allowed. However, the specific deduction is not
allowed in computing a net operating loss or the net operating loss
deduction.
Generally, the deduction is limited to $1,000 regardless of the
number of unrelated businesses in which the organization is engaged.
Exception.
An exception is provided in the case of a diocese, province of a
religious order, or a convention or association of churches that may
claim a specific deduction for each parish, individual church,
district, or other local unit. In these cases, the specific deduction
for each local unit is limited to the lower of:
- $1,000, or
- Gross income derived from an unrelated trade or business
regularly carried on by the local unit.
This exception applies only to parishes, districts, or other local
units that are not separate legal entities, but are components of a
larger entity (diocese, province, convention, or association) filing
Form 990-T. The parent organization must file a return reporting
the unrelated business gross income and related deductions of all
units that are not separate legal entities. The local units cannot
file separate returns. However, each local unit that is separately
incorporated must file its own return and cannot include, or be
included with, any other entity. See Title-holding corporations
in chapter 1 for a discussion of the only situation in which more than
one legal entity may be included on the same Form 990-T.
Example.
X is an association of churches and is divided into local units A,
B, C, and D. Last year, A, B, C, and D derived gross income of,
respectively, $1,200, $800, $1,500, and $700 from unrelated businesses
that they regularly conduct. X may claim a specific deduction of
$1,000 with respect to A, $800 with respect to B, $1,000 with respect
to C, and $700 with respect to D.
Partnership Income or Loss
An organization may have unrelated business income or loss as a
member of a partnership, rather than through direct business dealings
with the public. If so, it must treat its share of the partnership
income or loss as if it had conducted the business activity in its own
capacity as a corporation or trust. No distinction is made between
limited and general partners.
Thus, if an organization is a member of a partnership regularly
engaged in a trade or business that is an unrelated trade or business
with respect to the organization, the organization must include in its
unrelated business taxable income its share of the partnership's gross
income from the unrelated trade or business (whether or not
distributed), and the deductions attributable to it. The partnership
income and deductions to be included in the organization's unrelated
business taxable income are figured the same way as any income and
deductions from an unrelated trade or business conducted directly by
the organization.
Example.
An exempt educational organization is a partner in a partnership
that operates a factory. The partnership also holds stock in a
corporation. The exempt organization must include its share of the
gross income from operating the factory in its unrelated business
taxable income, but may exclude its share of any dividends the
partnership received from the corporation.
Different tax years.
If the exempt organization and the partnership of which it is a
member have different tax years, the partnership items that enter into
the computation of the organization's unrelated business taxable
income must be based on the income and deductions of the partnership
for the partnership's tax year that ends within or with the
organization's tax year.
S Corporation Income or Loss
An organization that owns S corporation stock must take into
account its share of the S corporation's income, deductions, or losses
in figuring unrelated business taxable income, regardless of the
actual source or nature of the income, deductions, and losses. For
example, the organization's share of the S corporation's interest and
dividend income will be taxable, even though interest and dividends
are normally excluded from unrelated business taxable income. The
organization must also take into account its gain or loss on the sale
or other disposition of the S corporation stock in figuring unrelated
business taxable income.
Special Rules for Foreign Organizations
The unrelated business taxable income of a foreign organization
exempt from tax under section 501(a) consists of the organization's:
- Unrelated business taxable income derived from sources
within the United States, but not effectively connected with the
conduct of a trade or business within the United States, plus
- Unrelated business taxable income effectively connected with
the conduct of a trade or business within the United States, whether
or not this income is derived from sources within the United
States.
To determine whether income realized by a foreign organization is
derived from sources within the United States or is effectively
connected with the conduct of a trade or business within the United
States, see sections 861 through 865 and the related regulations.
Special Rules for Social Clubs, VEBAs and SUBs
The following discussion applies to:
- Social clubs described in section
501(c)(7),
- Voluntary employees' beneficiary associations (VEBAs)
described in section 501(c)(9), and
- Supplemental unemployment compensation benefit trusts
(SUBs) described in section 501(c)(17).
These organizations must figure unrelated business taxable
income under special rules. Unlike other exempt organizations, they
cannot exclude their investment income (dividends, interest, rents,
etc.). (See Exclusions under Income, earlier.)
Therefore, they are generally subject to unrelated business income tax
on this income.
The unrelated business taxable income of these organizations
includes all gross income, less deductions directly connected with the
production of that income, except that gross income for this purpose
does not include exempt function income. The dividends
received deduction for corporations is not allowed in computing
unrelated business taxable income because it is not an expense
incurred in the production of income.
Losses from nonexempt activities.
Losses from nonexempt activities of these organizations cannot be
used to offset investment income unless the activities were undertaken
with the intent to make a profit.
Example.
A private golf and country club that is a qualified tax-exempt
social club has nonexempt function income from interest and from the
sale of food and beverages to nonmembers. The club sells food and
beverages as a service to members and their guests rather than for the
purpose of making a profit. Therefore, any loss resulting from sales
to nonmembers cannot be used to offset the club's interest income.
Modifications.
The unrelated business taxable income is modified by any net
operating loss or charitable contributions deduction and by the
specific deduction (described earlier under Deductions.
Exempt function income.
This is gross income from dues, fees, charges or similar items paid
by members for goods, facilities, or services to the members or their
dependents or guests, to further the organization's exempt purposes.
Exempt function income also includes income that is set aside
for qualified purposes.
Income that is set aside.
This is income set aside to be used for religious, charitable,
scientific, literary, or educational purposes or for the prevention of
cruelty to children or animals.In addition, for a VEBA or SUB, it is
income set aside to provide for the payment of life, sick, accident,
or other benefits.
However, any amounts set aside by a VEBA or SUB that exceed the
organization's qualified asset account limit (determined under section
419A) are unrelated business income. Special rules apply to the
treatment of existing reserves for post-retirement medical or life
insurance benefits. These rules are explained in section 512(a)(3)(E).
Income derived from an unrelated trade or business may not be set
aside and therefore cannot be exempt function income. In addition, any
income set aside and later spent for other purposes must be included
in unrelated business taxable income.
Set-aside income is generally excluded from gross income only if it
is set aside in the tax year in which it is otherwise includible in
gross income. However, income set aside on or before the date for
filing Form 990-T, including extensions of time, may, at the
election of the organization, be treated as having been set aside in
the tax year for which the return was filed. The income set aside must
have been includible in gross income for that earlier year.
Nonrecognition of gain.
If the organization sells property used directly in performing an
exempt function and purchases other property used directly in
performing an exempt function, any gain on the sale is recognized only
to the extent that the sales price of the old property exceeds the
cost of the new property. The purchase of the new property must be
made within 1 year before the date of sale of the old property or
within 3 years after the date of sale.
This rule also applies to gain from an involuntary conversion of
the property resulting from its destruction in whole or in part,
theft, seizure, requisition, or condemnation.
Special Rules for Veterans' Organizations
Unrelated business taxable income of a veterans' organization that
is exempt under section 501(c)(19) does not include the net income
from insurance business that is properly set aside. The organization
may set aside income from payments received for life, sick, accident,
or health insurance for the organization's members or their dependents
for the payment of insurance benefits or reasonable costs of insurance
administration, or for use exclusively for religious, charitable,
scientific, literary, or educational purposes, or the prevention of
cruelty to children or animals. For details, see section 512(a)(4) and
the regulations under that section.
Income From Controlled Organizations
The exclusions for interest, annuities, royalties, and rents,
explained earlier in this chapter under Income, may not
apply to a payment of these items received by a controlling
organization from its controlled organization. The payment is included
in the controlling organization's unrelated business taxable income to
the extent it reduced the net unrelated income (or increased the net
unrelated loss) of the controlled organization. All deductions of the
controlling organization directly connected with the amount included
in its unrelated business taxable income are allowed.
For a payment made under a contract in effect on June 8, 1997, and
received during the first 2 tax years beginning after August 4, 1997,
the definition of a controlled organization and the computation of the
amount included in the controlling organization's unrelated business
taxable income are different. See section 1.512(b)-1(l) of the
regulations for details.
Net unrelated income.
This is:
- For an exempt organization, its unrelated business taxable
income, or
- For a nonexempt organization, the part of its taxable income
that would be unrelated business taxable income if it were exempt and
had the same exempt purposes as the controlling organization.
Net unrelated loss.
This is:
- For an exempt organization, its net operating loss,
or
- For a nonexempt organization, the part of its net operating
loss that would be its net operating loss if it were exempt and had
the same exempt purposes as the controlling organization.
Control.
An organization is controlled if:
- For a corporation, the controlling organization owns (by
vote or value) more than 50% of the stock,
- For a partnership, the controlling organization owns more
than 50% of the profits or capital interests, or
- For any other organization, the controlling organization
owns more than 50% of the beneficial interest.
For this purpose, constructive ownership of stock (determined
under section 318) or other interests is taken into account.
Therefore, an exempt parent organization is treated as controlling
any subsidiary in which it holds more than 50% of the voting power or
value, whether directly (as in the case of a first-tier subsidiary) or
indirectly (as in the case of a second-tier subsidiary).
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