Nonprofits Escaping Tax on Unrelated Business Activities

Large and wealthy not-for-profit organizations are apparently escaping taxation on income earned on commercial ventures (for example, real estate, publishing, mail order merchandise, etc.) by offsetting the income with expenses from other activities. As a CPA, I would love to see the details on how many of the not-for-profits whose returns for unrelated business income tax (UBIT) were analyzed  by Chronicle of Philanthropy managed to turn positive revenue streams from unrelated business activities into often substantial losses for tax purposes.

For example, NPR managed to come up with a $9,487,227 tax loss on $5,756,151 of unrelated business income (UBI).  

Creative expense allocation by tax exempts for purposes of avoiding UBIT has been going on for years.  Maybe someone will finally take a serious look at it.  It's been my experience that those responsible for the tax returns see such allocations partly as a game and partly through a well honed sense of entitlement.  Taxes, after all, are something paid by those money grubbing capitalists, not by those who pursue more pure causes in the world of not- for-profit organizations. 

Here is one example of how I saw this game being played.  A professional organization has a group of employees that publish a glossy monthly magazine that goes out to all of its numerous affluent, educated members.  The publication contains general information on trends in the profession, managing a practice, news about the organization itself and an occasional feature about the history of the profession.  The feature stories are all illustrated with photos and even custom art work. The hefty advertising content of this publication, including many ads for upscale consumer products, means that it generates significant income for the organization.  In fact, those in charge of this monthly publication spend significant time soliciting advertisements, on market research and even plan entire issues around topics of interest to specific types of advertisers. 

Other departments in the organization also publish periodicals of a decidedly different nature: These are low circulation, monthly, quarterly and semi annual journals often printed on rough paper stock, many of which consist of long, jargon-filled articles complete with dozens of footnotes reviewed by various specialist and sub-specialist among the organization's members.  No organized attempt is made to solicit ads for these types of publications because it is understood their format simply isn't attractive to advertisers.  In addition, the employees who produce the glossy monthly have almost no contact with the employees who produce the purely technical journals for the various divisions and groups within the organization as a whole. 

For tax purposes, this organization offset the advertising income of the glossy monthly publication with the expense of producing the technical reviews, producing to produce a net tax loss from publishing activities for purpose of the unrelated business income tax. . 

To its credit, the IRS did take issue with the allocation. The compromise made was that expenses related to technical publications with no advertising at all could not be used to offset income from the advertising rich general purpose monthly.  Needless to say,  ads soon sprouted on the inside covers of some of those technical publications.  I was a bit amazed by this result at the time. Because there was no operating relationship between the two publishing arms, from a purely theoretical cost accounting perspective there should not be any offsets at all between the two types of publishing operations.    

I suspect that part of the above result was because traditionally the IRS has seen less revenue potential from auditing major tax exempt organization for UBIT issues than it has from matters of properly classifying tax exempt organizations as public charities and issues related to private inurement (the use of tax exempt organizations and assets for the benefit of a person or entity with a close relationship to the organization).  The reason for this emphasis has been twofold. 

First, the deduction of contributions to public charities by individual and corporate taxpayers has a far greater impact on net tax revenue than any other issue in the not-for-profit sector.  Determining if the organization receiving donations qualifies for public charity status is thus rightfully high on the IRS priority list.

Second, the fines levied from a finding of private inurement can be substantial and can even result in the revocation of tax exempt status. In recent years, the tax exempt division at the IRS has had a very full plate dealing with the doctrine of private inurement and the often complicated arrangements between charitable medical organizations and related doctors and other service providers definitely seeking benefit from the relationship. The abuse of tax exempt status by credit counseling operations was also a high priority until recently.   

The intent of the UBIT is to address the problem of unfair competition between for profit companies and non profit organizations conducting for profit activities unrelated to the exempt purpose.  As the Chronicle of Philanthropy summary has revealed, the amount of UBIT actually getting paid by many exempt organizations is paltry when compared to the revenues coming in. Better enforcement of UBIT needs to be on the agenda.  

Rosslyn Smith is a CPA and a lawyer.
Large and wealthy not-for-profit organizations are apparently escaping taxation on income earned on commercial ventures (for example, real estate, publishing, mail order merchandise, etc.) by offsetting the income with expenses from other activities. As a CPA, I would love to see the details on how many of the not-for-profits whose returns for unrelated business income tax (UBIT) were analyzed  by Chronicle of Philanthropy managed to turn positive revenue streams from unrelated business activities into often substantial losses for tax purposes.

For example, NPR managed to come up with a $9,487,227 tax loss on $5,756,151 of unrelated business income (UBI).  

Creative expense allocation by tax exempts for purposes of avoiding UBIT has been going on for years.  Maybe someone will finally take a serious look at it.  It's been my experience that those responsible for the tax returns see such allocations partly as a game and partly through a well honed sense of entitlement.  Taxes, after all, are something paid by those money grubbing capitalists, not by those who pursue more pure causes in the world of not- for-profit organizations. 

Here is one example of how I saw this game being played.  A professional organization has a group of employees that publish a glossy monthly magazine that goes out to all of its numerous affluent, educated members.  The publication contains general information on trends in the profession, managing a practice, news about the organization itself and an occasional feature about the history of the profession.  The feature stories are all illustrated with photos and even custom art work. The hefty advertising content of this publication, including many ads for upscale consumer products, means that it generates significant income for the organization.  In fact, those in charge of this monthly publication spend significant time soliciting advertisements, on market research and even plan entire issues around topics of interest to specific types of advertisers. 

Other departments in the organization also publish periodicals of a decidedly different nature: These are low circulation, monthly, quarterly and semi annual journals often printed on rough paper stock, many of which consist of long, jargon-filled articles complete with dozens of footnotes reviewed by various specialist and sub-specialist among the organization's members.  No organized attempt is made to solicit ads for these types of publications because it is understood their format simply isn't attractive to advertisers.  In addition, the employees who produce the glossy monthly have almost no contact with the employees who produce the purely technical journals for the various divisions and groups within the organization as a whole. 

For tax purposes, this organization offset the advertising income of the glossy monthly publication with the expense of producing the technical reviews, producing to produce a net tax loss from publishing activities for purpose of the unrelated business income tax. . 

To its credit, the IRS did take issue with the allocation. The compromise made was that expenses related to technical publications with no advertising at all could not be used to offset income from the advertising rich general purpose monthly.  Needless to say,  ads soon sprouted on the inside covers of some of those technical publications.  I was a bit amazed by this result at the time. Because there was no operating relationship between the two publishing arms, from a purely theoretical cost accounting perspective there should not be any offsets at all between the two types of publishing operations.    

I suspect that part of the above result was because traditionally the IRS has seen less revenue potential from auditing major tax exempt organization for UBIT issues than it has from matters of properly classifying tax exempt organizations as public charities and issues related to private inurement (the use of tax exempt organizations and assets for the benefit of a person or entity with a close relationship to the organization).  The reason for this emphasis has been twofold. 

First, the deduction of contributions to public charities by individual and corporate taxpayers has a far greater impact on net tax revenue than any other issue in the not-for-profit sector.  Determining if the organization receiving donations qualifies for public charity status is thus rightfully high on the IRS priority list.

Second, the fines levied from a finding of private inurement can be substantial and can even result in the revocation of tax exempt status. In recent years, the tax exempt division at the IRS has had a very full plate dealing with the doctrine of private inurement and the often complicated arrangements between charitable medical organizations and related doctors and other service providers definitely seeking benefit from the relationship. The abuse of tax exempt status by credit counseling operations was also a high priority until recently.   

The intent of the UBIT is to address the problem of unfair competition between for profit companies and non profit organizations conducting for profit activities unrelated to the exempt purpose.  As the Chronicle of Philanthropy summary has revealed, the amount of UBIT actually getting paid by many exempt organizations is paltry when compared to the revenues coming in. Better enforcement of UBIT needs to be on the agenda.  

Rosslyn Smith is a CPA and a lawyer.