Daily Record August 17, 2007 Edition
FIN 48 EFFECTS ON NONPROFIT ORGAINIZATIONS
By Raymond Jacobi, CPA
FIN 48, effective for fiscal years beginning after December 15, 2006, is a consideration when there is uncertainty regarding:
- whether a particular type of tax is applicable to an entity at all
- in what jurisdictions (Federal, state, local, and foreign) a tax return must be filed and taxes paid
- amount of income potentially subject to tax
- amounts of deductible expenses, especially when allocations are involved
- amounts of deferred tax assets and liabilities
An overriding tax position for nonprofit organizations is whether they do in fact qualify for tax-exempt status. If there is uncertainty about this position, then FIN 48 would apply to it. Circumstances that might raise questions about qualification for tax-exempt status include:
- Private benefit and repeated flagrant acts of private inurement (consider especially compensation of highly paid people, insider transactions, etc.)
- Excessive lobbying or political activity
- Failure to meet the “organizational” and “operational” tests (in other words, failure to do what you told the IRS you would do when you applied for exempt status)
- Having so much unrelated business activities (as a percentage of total activities) that the IRS might assert you are really a business
- Gross violations of other laws
In addition, FIN 48 would apply to uncertain tax positions of nonprofit organizations associated with the following:
Private foundation excise tax on net investment income, under IRC Sec. 4940
Although this is technically an excise tax, it is covered by FIN 48 because it is calculated based on a type of income. See the definition of “income tax” in the Glossary (Appendix E; para. 289) of SFAS 109, Accounting for Income Taxes.
However, FIN 48 will only infrequently need to be considered, as the applicability and computation of this tax (including deferred amounts) are in most cases not likely to be uncertain. Further, since the tax rate is only 2% (1% in some cases); any uncertain tax amounts are not likely to be material to a foundation’s financial statements.
Tax on Unrelated Business Income (UBI), under IRC Sec. 511
FIN 48 will usually need to be considered in relation to this tax.
The fundamental question is whether the organization has over $1000 of net income, as defined in IRC Sec. 512(a), from an unrelated trade or business, as defined in Sec. 513(a). Since there is allowed a specific deduction of that amount, lesser amounts of net income will not result in any tax payable. (There is a $1000 gross income threshold for filing Form 990-T, but if no tax is due, there will be no penalty for failure to file this form.)
The following aspects of this tax may give rise to uncertain tax positions:
- Every nonprofit organization (including those not required to file Form 990, such as churches and small organizations) must analyze its sources of gross income and determine which ones might be considered by the IRS to be UBI.
- Aspects of the IRC definition of UBI that are especially subject to judgment, and thus to uncertainty, include whether an activity is:
- “unrelated” to the organization’s exempt purpose,
- considered a “trade or business,” and
- “regularly carried on.”
- So-called “passive income”—return on investments—is, by law (Sec. 512(b)), not generally subject to the UBI tax. However the rules surrounding some types of this income, such as royalties and certain rental income, are complex. There may be uncertainties as to whether an item qualifies as a royalty, or whether part or all of rental income is taxable because of certain of its attributes. (Such attributes include whether it: is from debt-financed property; is from rental of personal—as opposed to real—property; also includes payment for provision of personal services; is based on a percentage of the net—as opposed to gross—income of the property).
- Income from certain trade shows conducted by 501(c)(3, 4, 5, & 6) organizations may be excluded from taxable income (Sec. 513(d)(3)), but only if certain judgmental criteria are satisfied.
- UBI also does not include income from: activities carried on largely by volunteers, selling of donated merchandise, and activities carried on for the convenience of members, students, patients, etc. (Sec. 513(a)). These definitions are subject to interpretation and may be challenged by the IRS.
- Once a source of UBI has been identified, then there may be uncertainty in computing the amount of gross income from this source. Besides normal matters of accounting judgment:
- Advertising income is taxable, but when the affected publications are
furnished to dues-paying members of a membership organization,
a complex allocation is required to compute the taxable advertising
amount and related deductible expenses.
- There is often some judgment involved in determining amounts of expenses that may be deducted in computing taxable net income. This is especially likely to be the case when allocations of expenses are required, as is usual for personnel costs, occupancy, administrative expenses, etc.
- Allocation of occupancy costs is especially subject to IRS challenge if the
facility is used for both exempt and non-exempt purposes.
- There are exceptions to most of the rules (and exceptions to the exceptions!).
- If an organization operates in multiple taxing jurisdictions, there may be uncertainty over allocating the taxable income among those jurisdictions.
- If timing differences between book and taxable amounts exist, there may be uncertainties as to the expected timing of the reversal of those differences, and the recoverability of any deferred tax assets.
Tax on income of a taxable subsidiary of a nonprofit organization
All of the normal uncertainties affecting for-profit organizations apply here; they are discussed in FIN 48 and elsewhere in professional literature.
Raymond J. Jacobi, CPA is a partner with Mengel, Metzger, Barr & Co. LLP and may be reached at Rjacobi@mmb-co.com.
