Author Archives: Kathy Cuddapah

UBI Activity Loophole for Schools

schools

Schools often rent their facilities to a third party when they’re not in use or have excess space. They usually do this as a community service; for instance, renting the facility to a daycare provider or a summer school, or to produce additional income. School business managers and CFOs should know that this type of activity typically has to be treated as Unrelated Business Income (UBI), and may be subject to tax. However, it warrants a closer look, as the rules are not “typical” and many exceptions exist.

Schools are not taxed on income generated from their mission or programs. However, the same rules do not apply when schools use their facilities for unrelated activities. The tax code contains numerous rules that designate what an unrelated income stream is and assist in determining if it is taxable. Unrelated activities are those that fit a three-pronged definition: the school is conducting a trade or business for the production of income from selling goods or services; the trade or business is regularly carried on; and, the activity is not substantially related to the organization’s exempt purpose. When schools lease or share space, and collect rental income, they should make sure that their accounting team is aware of the intricacies in the tax code as the facts and circumstances warrant.

In the event that a school rents out any part of a debt-financed property, the rules should be evaluated to determine if it is a taxable activity. There are exceptions to the acquisition indebtedness portion of the definition of a taxable activity for certain qualified organizations. A school described in section 170(b)(1)(a)(ii) is a qualified organization under one of the exception rules, which negates the acquisition indebtedness portion of the general rule. If applied properly, a school is not subject to unrelated business tax on such income.

Generally, when UBI rules are applied, revenue can easily be categorized as such. However, when all the exceptions are carefully considered, there are often rules that exist to negate certain revenues from being considered UBI – the trick is finding it. A nonprofit school, if organized under the correct section of the tax law, qualifies for this exception under the definition of acquisition indebtedness so that rental income on a debt-financed property is actually not subject to the UBI rules.

For more information or questions, please contact Aronson’s Kathy Cuddapah at 301.231.6200.

Alternative Investments and Reporting Requirements for Associations

investment

Additional disclosures in the annual Form 990 and possible taxable implications — Many associations are investing in alternatives due to the ongoing economic recovery and low rate of returns from traditional investments. Endowment and board designated funds need to achieve investment targets, which can be near impossible to make with the average returns from mutual funds and managed accounts. Alternative investments provide the allure of increased returns, albeit at an increased risk. Many associations have been successful at hitting higher returns through alternative investments. These investments do come with added oversight and considerations for additional disclosures to the government in certain ownership situations or because of certain transactions.

ALTERNATIVE INVESTMENTS

Typical alternative investments are hedge funds, private equity funds, commodities, and private investment funds. When you dig a little deeper into the investment vehicle these alternatives utilize, you find partnerships and Limited Liability Companies (LLC). Most, with the exception of a select few, are not publicly traded on an open market. These investment types require careful analysis to value and record under Generally Accepted Accounting Principles (GAAP), as well as tax review for issues involving special disclosure options. Here are some of the main considerations an association’s financial officer should review annually with regard to alternative investment activity.

ADDITIONAL DISCLOSURES

If invested in a LLC or partnership, it should be reviewed to understand the origin, whether foreign or domestic. Investment holdings of more than $100,000 in foreign sourced investments require disclosure in Schedule F of the annual Federal Form 990. Additionally, certain activity such as a current investment of $100,000 or more could require additional forms for completion and submission with Form 990. Potential forms can include Form 926 for foreign corporations, and Form 8865 for foreign partnerships. Form 8621 is necessary if the association is a shareholder in a Passive Foreign Investment Company (PFIC) or a qualified electing fund. Identifying these entities and determining the forms to complete may require assistance from an international tax specialist.

TAX IMPLICATIONS

Partnerships and LLCs provide K-1s at year-end summarizing the taxable information for the recipient. An association could be subject to unrelated business income from debt-financed property reported on the K-1. Investment managers report details of nonprofit unrelated activity in a special place on a K-1 as footnotes or additional disclosures behind the printed form. This can require the association to file Federal Form 990-T. State taxable income can be disclosed in the K-1 nonprofit section, reporting the states that have nexus by location, requiring one or more state income tax returns in addition to Form 990-T.

For more information, please contact Kathy Cuddapah at Kcuddapah@aronsonllc.com.

 

New ASU 2016-14 Requires Expanded Nonprofit Expense Reporting – Does Your Chart of Accounts Measure Up?

checkboxOr more precisely, does your chart of accounts provide, easily, the reporting that is going to now be required of all nonprofits?

The new ASU, 2016-14 Not-for-Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit Entities, will require financials statements of nonprofits to disclose expenses by both functional and natural classifications. In English, this means a Statement or Schedule of Functional Expenses will be required for all, when previously only voluntary health and welfare nonprofits were required to disclose such information. This disclosure will be necessary to report either in the financial statements themselves, or in the notes.

Most assume that this information is readily available to the organization, but when the pedal hits the metal and the report needs to be put together, and further be analyzed by higher ups and board or trustee members, it may not always be the case that it’s the result of merely pushing a button. It could be that easy, though, if your chart of accounts were set up properly to capture information. Not all charts of accounts are set up, or used properly, to do this. The good news is there is time to evaluate your systems and see if they are up to the task. Some small changes may be needed, or an entire overhaul. Now is a good time to find out. Also a tune up of how to use the coding system pairs with a properly functioning system that results in good reporting. So some timely training for the staff that input data, and those who review output, may also be appropriate.

The effective date of the new ASU 2016-14 is for fiscal years beginning after 12/15/2017 (so for calendar year 2018). This is the time to make decisions about changing the underpinning of the accounting system, better known as the chart of accounts.

A Welcome Break on the Fee for 1023-EZ Application for Tax Exempt Status

check the boxEffective July 1, 2016, the application fee for filing the Form 1023EZ has been lowered to $275. The old fee was $400. That’s a savings of $125, and is a welcome relief to small nonprofits applying for tax exempt status.

The new streamlined Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, was introduced by the IRS in 2014 to provide relief for small nonprofits applying for tax exempt status from having to complete the full Form 1023, Application for Recognition of Exemption Under Section 501(c)(3). The full form is 26 pages long, and the IRS estimates it requires an average of 15 ½ hours to prepare, with 185 hours of other reading and record keeping; compared to 2 ½ pages and 5 ½ hours to prepare the EZ version, with an additional 12 ½ hours reading and record keeping. So the new 1023-EZ form is a winner when it comes to cutting down on paper work and time invested to comply with IRS requirements.

And customer satisfaction rates are way up for the IRS on the Streamlined EZ form compared to the regular long form.

Not every organization is eligible to complete the streamlined EZ form. Here is a summary of the not-so-short list of twenty-six points your organization needs to pass in order to qualify:

  1. Gross receipts (estimated) will be less than $50,000 for each of the succeeding three years,
  2. Did not exceed $50,000 in gross receipts in each of the past three years (if already operating),
  3. Total assets valued at fair market value are less than $250,000,
  4. Were formed under laws in the U.S. (States, territories and possessions),
  5. Have a mailing address in the U.S. (States, territories and possessions),
  6. Are not a successor to, or controlled by, an entity suspended as a terrorist organization,
  7. Are organized as a corporation, unincorporated association, or a trust,
  8. Are not a successor to a for-profit entity,
  9. Are not a previously revoked organization, or a successor to a previously revoked organization, with the exception of a revocation due to not filing a Form 990 series form for three consecutive years,
  10. Are not a church, convention or association of churches,
  11. Are not a school, college or university,
  12. Are not a hospital or medical research organization in conjunction with a hospital,
  13. Are not a cooperative hospital service organization,
  14. Are not a cooperative service organization of operating educational organizations,
  15. Are not a charitable risk pool,
  16. Are not going to be a supporting organization under section 509(a)(3),
  17. Are not going to be providing credit counseling as a substantial part of your activities,
  18. Plan to invest 5% or more of assets in securities or funds that are not publicly traded,
  19. Do not plan to participate in partnerships in which losses would be shared with for profit entities,
  20. Sell carbon credits or carbon offsets,
  21. Are an HMO,
  22. Are an Accountable Care Organization or engage in ACO activities,
  23. Will maintain donor advised funds,
  24. Organized and operated exclusively for testing for public safety,
  25. A private operating foundation,
  26. Applying for retroactive reinstatement of exemption after being automatically revoked.

IRS Issues Guidance on Notification to Operate as a 501(c)(4) Social Welfare Organization

IRS logoThe IRS on July 8, 2016, issued temporary regulations describing how to communicate with the IRS if you are starting a new social welfare organization, also known as a Section 501(c)(4) organization. A new online form, Form 8976, is required to be submitted to the IRS electronically within 60 days after being established.

If you have started or in the process of organizing a social welfare organization, there are other federal and state filings and disclosures that may be necessary, depending on where and how you are operating. This requirement with the IRS has been up in the air for many months now, so this announcement is some solid news for these start-up organizations.

https://www.irs.gov/charities-non-profits/electronically-submit-your-form-8976-notice-of-intent-to-operate-under-section-501c4

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