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Turbotax Free File

Turbotax free file 5. Turbotax free file   Excise Taxes Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Prohibited Tax Shelter TransactionsEntity Level Tax Excess Benefit TransactionsTax on Disqualified Persons Tax on Organization Managers Excess Benefit Transaction Excess Business Holdings Taxable Distributions of Sponsoring Organizations Exception. Turbotax free file A donor advised fund does not include: Taxes on Prohibited Benefits Resulting From Donor Advised Fund Distributions Excise Taxes on Private Foundations Excise Taxes on Black Lung Benefit Trusts Excise Tax on Failure to Meet the Community Health Needs Assessment Requirements Introduction An excise tax may be imposed on certain tax-exempt organizations. Turbotax free file Topics - This chapter discusses: Prohibited tax shelter transactions Excess benefit transactions Excess business holdings Taxable distributions of sponsoring organizations Taxes on prohibited benefits distributed from donor advised funds Excise taxes on private foundations Excise taxes on 501(c)(21) black lung benefit trusts Excise Tax on Failure to Meet the Community Health Needs Assessment Requirements of Hospitals Useful Items - You may want to see: Forms (and Instructions) 4720 Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code See chapter 6 for more information about getting Form 4720. Turbotax free file Prohibited Tax Shelter Transactions Section 4965 imposes an excise tax on: Certain tax-exempt entities that are party to prohibited tax shelter transactions, and Any entity manager who approves or otherwise causes the entity to be a party to a prohibited tax shelter transaction and knows or has reason to know that the transaction is a prohibited tax shelter transaction. Turbotax free file  Additionally, section 6033 provides new disclosure requirements on a tax-exempt entity that is a party to a prohibited tax shelter transaction. Turbotax free file Tax-exempt entities. Turbotax free file   Tax-exempt entities that are subject to section 4965 include: Entities described in section 501(c), including but not limited to the following common types of entities: Instrumentalities of the United States described in section 501(c)(1); Churches, hospitals, museums, schools, scientific research organizations, and other charities described in section 501(c)(3); Civic leagues, social welfare organizations, and local associations of employees described in section 501(c)(4); Labor, agricultural, or horticultural organizations described in section 501(c)(5); Business leagues, chambers of commerce, trade associations, and other organizations described in section 501(c)(6); Voluntary employees' beneficiary associations (VEBAs) described in section 501(c)(9); Credit unions described in section 501(c)(14); Insurance companies described in section 501(c)(15); and Veterans' organizations described in section 501(c)(19). Turbotax free file Religious or apostolic associations or corporations described in section 501(d). Turbotax free file Entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States). Turbotax free file Indian tribal governments within the meaning of section 7701(a)(40). Turbotax free file Entity manager. Turbotax free file    An entity manager is any person with authority or responsibility similar to that exercised by an officer, director, or trustee, and, for any act, the person that has authority or responsibility with respect to the prohibited transaction. Turbotax free file Prohibited tax shelter transaction. Turbotax free file   A prohibited tax shelter transaction is any listed transaction, within the meaning of section 6707A(c)(2), and any prohibited reportable transactions. Turbotax free file A prohibited reportable transaction is a confidential transaction within the meaning of Regulations section 1. Turbotax free file 6011-4(b)(3), and a transaction with contractual protection within the meaning of Regulations section 1. Turbotax free file 6011-4(b)(4). Turbotax free file See the Instructions for Form 8886 for more information on listed transactions and prohibited reportable transactions. Turbotax free file Subsequently listed transaction. Turbotax free file   Any transaction to which the tax-exempt entity is a party and is later determined to be a listed transaction after the entity has become a party to it, is a subsequently listed transaction. Turbotax free file Entity Level Tax Section 4965(a)(1) imposes an entity level excise tax on any tax-exempt entity described in 1, 2, 3, or 4 above that becomes a party to a prohibited tax shelter transaction or is a party to a subsequently listed transaction (defined earlier). Turbotax free file The excise tax imposed on a tax-exempt entity applies to tax years in which the entity becomes a party to the prohibited tax shelter transaction and any subsequent tax years. Turbotax free file The amount of the excise tax depends on whether the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time it became a party to the transaction. Turbotax free file To figure and report the excise tax imposed on a tax-exempt entity for being a party to a prohibited tax shelter transaction, file Form 4720. Turbotax free file For more information about this excise tax, including information about how it is figured, see the Instructions for Form 4720. Turbotax free file Manager Level Tax Section 4965(a)(2) imposes an excise tax on any tax-exempt entity manager who approves or otherwise causes the entity to be a party to a prohibited tax shelter transaction and knows (or has reason to know) that the transaction is a prohibited tax shelter transaction. Turbotax free file The excise tax, in the amount of $20,000, is assessed for each approval or other act causing the organization to be a party to the prohibited tax shelter transaction. Turbotax free file To report this tax, file Form 4720. Turbotax free file Excess Benefit Transactions Excise tax on excess benefit transactions. Turbotax free file   A disqualified person who benefits from an excess benefit transaction, such as compensation, fringe benefits, or contract payments from certain section 501(c)(3), 501(c)(4), or 501(c)(29) organizations, must correct the transaction and may have to pay an excise tax under section 4958. Turbotax free file A manager of the organization may also have to pay an excise tax under section 4958. Turbotax free file These taxes are reported on Form 4720. Turbotax free file   The excise taxes are imposed if an applicable tax-exempt organization provides an excess benefit to a disqualified person and that benefit exceeds the value of the benefit received in exchange. Turbotax free file   There are three taxes under section 4958. Turbotax free file Disqualified persons are liable for the first two taxes and certain organization managers are liable for the third tax. Turbotax free file    Taxes imposed on excess benefit transactions do not apply to a transaction under a written contract that was binding on September 13, 1995, and at all times thereafter before the transaction occurred. Turbotax free file Tax on Disqualified Persons An excise tax equal to 25% of the excess benefit is imposed on each excess benefit transaction between an applicable tax-exempt organization and a disqualified person. Turbotax free file The disqualified person who benefited from the transaction is liable for the tax. Turbotax free file See definition of Disqualified person, later at Disqualified person. Turbotax free file Additional tax on the disqualified person. Turbotax free file   If the 25% tax is imposed and the excess benefit transaction is not corrected within the taxable period, an additional excise tax equal to 200% of the excess benefit is imposed on any disqualified person involved. Turbotax free file   If a disqualified person makes a payment of less than the full correction amount, the 200% tax is imposed only on the unpaid portion of the correction amount. Turbotax free file If more than one disqualified person received an excess benefit from an excess benefit transaction, all such disqualified persons are jointly and severally liable for the taxes. Turbotax free file   To avoid the 200% tax, a disqualified person must correct the excess benefit transaction during the taxable period. Turbotax free file The 200% tax is abated (refunded if collected) if the excess benefit transaction is corrected within a 90-day correction period beginning on the date a statutory notice of deficiency is issued. Turbotax free file Taxable period. Turbotax free file   The taxable period means the period beginning with the date on which the excess benefit transaction occurs and ending on the earlier of: The date a notice of deficiency was mailed to the disqualified person for the initial tax on the excess benefit transaction, or The date on which the initial tax on the excess benefit transaction for the disqualified person is assessed. Turbotax free file Tax on Organization Managers If tax is imposed on a disqualified person for any excess benefit transaction, an excise tax equal to 10% of the excess benefit is imposed on an organization manager who knowingly participated in an excess benefit transaction, unless such participation was not willful and was due to reasonable cause. Turbotax free file This tax cannot exceed $20,000 ($10,000 for transactions entered in a tax year beginning before August 18, 2006), for each transaction. Turbotax free file There is also joint and several liability for this tax. Turbotax free file A person can be liable for both the tax paid by the disqualified person and the organization manager tax for a particular excess benefit transaction. Turbotax free file Organization Manager. Turbotax free file   An organization manager is any officer, director, or trustee of an applicable tax-exempt organization, or any individual having powers or responsibilities similar to officers, directors, or trustees of the organization, regardless of title. Turbotax free file An organization manager is not considered to have participated in an excess benefit transaction where the manager has opposed the transaction in a manner consistent with the fulfillment of the manager's responsibilities to the organization. Turbotax free file For example, a director who votes against giving an excess benefit would ordinarily not be subject to the 10% tax. Turbotax free file A person participates in a transaction knowingly if the person: Has actual knowledge of sufficient facts so that, based solely upon those facts, such transaction would be an excess benefit transaction; Is aware that such a transaction under these circumstances may violate the provisions of federal tax law governing excess benefit transactions; and Negligently fails to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction. Turbotax free file Knowing does not mean having reason to know. Turbotax free file The organization manager ordinarily will not be considered knowing if, after full disclosure of the factual situation to an appropriate professional, the organization manager relied on the professional's reasoned written opinion on matters within the professional's expertise or if the manager relied on the fact that the requirements for the rebuttable presumption of reasonableness have been satisfied. Turbotax free file Participation by an organization manager is willful if it is voluntary, conscious, and intentional. Turbotax free file An organization manager's participation is due to reasonable cause if the manager has exercised responsibility on behalf of the organization with ordinary business care and prudence. Turbotax free file Excess Benefit Transaction An excess benefit transaction is a transaction in which an economic benefit is provided by an applicable tax-exempt organization, directly or indirectly, to or for the use of any disqualified person, and the value of the economic benefit provided by the organization exceeds the value of the consideration (including the performance of services) received for providing such benefit. Turbotax free file The excess benefit transaction rules apply to all transactions with disqualified persons, regardless of whether the amount of the benefit provided is determined in whole or in part by the revenues of one or more activities of the organization. Turbotax free file To determine whether an excess benefit transaction has occurred, all consideration and benefits exchanged between a disqualified person and the applicable tax-exempt organization, and all entities it controls, are taken into account. Turbotax free file For purposes of determining the value of economic benefits, the value of property, including the right to use property, is the fair market value. Turbotax free file Fair market value is the price at which property, or the right to use property, would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy, sell, or transfer property or the right to use property, and both having reasonable knowledge of relevant facts. Turbotax free file Donor advised fund transactions occurring after August 17, 2006. Turbotax free file   For a donor advised fund, an excess benefit transaction includes a grant, loan, compensation, or other similar payment from the fund to a: Donor or donor advisor, Family member of a donor, or donor advisor, 35% controlled entity of a donor, or donor advisor, or 35% controlled entity of a family member of a donor, or donor advisor. Turbotax free file   The excess benefit in this transaction is the amount of the grant, loan, compensation, or other similar payment. Turbotax free file For additional information, see the Instructions for Form 4720. Turbotax free file Supporting organization transactions occurring after July 25, 2006. Turbotax free file   For any supporting organization, defined in section 509(a)(3), an excess benefit transaction includes grants, loans, compensation, or other similar payment provided by the supporting organization to a: Substantial contributor, Family member of a substantial contributor, 35% controlled entity of a substantial contributor, or 35% controlled entity of a family member of a substantial contributor. Turbotax free file   Additionally, an excess benefit transaction includes any loans provided by the supporting organization to a disqualified person (other than an organization described in section 509(a)(1), (2), or (4)). Turbotax free file   The excess benefit for substantial contributors and parties related to those contributors includes the amount of the grant, loan, compensation, or other similar payment. Turbotax free file For additional information, see the Instructions for Form 4720. Turbotax free file   Excess benefit transaction rules generally do not apply to transactions between a supporting organization and its supported organization described in section 501(c)(4), (5), or (6) in furtherance of charitable purposes. Turbotax free file Date of Occurrence An excess benefit transaction occurs on the date the disqualified person receives the economic benefit from the organization for federal income tax purposes. Turbotax free file However, when a single contractual arrangement provides for a series of compensation or other payments to or for the use of a disqualified person during the disqualified person's tax year, any excess benefit transaction with respect to these payments occurs on the last day of the taxpayer's tax year. Turbotax free file In the case of benefits provided to a qualified pension, profit-sharing, or stock bonus plan, the transaction occurs on the date the benefit is vested. Turbotax free file In the case of the transfer of property subject to a substantial risk of forfeiture, or in the case of rights to future compensation or property, the transaction occurs on the date the property, or the rights to future compensation or property, is not subject to a substantial risk of forfeiture. Turbotax free file Where the disqualified person elects to include an amount in gross income in the tax year of transfer under section 83(b), the excess benefit transaction occurs on the date the disqualified person receives the economic benefit for federal income tax purposes. Turbotax free file Correcting the excess benefit. Turbotax free file   An excess benefit transaction is corrected by undoing the excess benefit to the extent possible, and by taking any additional measures necessary to place the organization in a financial position not worse than what it would have been if the disqualified person were dealing under the highest fiduciary standards. Turbotax free file   A disqualified person corrects an excess benefit by making a payment in cash or cash equivalents, excluding payment by a promissory note, equal to the correction amount to the applicable tax-exempt organization. Turbotax free file The correction amount equals the excess benefit plus the interest on the excess benefit. Turbotax free file The interest rate can be no lower than the applicable federal rate, compounded annually, for the month the transaction occurred. Turbotax free file   A disqualified person can, with the agreement of the applicable tax-exempt organization, make a payment by returning the specific property previously transferred in the excess transaction. Turbotax free file In this case, the disqualified person is treated as making a payment equal to the lesser of: The fair market value of the property on the date the property is returned to the organization, or The fair market value of the property on the date the excess benefit transaction occurred. Turbotax free file   If the payment resulting from the return of property is less than the correction amount, the disqualified person must make an additional cash payment to the organization equal to the difference. Turbotax free file   If the payment resulting from the return of the property exceeds the correction amount described above, the organization can make a cash payment to the disqualified person equal to the difference. Turbotax free file Exception. Turbotax free file   For a correction of an excess benefit transaction (discussed earlier), no amount repaid in a manner prescribed by the Secretary can be held in a donor advised fund. Turbotax free file Applicable Tax-Exempt Organization An applicable tax-exempt organization is a section 501(c)(3), 501(c)(4), or 501(c)(29) organization that is tax-exempt under section 501(a), or was such an organization at any time during a 5-year period ending on the day of the excess benefit transaction. Turbotax free file An applicable tax-exempt organization does not include: A private foundation as defined in section 509(a), A governmental entity that is: Exempt from (or not subject to) taxation without regard to section 501(a), or Not required to file an annual return, or A foreign organization, recognized by the IRS or by treaty, that receives substantially all of its support (other than gross investment income) from sources outside the United States. Turbotax free file An organization is not treated as a section 501(c)(3), 501(c)(4), or 501(c)(29) organization for any period covered by a final determination that the organization was not tax-exempt under section 501(a), but only if the determination was not based on private inurement or one or more excess benefit transactions. Turbotax free file Disqualified Person A disqualified person is: Any person (at any time during the 5-year period ending on the date of the transaction) in a position to exercise substantial influence over the affairs of the organization, A family member of an individual described in 1, and A 35% controlled entity. Turbotax free file For donor advised funds, sponsoring organizations, and certain supporting organizations occurring after August 17, 2006. Turbotax free file   The following persons will be considered disqualified persons along with certain family members and 35% controlled entities associated with them. Turbotax free file Donors of donor advised funds, Investment advisors of sponsoring organizations, and Disqualified persons of a section 509(a)(3) supporting organization that supports the applicable tax-exempt organization. Turbotax free file For certain supporting organization transactions occurring after July 25, 2006. Turbotax free file   Substantial contributors to supporting organizations will also be considered disqualified persons with respect to the supporting organizations, along with their family members and 35% controlled entities. Turbotax free file Investment advisor. Turbotax free file   Investment advisor means for any sponsoring organization, any person compensated by such organization (but not an employee of such organization) for managing the investment of, or providing investment advice for, assets maintained in donor advised funds owned by such sponsoring organization. Turbotax free file Substantial contributor. Turbotax free file   In general, a substantial contributor means any person who contributed or bequeathed an aggregate of more than $5,000 to the organization, if that amount is more than 2% of the total contributions and bequests received by the end of the organization's tax year in which the contribution or bequest is received. Turbotax free file A substantial contributor includes the grantor of a trust. Turbotax free file Family members. Turbotax free file   Family members of a disqualified person include a disqualified person's spouse, brothers or sisters (whether by whole or half-blood), spouses of brothers or sisters (whether by whole or half-blood), ancestors, children (including a legally adopted child), grandchildren, great grandchildren, and spouses of children, grandchildren, and great grandchildren (whether by whole or half-blood). Turbotax free file 35% controlled entity. Turbotax free file   A 35% controlled entity is: A corporation in which disqualified persons own more than 35% of the total combined voting power, A partnership in which such persons own more than 35% of the profits interest, or A trust or estate in which such persons own more than 35% of the beneficial interest. Turbotax free file   In determining the holdings of a business enterprise, any stock or other interest owned directly or indirectly shall apply. Turbotax free file Persons having substantial influence. Turbotax free file   Among those who are in a position to exercise substantial influence over the affairs of the organization are, for example, voting members of the governing body, and persons holding the power of: Presidents, chief executives, or chief operating officers. Turbotax free file Treasurers and chief financial officers. Turbotax free file Persons with a material financial interest in a provider-sponsored organization. Turbotax free file Persons not considered to have substantial influence. Turbotax free file   Persons who are not considered to be in a position to exercise substantial influence over the affairs of an organization include: An employee who receives benefits that total less than the highly compensated amount in section 414(q)(1)(B)(i) and who does not hold the executive or voting powers mentioned earlier in the discussion on Disqualified Person, is not a family member of a disqualified person, and is not a substantial contributor, Tax-exempt organizations described in section 501(c)(3), and Section 501(c)(4) organizations with respect to transactions engaged in with other section 501(c)(4) organizations. Turbotax free file Facts and circumstances. Turbotax free file   The determination of whether a person has substantial influence over the affairs of an organization is based on all the facts and circumstances. Turbotax free file Facts and circumstances that tend to show a person has substantial influence over the affairs of an organization include, but are not limited to, the following. Turbotax free file The person founded the organization. Turbotax free file The person is a substantial contributor to the organization under the section 507(d)(2)(A) definition, only taking into account contributions to the organization for the past 5 years. Turbotax free file The person's compensation is primarily based on revenues derived from activities of the organization that the person controls. Turbotax free file The person has or shares authority to control or determine a substantial portion of the organization's capital expenditures, operating budget, or compensation for employees. Turbotax free file The person manages a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole. Turbotax free file The person owns a controlling interest (measured by either vote or value) in a corporation, partnership, or trust that is a disqualified person. Turbotax free file The person is a nonstock organization controlled directly or indirectly by one or more disqualified persons. Turbotax free file   Facts and circumstances tending to show that a person does not have substantial influence over the affairs of an organization include, but are not limited to, the following. Turbotax free file The person has taken a bona fide vow of poverty as an employee or agent of a religious organization or on its behalf. Turbotax free file The person is an independent contractor whose sole relationship to the organization is providing professional advice (without having decision-making authority) with respect to transactions from which the independent contractor will not economically benefit either directly or indirectly aside from customary fees received for the professional advice rendered. Turbotax free file Any preferential treatment the person receives based on the size of the person's donation is also offered to others making comparable widely solicited donations. Turbotax free file The direct supervisor of the person is not a disqualified person. Turbotax free file The person does not participate in any management decisions affecting the organization as a whole or a discrete segment of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole. Turbotax free file   In the case of multiple organizations affiliated by common control or governing documents, the determination of whether a person does or does not have substantial influence is made separately for each applicable tax-exempt organization. Turbotax free file A person may be a disqualified person with respect to transactions with more than one organization. Turbotax free file Reasonable Compensation. Turbotax free file    Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances. Turbotax free file The section 162 standard will apply in determining the reasonableness of compensation. Turbotax free file The fact that a bonus or revenue-sharing arrangement is subject to a cap is a relevant factor in determining reasonableness of compensation. Turbotax free file   To determine the reasonableness of compensation, all items of compensation provided by an applicable tax-exempt organization in exchange for performance of services are taken into account in determining the value of compensation (except for economic benefits that are disregarded under the discussion Disregarded benefits , later). Turbotax free file Items of compensation include: All forms of cash and noncash compensation, including salary, fees, bonuses, severance payments, and deferred noncash compensation, The payment of liability insurance premiums for, or the payment or reimbursement by the organization of penalties, taxes, or certain expenses under section 4958, unless excludable from income as a de minimis fringe benefit under section 132(a)(4), All other compensatory benefits, whether or not included in gross income for income tax purposes, Taxable and nontaxable fringe benefits, except fringe benefits described in section 132, and Foregone interest on loans. Turbotax free file    Intent to treat benefits as compensation. Turbotax free file An economic benefit is not treated as consideration for the performance of services unless the organization providing the benefit clearly indicates its intent to treat the benefit as compensation when the benefit is paid. Turbotax free file   An applicable tax-exempt organization (or entity that it controls) is treated as clearly indicating its intent to provide an economic benefit as compensation for services only if the organization provides written substantiation that is contemporaneous with the transfer of the economic benefits under consideration. Turbotax free file Ways to provide contemporaneous written substantiation of its intent to provide an economic benefit as compensation include: The organization produces a signed written employment contract, The organization reports the benefit as compensation on an original Form W-2, Form 1099, or Form 990, or on an amended form filed before starting an IRS examination, or The disqualified person reports the benefit as income on the person's original Form 1040, or on an amended form filed before starting an IRS examination. Turbotax free file Exception. Turbotax free file   If the economic benefit is excluded from the disqualified person's gross income for income tax purposes, the applicable tax-exempt organization is not required to indicate its intent to provide an economic benefit as compensation for services. Turbotax free file Rebuttable presumption that a transaction is not an excess benefit transaction. Turbotax free file   Payments under a compensation arrangement are presumed to be reasonable and the transfer of property (or right to use property) is presumed to be at fair market value, if the following three conditions are met. Turbotax free file The transaction is approved in advance by an authorized body of the organization (or an entity it controls) which is composed of individuals who do not have a conflict of interest concerning the transaction. Turbotax free file Before making its determination, the authorized body obtained and relied upon appropriate data as to comparability. Turbotax free file (There is a special safe harbor for small organizations. Turbotax free file If the organization has gross receipts of less than $1 million, appropriate comparability data includes data on compensation paid by three comparable organizations in the same or similar communities for similar services. Turbotax free file ) The authorized body adequately documents the basis for its determination concurrently with making that determination. Turbotax free file The documentation should include: The terms of the approved transaction and the date approved, The members of the authorized body who were present during debate on the transaction that was approved and those who voted on it, The comparability data obtained and relied upon by the authorized body and how the data was obtained, Any actions by a member of the authorized body having conflict of interest, and Documentation of the basis of the determination before the later of the next meeting of the authorized body or 60 days after the final actions of the authorized body are taken, and approval of records as reasonable, accurate, and complete within a reasonable time thereafter. Turbotax free file Disregarded benefits. Turbotax free file   The following economic benefits are disregarded for section 4958 purposes. Turbotax free file Nontaxable fringe benefits that are excluded from income under section 132. Turbotax free file Benefits provided to a volunteer for the organization if the benefit is provided to the general public in exchange for a membership fee or contribution of $75 or less. Turbotax free file Benefits provided to a member of an organization due to the payment of a membership fee or to a donor as a result of a deductible contribution, if a significant number of disqualified persons make similar payments or contributions and are offered a similar economic benefit. Turbotax free file Benefits provided to a person solely as a member of a charitable class that the applicable tax-exempt organization intends to benefit as part of the accomplishment of its exempt purpose. Turbotax free file A transfer of an economic benefit to or for the use of a governmental unit, as defined in section 170(c)(1), if exclusively for public purposes. Turbotax free file Special Exception for Initial Contracts      Section 4958 does not apply to any fixed payment made to a person under an initial contract. Turbotax free file   A fixed payment is an amount of cash or other property specified in the contract, or determined by a fixed formula that is specified in the contract, which is to be paid or transferred in exchange for the provision of specified services or property. Turbotax free file   A fixed formula can, generally, incorporate an amount that depends upon future specified events or contingencies, as long as no one has discretion when calculating the amount of a payment or deciding whether to make a payment (such as a bonus). Turbotax free file   An initial contract is a binding written contract between an applicable tax-exempt organization and a person who was not a disqualified person immediately before entering into the contract. Turbotax free file   A binding written contract, providing it can be terminated or canceled by the applicable tax-exempt organization without the other party's consent (except as a result of substantial nonperformance) and without substantial penalty, is treated as a new contract, as of the earliest date any termination or cancellation would be effective. Turbotax free file Also, if the parties make a material change to a contract, which includes an extension or renewal of the contract (except for an extension or renewal resulting from the exercise of an option by the disqualified person), or a more than incidental change to the amount payable under the contract, it is treated as a new contract as of the effective date of the material change. Turbotax free file More information. Turbotax free file   For more information, see the Instructions to Forms 990 and 4720. Turbotax free file Excess Business Holdings Private foundations are generally not permitted to hold more than a 20% interest in an unrelated business enterprise. Turbotax free file They may be subject to an excise tax on the amount of any excess business holdings. Turbotax free file For purposes of section 4943, for tax years beginning after August 17, 2006, donor advised funds and certain supporting organizations are considered private foundations. Turbotax free file Donor advised fund. Turbotax free file   In general, a donor advised fund is a fund or account separately identified by reference to contributions of a donor or donors that is owned and controlled by a sponsoring organization and for which the donor has or expects to have advisory privileges concerning the distribution or investment of the funds. Turbotax free file Supporting organizations. Turbotax free file   Only certain supporting organizations are subject to the excess business holdings tax under section 4943. Turbotax free file These include (1) Type III supporting organizations that are not functionally integrated and (2) Type II supporting organizations that accept any gift or contribution from a person who by himself or in connection with a related party controls the supported organization that the Type II supporting organization supports. Turbotax free file Taxes. Turbotax free file   A private foundation that has excess holdings in a business enterprise may become liable for an excise tax based on the amount of holdings. Turbotax free file The initial tax is 10% (5% for tax years beginning before August 18, 2006) of the value of the excess holdings and is imposed on the last day of each tax year that ends during the taxable period. Turbotax free file The excess holdings are determined on the day during the tax year when they were the largest. Turbotax free file   A foundation that fails to correct the excess business holdings becomes liable for an additional tax of 200% of the remaining excess business holdings as of the earlier of tax assessment or mailing of a notice of deficiency. Turbotax free file   For more information on the tax on excess business holdings, see the Instructions for Form 4720. Turbotax free file Taxable Distributions of Sponsoring Organizations An excise tax is imposed on a sponsoring organization for each taxable distribution it makes from a donor advised fund. Turbotax free file An excise tax is also imposed on any fund manager of the sponsoring organization who agreed to the making of a distribution, knowing that it is a taxable distribution. Turbotax free file Taxable distribution. Turbotax free file   A taxable distribution is any distribution from a donor advised fund to any natural person or to any other person if: The distribution is for any purpose other than one specified in section 170(c)(2)(B), or The sponsoring organization maintaining the donor advised fund does not exercise expenditure responsibility with respect to the distribution in accordance with section 4945(h). Turbotax free file    However, a taxable distribution does not include a distribution from a donor advised fund to: Any organization described in section 170(b)(1)(A) (other than a disqualified supporting organization), The sponsoring organization of the donor advised fund, or Any other donor advised fund. Turbotax free file The tax on taxable distributions applies to distributions occurring in tax years beginning after August 17, 2006. Turbotax free file Sponsoring organization. Turbotax free file   A sponsoring organization is a section 170(c) organization that is neither a government organization (as referred to in section 170(c)(1) and (2)(A)) nor a private foundation. Turbotax free file Donor advised fund. Turbotax free file    A donor advised fund is a fund or account: Which is separately identified by reference to contributions of a donor or donors, Which is owned and controlled by a sponsoring organization, and For which the donor (or any person appointed or designated by the donor) has or expects to have advisory privileges concerning the distribution or investment of the funds held in the donor advised funds or accounts because of the donor's status as a donor. Turbotax free file Exception. Turbotax free file A donor advised fund does not include:    A fund or account that makes distributions only to a single identified organization or governmental entity, or Any fund or account for a person described in 3 above that gives advice about which individuals receive grants for travel, study, or similar purposes, if the following three requirements are met: The person's advisory privileges are performed exclusively by such person in their capacity as a committee member of which all the committee members are appointed by the sponsoring organization, No combination of persons with advisory privileges, described in 3 above, or persons related to those in 3 above directly or indirectly control the committee, and All grants from the fund or account are awarded on an objective and nondiscriminatory basis according to a procedure approved in advance by the board of directors of the sponsoring organization. Turbotax free file The procedure must be designed to ensure that all grants meet the requirements of section 4945(g)(1), (2), or (3). Turbotax free file Disqualified supporting organization. Turbotax free file   A disqualified supporting organization includes (1) a Type III supporting organization that is not functionally integrated and (2) any supporting organization where the donor or donor advisor (and any related parties) directly or indirectly controls a supported organization of the supporting organization. Turbotax free file Tax on sponsoring organization. Turbotax free file   A tax of 20% of the amount of each taxable distribution is imposed on the sponsoring organization. Turbotax free file Tax on fund manager. Turbotax free file   If a tax is imposed on a taxable distribution of the sponsoring organization, a tax of 5% of the distribution will be imposed on any fund manager who agreed to the distribution knowing that it was a taxable distribution. Turbotax free file Any fund manager who took part in the distribution and is liable for the tax must pay the tax. Turbotax free file The maximum amount of tax on all fund managers for any one taxable distribution is $10,000. Turbotax free file If more than one fund manager is liable for tax on a taxable distribution, all such managers are jointly and severally liable for the tax. Turbotax free file   For more information on the tax on taxable distributions of sponsoring organizations, see the Instructions for Form 4720. Turbotax free file Taxes on Prohibited Benefits Resulting From Donor Advised Fund Distributions Prohibited benefit. Turbotax free file   If any donor, donor advisor, or related party advises the sponsoring organization about making a distribution which results in a donor, donor advisor, or related party receiving (either directly or indirectly) a more than incidental benefit, then such benefit is a prohibited benefit. Turbotax free file The tax on prohibited benefits applies to distributions occurring in tax years beginning after August 17, 2006. Turbotax free file Donor advisor. Turbotax free file   A donor advisor is any person appointed or designated by a donor to advise a sponsoring organization on the distribution or investment of amounts held in the donor's fund or account. Turbotax free file Related party. Turbotax free file   A related party includes any family member or 35% controlled entity. Turbotax free file See the definition of those terms under Disqualified Person , earlier. Turbotax free file Tax on donor, donor advisor, or related person. Turbotax free file    A tax of 125% of the benefit resulting from the distribution is imposed on both the party who advised as to the distribution (which might be a donor, donor advisor, or related party) and the party who received such benefit (which might be a donor, donor advisor, or related party). Turbotax free file The advisor and the party who received the benefit are jointly and severally liable for the tax. Turbotax free file Tax on fund managers. Turbotax free file   If a tax is imposed on a prohibited benefit received by a donor, donor advisor, or related person, a tax of 10% of the amount of the prohibited benefit is imposed on any fund manager who agreed to the distribution knowing that it would confer a prohibited benefit. Turbotax free file Any fund manager who took part in the distribution and is liable for the tax must pay the tax. Turbotax free file The maximum amount of tax on all fund managers for any one taxable distribution is $10,000. Turbotax free file If more than one fund manager is liable for tax on a taxable distribution, all such managers are jointly and severally liable for the tax. Turbotax free file Exception. Turbotax free file   If a person engaged in an excess benefit transaction and received a prohibited benefit for the same transaction, the person is taxed under section 4958, and no tax is imposed under section 4967 for a prohibited benefit. Turbotax free file   For more information on taxes on prohibited benefits distributed from donor advised funds, see the Instructions for Form 4720. Turbotax free file Excise Taxes on Private Foundations There is an excise tax on the net investment income of most domestic private foundations. Turbotax free file Capital gains from appreciation are included in the tax base on private foundation net investment income. Turbotax free file This tax must be reported on Form 990-PF and must be paid annually at the time for filing that return or in quarterly estimated tax payments if the total tax for the year (section 4940 tax minus credits) is $500 or more. Turbotax free file Form 990-W is used to calculate the estimated tax. Turbotax free file In addition, there are several other rules that apply to excise taxes on private foundations. Turbotax free file These include: Restrictions on self-dealing between private foundations and their substantial contributors and other disqualified persons, Requirements that the foundation annually distribute income for charitable purposes, Limits on their holdings in any business enterprise (see Excess Business Holdings, earlier), Provisions that investments must not jeopardize the carrying out of exempt purposes, and Provisions to assure that expenditures further the organization's exempt purposes. Turbotax free file Violations of these provisions give rise to taxes and penalties against the private foundation and, in some cases, its managers, its substantial contributors, and certain related persons. Turbotax free file For more information on the excise taxes imposed on private foundations, see the Instructions for Form 4720 and the Instructions for Form 990-PF. Turbotax free file Excise Taxes on Black Lung Benefit Trusts A black lung benefit trust that makes any expenditures, payments, or investments other than those described in chapter 4 under 501(c)(21) - Black Lung Benefit Trusts must pay a tax equal to 10% of the amount of such expenditures. Turbotax free file If there are any acts of self-dealing between the trust and a disqualified person, a tax equal to 10% of the amount involved is imposed on the disqualified person. Turbotax free file Both of these excise taxes are reported on Schedule A (Form 990-BL). Turbotax free file See the Form 990-BL instructions for more information on these taxes and what has to be filed, even if the trust is excepted from filing. Turbotax free file Excise Tax on Failure to Meet the Community Health Needs Assessment Requirements For tax years beginning after March 23, 2012, new section 4959 imposes an excise tax on hospital organizations which fail to meet certain section 501(r) requirements for each of their hospital facilities. Turbotax free file These entities must meet section 501(r)(3) requirements at all times during their tax year. Turbotax free file Section 501(r)(3) requirements pertain to a hospital organization preparing a community health needs assessment (CHNA). Turbotax free file See Schedule H, Hospitals (Form 990), for details. Turbotax free file Prev  Up  Next   Home   More Online Publications
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The Turbotax Free File

Turbotax free file 4. Turbotax free file   Unrelated Business Taxable Income Table of Contents IncomeExclusions Dues of Agricultural Organizations and Business Leagues DeductionsDirectly Connected Exploitation of Exempt Activity—Advertising Sales Modifications Partnership Income or Loss S Corporation Income or Loss Special Rules for Foreign Organizations Special Rules for Social Clubs, VEBAs, SUBs, and GLSOsIncome that is set aside. Turbotax free file Special Rules for Veterans' Organizations Income From Controlled OrganizationsAddition to tax for valuation misstatements. Turbotax free file Net unrelated income. Turbotax free file Net unrelated loss. Turbotax free file Control. Turbotax free file Income from property financed with qualified 501(c)(3) bonds. Turbotax free file Disposition of property received from taxable subsidiary and used in unrelated business. Turbotax free file Income From Debt-Financed Property Debt-Financed PropertyAcquisition Indebtedness Computation of Debt-Financed Income Deductions for Debt-Financed Property Allocation Rules How to Get Tax Help The term “unrelated business taxable income” generally means the gross income derived from any unrelated trade or business regularly conducted by the exempt organization, less the deductions directly connected with carrying on the trade or business. Turbotax free file If an organization regularly carries on two or more unrelated business activities, its unrelated business taxable income is the total of gross income from all such activities less the total allowable deductions attributable to all the activities. Turbotax free file In computing unrelated business taxable income, gross income and deductions are subject to the modifications and special rules explained in this chapter. Turbotax free file Whether a particular item of income or expense falls within any of these modifications or special rules must be determined by all the facts and circumstances in each specific case. Turbotax free file For example, if the organization received a payment termed rent that is in fact a return of profits by a person operating the property for the benefit of the organization, or that is a share of the profits retained by the organization as a partner or joint venturer, the payment is not within the income exclusion for rents, discussed later under Exclusions. Turbotax free file Income Generally, unrelated business income is taxable, but there are exclusions and special rules that must be considered when figuring the income. Turbotax free file Exclusions The following types of income (and deductions directly connected with the income) are generally excluded when figuring unrelated business taxable income. Turbotax free file Dividends, interest, annuities and other investment income. Turbotax free file   All dividends, interest, annuities, payments with respect to securities loans, income from notional principal contracts, and other income from an exempt organization's ordinary and routine investments that the IRS determines are substantially similar to these types of income are excluded in computing unrelated business taxable income. Turbotax free file Exception for insurance activity income of a controlled foreign corporation. Turbotax free file   This exclusion does not apply to income from certain insurance activities of an exempt organization's controlled foreign corporation. Turbotax free file The income is not excludable dividend income, but instead is unrelated business taxable income to the extent it would be so treated if the exempt organization had earned it directly. Turbotax free file Certain exceptions to this rule apply. Turbotax free file For more information, see section 512(b)(17). Turbotax free file Other exceptions. Turbotax free file   This exclusion does not apply to unrelated debt-financed income (discussed under Income From Debt-Financed Property, later), to interest or annuities received from a controlled corporation (discussed under Income From Controlled Organizations, later). Turbotax free file Income from lending securities. Turbotax free file   Payments received with respect to a security loan are excluded in computing unrelated business taxable income only if the loan is made under an agreement that:    Provides for the return to the exempt organization of securities identical to the securities loaned, Requires payments to the organization of amounts equivalent to all interest, dividends, and other distributions that the owner of the securities is entitled to receive during the period of the loan, Does not reduce the organization's risk of loss or opportunity for gain on the securities, Contains reasonable procedures to implement the obligation of the borrower to furnish collateral to the organization with a fair market value each business day during the period of the loan in an amount not less than the fair market value of the securities at the close of the preceding business day, and Permits the organization to terminate the loan upon notice of not more than 5 business days. Turbotax free file   Payments with respect to securities loans include: Amounts in respect of dividends, interest, and other distributions, Fees based on the period of time the loan is in effect and the fair market value of the security during that period, Income from collateral security for the loan, and Income from the investment of collateral security. Turbotax free file The payments are considered to be from the securities loaned and not from collateral security or the investment of collateral security from the loans. Turbotax free file Any deductions that are directly connected with collateral security for the loan, or with the investment of collateral security, are considered deductions that are directly connected with the securities loaned. Turbotax free file Royalties. Turbotax free file   Royalties, including overriding royalties, are excluded in computing unrelated business taxable income. Turbotax free file   To be considered a royalty, a payment must relate to the use of a valuable right. Turbotax free file Payments for trademarks, trade names, or copyrights are ordinarily considered royalties. Turbotax free file Similarly, payments for the use of a professional athlete's name, photograph, likeness, or facsimile signature are ordinarily considered royalties. Turbotax free file However, royalties do not include payments for personal services. Turbotax free file Therefore, payments for personal appearances and interviews are not excluded as royalties and must be included in figuring unrelated business taxable income. Turbotax free file   Unrelated business taxable income does not include royalty income received from licensees by an exempt organization that is the legal and beneficial owner of patents assigned to it by inventors for specified percentages of future royalties. Turbotax free file   Mineral royalties are excluded whether measured by production or by gross or taxable income from the mineral property. Turbotax free file However, the exclusion does not apply to royalties that stem from an arrangement whereby the organization owns a working interest in a mineral property and is liable for its share of the development and operating costs under the terms of its agreement with the operator of the property. Turbotax free file To the extent they are not treated as loans under section 636 (relating to income tax treatment of mineral production payments), payments for mineral production are treated in the same manner as royalty payments for the purpose of computing unrelated business taxable income. Turbotax free file To the extent they are treated as loans, any payments for production that are the equivalent of interest are treated as interest and are excluded. Turbotax free file Exceptions. Turbotax free file   This exclusion does not apply to debt-financed income (discussed under Income From Debt-Financed Property, later) or to royalties received from a controlled corporation (discussed under Income From Controlled Organizations, later). Turbotax free file Rents. Turbotax free file   Rents from real property, including elevators and escalators, are excluded in computing unrelated business taxable income. Turbotax free file Rents from personal property are not excluded. Turbotax free file However, special rules apply to “mixed leases” of both real and personal property. Turbotax free file Mixed leases. Turbotax free file   In a mixed lease, all of the rents are excluded if the rents attributable to the personal property are not more than 10% of the total rents under the lease, as determined when the personal property is first placed in service by the lessee. Turbotax free file If the rents attributable to personal property are more than 10% but not more than 50% of the total rents, only the rents attributable to the real property are excluded. Turbotax free file If the rents attributable to the personal property are more than 50% of the total rents, none of the rents are excludable. Turbotax free file   Property is placed in service when the lessee first may use it under the terms of a lease. Turbotax free file For example, property subject to a lease entered into on November 1, for a term starting on January 1 of the next year, is considered placed in service on January 1, regardless of when the lessee first actually uses it. Turbotax free file   If separate leases are entered into for real and personal property and the properties have an integrated use (for example, one or more leases for real property and another lease or leases for personal property to be used on the real property), all the leases will be considered as one lease. Turbotax free file   The rent attributable to the personal property must be recomputed, and the treatment of the rents must be redetermined, if: The rent attributable to all the leased personal property increases by 100% or more because additional or substitute personal property is placed in service, or The lease is modified to change the rent charged (whether or not the amount of rented personal property changes). Turbotax free file Any change in the treatment of rents resulting from the recomputation is effective only for the period beginning with the event that caused the recomputation. Turbotax free file Exception for rents based on net profit. Turbotax free file   The exclusion for rents does not apply if the amount of the rent depends on the income or profits derived by any person from the leased property, other than an amount based on a fixed percentage of the gross receipts or sales. Turbotax free file Exception for income from personal services. Turbotax free file   Payment for occupying space when personal services are also rendered to the occupant does not constitute rent from real property. Turbotax free file Therefore, the exclusion does not apply to transactions such as renting hotel rooms, rooms in boarding houses or tourist homes, and space in parking lots or warehouses. Turbotax free file Other exceptions. Turbotax free file   This exclusion does not apply to unrelated debt-financed income (discussed under Income From Debt-Financed Property, later), or to interest, annuities, royalties and rents received from a controlled corporation (discussed under Income From Controlled Organizations, later), investment income (dividends, interest, rents, etc. Turbotax free file ) received by organizations described in sections 501(c)(7), 501(c)(9), 501(c)(17), and 501(c)(20). Turbotax free file See Special Rules for Social Clubs, VEBAs, SUBs, and GLSOs, discussed later for more information. Turbotax free file Income from research. Turbotax free file   A tax-exempt organization may exclude income from research grants or contracts from unrelated business taxable income. Turbotax free file However, the extent of the exclusion depends on the nature of the organization and the type of research. Turbotax free file   Income from research for the United States, any of its agencies or instrumentalities, or a state or any of its political subdivisions is excluded when computing unrelated business taxable income. Turbotax free file   For a college, university, or hospital, all income from research, whether fundamental or applied, is excluded in computing unrelated business taxable income. Turbotax free file   When an organization is operated primarily to conduct fundamental research (as distinguished from applied research) and the results are freely available to the general public, all income from research performed for any person is excluded in computing unrelated business taxable income. Turbotax free file   The term research, for this purpose, does not include activities of a type normally conducted as an incident to commercial or industrial operations, such as testing or inspecting materials or products, or designing or constructing equipment, buildings, etc. Turbotax free file In addition, the term fundamental research does not include research conducted for the primary purpose of commercial or industrial application. Turbotax free file Gains and losses from disposition of property. Turbotax free file   Also excluded from unrelated business taxable income are gains or losses from the sale, exchange, or other disposition of property other than: Stock in trade or other property of a kind that would properly be includable in inventory if on hand at the close of the tax year, Property held primarily for sale to customers in the ordinary course of a trade or business, or Cutting of timber that an organization has elected to consider as a sale or exchange of the timber. Turbotax free file   It should be noted that the last exception relates only to cut timber. Turbotax free file The sale, exchange, or other disposition of standing timber is excluded from the computation of unrelated business income, unless it constitutes property held for sale to customers in the ordinary course of business. Turbotax free file Lapse or termination of options. Turbotax free file   Any gain from the lapse or termination of options to buy or sell securities is excluded from unrelated business taxable income. Turbotax free file The exclusion applies only if the option is written in connection with the exempt organization's investment activities. Turbotax free file Therefore, this exclusion is not available if the organization is engaged in the trade or business of writing options or the options are held by the organization as inventory or for sale to customers in the ordinary course of a trade or business. Turbotax free file Exception. Turbotax free file   This exclusion does not apply to unrelated debt-financed income, discussed later under Income From Debt-Financed Property. Turbotax free file Gain or loss on disposition of certain brownfield property. Turbotax free file   Gain or loss from the qualifying sale, exchange, or other disposition of a qualifying brownfield property (as defined in section 512(b)(19)(C)), which was acquired by the organization after December 31, 2005 and before January 1, 2011, is excluded from unrelated business taxable income and is excepted from the debt-financed rules for such property. Turbotax free file See sections 512(b)(19) and 514(b)(1)(E). Turbotax free file Income from services provided under federal license. Turbotax free file   There is a further exclusion from unrelated business taxable income of income from a trade or business conducted by a religious order or by an educational organization maintained by the order. Turbotax free file   This exclusion applies only if the following requirements are met. Turbotax free file The trade or business must have been operated by the order or by the institution before May 27, 1959. Turbotax free file The trade or business must provide services under a license issued by a federal regulatory agency. Turbotax free file More than 90% of the net income from the business for the tax year must be devoted to religious, charitable, or educational purposes that constitute the basis for the religious order's exemption. Turbotax free file The rates or other charges for these services must be fully competitive with the rates or other charges of similar taxable businesses. Turbotax free file Rates or other charges for these services will be considered as fully competitive if they are neither materially higher nor materially lower than the rates charged by similar businesses operating in the same general area. Turbotax free file Exception. Turbotax free file    This exclusion does not apply to unrelated debt-financed income (discussed under Income From Debt-Financed Property, later). Turbotax free file Member income of mutual or cooperative electric companies. Turbotax free file   Income of a mutual or cooperative electric company described in section 501(c)(12) which is treated as member income under subparagraph (H) of that section is excluded from unrelated business taxable income. Turbotax free file Dues of Agricultural Organizations and Business Leagues Dues received from associate members by organizations exempt under section 501(c)(5) or section 501(c)(6) may be treated as gross income from an unrelated trade or business if the associate member category exists for the principal purpose of producing unrelated business income. Turbotax free file For example, if an organization creates an associate member category solely to allow associate members to purchase insurance through the organization, the associate member dues may be unrelated business income. Turbotax free file Exception. Turbotax free file   Associate member dues received by an agricultural or horticultural organization are not treated as gross income from an unrelated trade or business, regardless of their purpose, if they are not more than the annual limit. Turbotax free file The limit on dues paid by an associate member is $148 for 2011. Turbotax free file   If the required annual dues are more than the limit, the entire amount is treated as income from an unrelated business unless the associate member category was formed or availed of for the principal purpose of furthering the organization's exempt purposes. Turbotax free file Deductions To qualify as allowable deductions in computing unrelated business taxable income, the expenses, depreciation, and similar items generally must be allowable income tax deductions that are directly connected with carrying on an unrelated trade or business. Turbotax free file They cannot be directly connected with excluded income. Turbotax free file For an exception to the “directly connected” requirement, see Charitable contributions deduction, under Modifications, later. Turbotax free file Directly Connected To be directly connected with the conduct of an unrelated business, deductions must have a proximate and primary relationship to carrying on that business. Turbotax free file For an exception, see Expenses attributable to exploitation of exempt activities, later. Turbotax free file Expenses attributable solely to unrelated business. Turbotax free file   Expenses, depreciation, and similar items attributable solely to the conduct of an unrelated business are proximately and primarily related to that business and qualify for deduction to the extent that they are otherwise allowable income tax deductions. Turbotax free file   For example, salaries of personnel employed full-time to conduct the unrelated business and depreciation of a building used entirely in the conduct of that business are deductible to the extent otherwise allowable. Turbotax free file Expenses attributable to dual use of facilities or personnel. Turbotax free file   When facilities or personnel are used both to conduct exempt functions and to conduct an unrelated trade or business, expenses, depreciation, and similar items attributable to the facilities or personnel must be allocated between the two uses on a reasonable basis. Turbotax free file The part of an item allocated to the unrelated trade or business is proximately and primarily related to that business and is allowable as a deduction in computing unrelated business taxable income if the expense is otherwise an allowable income tax deduction. Turbotax free file Example 1. Turbotax free file A school recognized as a tax-exempt organization contracts with an individual to conduct a summer tennis camp. Turbotax free file The school provides the tennis courts, housing, and dining facilities. Turbotax free file The contracted individual hires the instructors, recruits campers, and provides supervision. Turbotax free file The income the school receives from this activity is from a dual use of the facilities and personnel. Turbotax free file The school, in computing its unrelated business taxable income, may deduct an allocable part of the expenses attributable to the facilities and personnel. Turbotax free file Example 2. Turbotax free file An exempt organization with gross income from an unrelated trade or business pays its president $90,000 a year. Turbotax free file The president devotes approximately 10% of his time to the unrelated business. Turbotax free file To figure the organization's unrelated business taxable income, a deduction of $9,000 ($90,000 × 10%) is allowed for the salary paid to its president. Turbotax free file Expenses attributable to exploitation of exempt activities. Turbotax free file   Generally, expenses, depreciation, and similar items attributable to the conduct of an exempt activity are not deductible in computing unrelated business taxable income from an unrelated trade or business that exploits the exempt activity. Turbotax free file (See Exploitation of exempt functions under Not substantially related in chapter 3. Turbotax free file ) This is because they do not have a proximate and primary relationship to the unrelated trade or business, and therefore, they do not qualify as directly connected with that business. Turbotax free file Exception. Turbotax free file   Expenses, depreciation, and similar items may be treated as directly connected with the conduct of the unrelated business if all the following statements are true. Turbotax free file The unrelated business exploits the exempt activity. Turbotax free file The unrelated business is a type normally conducted for profit by taxable organizations. Turbotax free file The exempt activity is a type normally conducted by taxable organizations in carrying on that type of business. Turbotax free file The amount treated as directly connected is the smaller of: The excess of these expenses, depreciation, and similar items over the income from, or attributable to, the exempt activity; or The gross unrelated business income reduced by all other expenses, depreciation, and other items that are actually directly connected. Turbotax free file   The application of these rules to an advertising activity that exploits an exempt publishing activity is explained next. Turbotax free file Exploitation of Exempt Activity—Advertising Sales The sale of advertising in a periodical of an exempt organization that contains editorial material related to the accomplishment of the organization's exempt purpose is an unrelated business that exploits an exempt activity, the circulation and readership of the periodical. Turbotax free file Therefore, in addition to direct advertising costs, exempt activity costs (expenses, depreciation, and similar expenses attributable to the production and distribution of the editorial or readership content) can be treated as directly connected with the conduct of the advertising activity. Turbotax free file (See Expenses attributable to exploitation of exempt activities under Directly Connected, earlier. Turbotax free file ) Figuring unrelated business taxable income (UBTI). Turbotax free file   The UBTI of an advertising activity is the amount shown in the following chart. Turbotax free file IF gross advertising income is . Turbotax free file . Turbotax free file . Turbotax free file THEN UBTI is . Turbotax free file . Turbotax free file . Turbotax free file More than direct advertising costs The excess advertising income, reduced (but not below zero) by the excess, if any, of readership costs over circulation income. Turbotax free file Equal to or less than direct advertising costs Zero. Turbotax free file   • Circulation income and readership costs are not taken into account. Turbotax free file   • Any excess advertising costs reduce (but not below zero) UBTI from any other unrelated business activity. Turbotax free file   The terms used in the chart are explained in the following discussions. Turbotax free file Periodical Income Gross advertising income. Turbotax free file   This is all the income from the unrelated advertising activities of an exempt organization periodical. Turbotax free file Circulation income. Turbotax free file   This is all the income from the production, distribution, or circulation of an exempt organization's periodical (other than gross advertising income). Turbotax free file It includes all amounts from the sale or distribution of the readership content of the periodical, such as income from subscriptions. Turbotax free file It also includes allocable membership receipts if the right to receive the periodical is associated with a membership or similar status in the organization. Turbotax free file Allocable membership receipts. Turbotax free file   This is the part of membership receipts (dues, fees, or other charges associated with membership) equal to the amount that would have been charged and paid for the periodical if: The periodical was published by a taxable organization, The periodical was published for profit, and The member was an unrelated party dealing with the taxable organization at arm's length. Turbotax free file   The amount used to allocate membership receipts is the amount shown in the following chart. Turbotax free file   For this purpose, the total periodical costs are the sum of the direct advertising costs and the readership costs, explained under Periodical Costs, later. Turbotax free file The cost of other exempt activities means the total expenses incurred by the organization in connection with its other exempt activities, not offset by any income earned by the organization from those activities. Turbotax free file IF . Turbotax free file . Turbotax free file . Turbotax free file THEN the amount used to allocate membership receipts is . Turbotax free file . Turbotax free file . Turbotax free file 20% or more of the total circulation consists of sales to nonmembers The subscription price charged nonmembers. Turbotax free file The above condition does not apply, and 20% or more of the members pay reduced dues because they do not receive the periodical The reduction in dues for a member not receiving the periodical. Turbotax free file Neither of the above conditions applies The membership receipts multiplied by this fraction:   Total periodical costs Total periodical costs Plus Cost of other exempt activities Example 1. Turbotax free file U is an exempt scientific organization with 10,000 members who pay annual dues of $15. Turbotax free file One of U's activities is publishing a monthly periodical distributed to all of its members. Turbotax free file U also distributes 5,000 additional copies of its periodical to nonmembers, who subscribe for $10 a year. Turbotax free file Since the nonmember circulation of U's periodical represents one-third (more than 20%) of its total circulation, the subscription price charged to nonmembers is used to determine the part of U's membership receipts allocable to the periodical. Turbotax free file Thus, U's allocable membership receipts are $100,000 ($10 times 10,000 members), and U's total circulation income for the periodical is $150,000 ($100,000 from members plus $50,000 from sales to nonmembers). Turbotax free file Example 2. Turbotax free file Assume the same facts except that U sells only 500 copies of its periodical to nonmembers, at a price of $10 a year. Turbotax free file Assume also that U's members may elect not to receive the periodical, in which case their dues are reduced from $15 a year to $6 a year, and that only 3,000 members elect to receive the periodical and pay the full dues of $15 a year. Turbotax free file U's stated subscription price of $9 to members consistently results in an excess of total income (including gross advertising income) attributable to the periodical over total costs of the periodical. Turbotax free file Since the 500 copies of the periodical distributed to nonmembers represent only 14% of the 3,500 copies distributed, the $10 subscription price charged to nonmembers is not used to determine the part of membership receipts allocable to the periodical. Turbotax free file Instead, since 70% of the members elect not to receive the periodical and pay $9 less per year in dues, the $9 price is used to determine the subscription price charged to members. Turbotax free file Thus, the allocable membership receipts will be $9 a member, or $27,000 ($9 times 3,000 copies). Turbotax free file U's total circulation income is $32,000 ($27,000 plus the $5,000 from nonmember subscriptions). Turbotax free file Periodical Costs Direct advertising costs. Turbotax free file   These are expenses, depreciation, and similar items of deduction directly connected with selling and publishing advertising in the periodical. Turbotax free file   Examples of allowable deductions under this classification include agency commissions and other direct selling costs, such as transportation and travel expenses, office salaries, promotion and research expenses, and office overhead directly connected with the sale of advertising lineage in the periodical. Turbotax free file Also included are other deductions commonly classified as advertising costs under standard account classifications, such as artwork and copy preparation, telephone, telegraph, postage, and similar costs directly connected with advertising. Turbotax free file   In addition, direct advertising costs include the part of mechanical and distribution costs attributable to advertising lineage. Turbotax free file For this purpose, the general account classifications of items includable in mechanical and distribution costs ordinarily employed in business-paper and consumer-publication accounting provide a guide for the computation. Turbotax free file Accordingly, the mechanical and distribution costs include the part of the costs and other expenses of composition, press work, binding, mailing (including paper and wrappers used for mailing), and bulk postage attributable to the advertising lineage of the publication. Turbotax free file   In the absence of specific and detailed records, the part of mechanical and distribution costs attributable to the periodical's advertising lineage can be based on the ratio of advertising lineage to total lineage in the periodical, if this allocation is reasonable. Turbotax free file Readership costs. Turbotax free file   These are all expenses, depreciation, and similar items that are directly connected with the production and distribution of the readership content of the periodical. Turbotax free file Costs partly attributable to other activities. Turbotax free file   Deductions properly attributable to exempt activities other than publishing the periodical may not be allocated to the periodical. Turbotax free file When expenses are attributable both to the periodical and to the organization's other activities, an allocation must be made on a reasonable basis. Turbotax free file The method of allocation will vary with the nature of the item, but once adopted, should be used consistently. Turbotax free file Allocations based on dollar receipts from various exempt activities generally are not reasonable since receipts usually do not accurately reflect the costs associated with specific activities that an exempt organization conducts. Turbotax free file Consolidated Periodicals If an exempt organization publishes more than one periodical to produce income, it may treat all of them (but not less than all) as one in determining unrelated business taxable income from selling advertising. Turbotax free file It treats the gross income from all the periodicals, and the deductions directly connected with them, on a consolidated basis. Turbotax free file Consolidated treatment, once adopted, must be followed consistently and is binding. Turbotax free file This treatment can be changed only with the consent of the Internal Revenue Service. Turbotax free file An exempt organization's periodical is published to produce income if: The periodical generates gross advertising income to the organization equal to at least 25% of its readership costs, and Publishing the periodical is an activity engaged in for profit. Turbotax free file Whether the publication of a periodical is an activity engaged in for profit can be determined only by all the facts and circumstances in each case. Turbotax free file The facts and circumstances must show that the organization carries on the activity for economic profit, although there may not be a profit in a particular year. Turbotax free file For example, if an organization begins publishing a new periodical whose total costs exceed total income in the start-up years because of lack of advertising sales, that does not mean that the organization did not have as its objective an economic profit. Turbotax free file The organization may establish that it had this objective by showing it can reasonably expect advertising sales to increase, so that total income will exceed costs within a reasonable time. Turbotax free file Example. Turbotax free file Y, an exempt trade association, publishes three periodicals that it distributes to its members: a weekly newsletter, a monthly magazine, and a quarterly journal. Turbotax free file Both the monthly magazine and the quarterly journal contain advertising that accounts for gross advertising income equal to more than 25% of their respective readership costs. Turbotax free file Similarly, the total income attributable to each periodical has exceeded the total deductions attributable to each periodical for substantially all the years they have been published. Turbotax free file The newsletter carries no advertising and its annual subscription price is not intended to cover the cost of publication. Turbotax free file The newsletter is a service that Y distributes to all of its members in an effort to keep them informed of changes occurring in the business world. Turbotax free file It is not engaged in for profit. Turbotax free file Under these circumstances, Y may consolidate the income and deductions from the monthly and quarterly journals in computing its unrelated business taxable income. Turbotax free file It may not consolidate the income and deductions from the newsletter with the income and deductions of its other periodicals, since the newsletter is not published for the production of income. Turbotax free file Modifications Net operating loss deduction. Turbotax free file   The net operating loss (NOL) deduction (as provided in section 172) is allowed in computing unrelated business taxable income. Turbotax free file However, the NOL for any tax year, the carrybacks and carryovers of NOLs, and the NOL deduction are determined without taking into account any amount of income or deduction that has been specifically excluded in computing unrelated business taxable income. Turbotax free file For example, a loss from an unrelated trade or business is not diminished because dividend income was received. Turbotax free file   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. Turbotax free file This would reduce the loss that could be applied against unrelated business income of prior or future tax years. Turbotax free file Therefore, to preserve the immunity of exempt income, all NOL computations are limited to those items of income and deductions that affect the unrelated business taxable income. Turbotax free file   In line with this concept, an NOL carryback or carryover is allowed only from a tax year for which the organization is subject to tax on unrelated business income. Turbotax free file   For example, if an organization just became subject to the tax last year, its NOL for that year is not a carryback to a prior year when it had no unrelated business taxable income, nor is its NOL carryover to succeeding years reduced by the related income of those prior years. Turbotax free file   However, in determining the span of years for which an NOL 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. Turbotax free file For example, if an organization was subject to the tax for 2009 and had an NOL for that year, the last tax year to which any part of that loss may be carried over is 2029, regardless of whether the organization was subject to the unrelated business income tax in any of the intervening years. Turbotax free file   For more details on the NOL deduction, including property eligible for an extended carryback period, see sections 172 and 1400N, Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts, and Publication 4492-B, Information for Affected Taxpayers in the Midwestern Disaster Areas. Turbotax free file Charitable contributions deduction. Turbotax free file   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. Turbotax free file   To be deductible, the contribution must be paid to another qualified organization. Turbotax free file 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. Turbotax free file   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. Turbotax free file Deduction limits. Turbotax free file   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. Turbotax free file See the Instructions for Form 990-T for more information. Turbotax free file    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. Turbotax free file 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. Turbotax free file   Contributions in excess of the limits just described may be carried over to the next 5 tax years. Turbotax free file A contribution carryover is not allowed, however, to the extent that it increases an NOL carryover. Turbotax free file Suspension of deduction limits for farmers and ranchers. Turbotax free file   The limitations discussed above are temporarily suspended for certain qualified conservation contributions of property used in agriculture or livestock production. Turbotax free file See the Instructions for Form 990-T for details. Turbotax free file Specific deduction. Turbotax free file   In computing unrelated business taxable income, a specific deduction of $1,000 is allowed. Turbotax free file However, the specific deduction is not allowed in computing an NOL or the NOL deduction. Turbotax free file   Generally, the deduction is limited to $1,000 regardless of the number of unrelated businesses in which the organization is engaged. Turbotax free file Exception. Turbotax free file   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. Turbotax free file 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 conducted by the local unit. Turbotax free file   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. Turbotax free file 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. Turbotax free file The local units cannot file separate returns. Turbotax free file However, each local unit that is separately incorporated must file its own return and cannot include, or be included with, any other entity. Turbotax free file 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. Turbotax free file Example. Turbotax free file X is an association of churches and is divided into local units A, B, C, and D. Turbotax free file 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. Turbotax free file 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. Turbotax free file 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. Turbotax free file 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. Turbotax free file No distinction is made between limited and general partners. Turbotax free file The organization is required to notify the partnership of its tax-exempt status. Turbotax free file 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. Turbotax free file 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. Turbotax free file The partnership is required to provide the organization this information on Schedule K-1. Turbotax free file Example. Turbotax free file An exempt educational organization is a partner in a partnership that operates a factory. Turbotax free file The partnership also holds stock in a corporation. Turbotax free file 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. Turbotax free file Different tax years. Turbotax free file   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. Turbotax free file 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. Turbotax free file 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. Turbotax free file 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. Turbotax free file 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, and 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. Turbotax free file 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. Turbotax free file Special Rules for Social Clubs, VEBAs, SUBs, and GLSOs The following discussion applies to: Social clubs described in section 501(c)(7), Voluntary employees' beneficiary associations (VEBAs) described in section 501(c)(9), Supplemental unemployment compensation benefit trusts (SUBs) described in section 501(c)(17), and Group legal services organizations (GLSOs) described in section 501(c)(20). Turbotax free file These organizations must figure unrelated business taxable income under special rules. Turbotax free file Unlike other exempt organizations, they cannot exclude their investment income (dividends, interest, rents, etc. Turbotax free file ). Turbotax free file (See Exclusions under Income, earlier. Turbotax free file ) Therefore, they are generally subject to unrelated business income tax on this income. Turbotax free file 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. Turbotax free file The dividends received by a corporation are not allowed in computing unrelated business taxable income because it is not an expense incurred in the production of income. Turbotax free file Losses from nonexempt activities. Turbotax free file   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. Turbotax free file Example. Turbotax free file 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. Turbotax free file The club sells food and beverages as a service to members and their guests rather than for the purpose of making a profit. Turbotax free file Therefore, any loss resulting from sales to nonmembers cannot be used to offset the club's interest income. Turbotax free file Modifications. Turbotax free file   The unrelated business taxable income is modified by any NOL or charitable contributions deduction and by the specific deduction (described earlier under Deductions). Turbotax free file Exempt function income. Turbotax free file   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. Turbotax free file Exempt function income also includes income set aside for qualified purposes. Turbotax free file Income that is set aside. Turbotax free file   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. Turbotax free file In addition, for a VEBA, SUB, or GLSO, it is income set aside to provide for the payment of life, sick, accident, or other benefits. Turbotax free file   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. Turbotax free file Special rules apply to the treatment of existing reserves for post-retirement medical or life insurance benefits. Turbotax free file These rules are explained in section 512(a)(3)(E)(ii). Turbotax free file   Income derived from an unrelated trade or business may not be set aside and therefore cannot be exempt function income. Turbotax free file In addition, any income set aside and later spent for other purposes must be included in unrelated business taxable income. Turbotax free file   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. Turbotax free file 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. Turbotax free file The income set aside must have been includible in gross income for that earlier year. Turbotax free file Nonrecognition of gain. Turbotax free file   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. Turbotax free file 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. Turbotax free file   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. Turbotax free file 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. Turbotax free file 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. Turbotax free file For details, see section 512(a)(4) and the regulations under that section. Turbotax free file 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. Turbotax free file 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. Turbotax free file All deductions of the controlling organization directly connected with the amount included in its unrelated business taxable income are allowed. Turbotax free file Excess qualifying specified payments. Turbotax free file   Excess qualifying specified payments received or accrued from a controlled entity are included in a controlling exempt organization's unrelated business taxable income only on the amount that exceeds that which would have been paid or accrued if the payments had been determined under section 482. Turbotax free file Qualifying specified payments means any payments of interest, annuities, royalties, or rents received or accrued from the controlled organization pursuant to a binding written contract in effect on August 17, 2006, or to a contract which is a renewal, under substantially similar terms of a binding written contract in effect on August 17, 2006, and the payments are received or accrued before January 1, 2012. Turbotax free file   If a controlled participant is not required to file a U. Turbotax free file S. Turbotax free file income tax return, the participant must ensure that the copy or copies of the Regulations section 1. Turbotax free file 482-7 Cost Sharing Arrangement Statement and any updates are attached to Schedule M of any Form 5471, Information Return of U. Turbotax free file S. Turbotax free file Persons With Respect To Certain Foreign Corporations, any Form 5472, Information Return of a 25% Foreign-Owned U. Turbotax free file S. Turbotax free file Corporation or a Foreign Corporation Engaged in a U. Turbotax free file S. Turbotax free file Trade or Business, or any Form 8865, Return of U. Turbotax free file S. Turbotax free file Persons With Respect to Certain Foreign Partnerships, filed for that participant. Turbotax free file Addition to tax for valuation misstatements. Turbotax free file   Under section 512(b)(13)(E)(ii), the tax imposed on a controlling organization will be increased by 20 percent of the excess qualifying specified payments that are determined with or without any amendments or supplements, whichever is larger. Turbotax free file See section 512(b)(13)(E)(ii) for more information. Turbotax free file Net unrelated income. Turbotax free file   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. Turbotax free file Net unrelated loss. Turbotax free file   This is: For an exempt organization, its NOL, or For a nonexempt organization, the part of its NOL that would be its NOL if it were exempt and had the same exempt purposes as the controlling organization. Turbotax free file Control. Turbotax free file   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. Turbotax free file For this purpose, constructive ownership of stock (determined under section 318) or other interests is taken into account. Turbotax free file   As a result, 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). Turbotax free file Income from property financed with qualified 501(c)(3) bonds. Turbotax free file If any part of a 501(c)(3) organization's property financed with qualified 501(c)(3) bonds is used in a trade or business of any person other than a section 501(c)(3) organization or a governmental unit, and such use is not consistent with the requirements for qualified 501(c)(3) bonds under section 145, the section 501(c)(3) organization is considered to have received unrelated business income in the amount of the greater of the actual rental income or the fair rental value of the property for the period it is used. Turbotax free file No deduction is allowed for interest on the private activity bond. Turbotax free file See sections 150(b)(3) and (c) for more information. Turbotax free file Disposition of property received from taxable subsidiary and used in unrelated business. Turbotax free file A taxable 80%-owned subsidiary corporation of one or more tax-exempt entities is generally subject to tax on a distribution in liquidation of its assets to its exempt parent (or parents). Turbotax free file The assets are treated as if sold at fair market value. Turbotax free file Tax-exempt entities include organizations described in sections 501(a), 529, and 115, charitable remainder trusts, U. Turbotax free file S. Turbotax free file and foreign governments, Indian tribal governments, international organizations, and similar non-taxable organizations. Turbotax free file A taxable corporation that transfers substantially all of its assets to a tax-exempt entity in a transaction that otherwise qualifies for nonrecognition treatment must recognize gain on the transaction as if it sold the assets at fair market value. Turbotax free file However, such a transfer is not taxable if it qualifies as a like-kind exchange under section 1031 or an involuntary conversion under section 1033. Turbotax free file In such a case the built-in appreciation is preserved in the replacement property received in the transaction. Turbotax free file A corporation that changes status from taxable to tax-exempt is treated generally as if it transferred all of its assets to a tax-exempt entity immediately before the change in status (thus subjecting it to the tax on a deemed sale for fair market value). Turbotax free file This rule does not apply where the taxable corporation becomes exempt within 3 years of formation, or had previously been exempt and within several years (generally a period of 3 years) regains exemption, unless the principal purpose of the transactions is to avoid the tax on the change in status. Turbotax free file In the transactions described above, the taxable event is deferred for property that the tax-exempt entity immediately uses in an unrelated business. Turbotax free file If the parent later disposes of the property, then any gain (not in excess of the amount not recognized) is included in the parent's unrelated business taxable income. Turbotax free file If there is partial use of the assets in unrelated business, then there is partial recognition of gain or loss. Turbotax free file Property is treated as disposed if the tax-exempt entity no longer uses it in an unrelated business. Turbotax free file Losses on the transfer of assets to a tax-exempt entity are disallowed if part of a plan with a principal purpose of recognizing losses. Turbotax free file Income From Debt-Financed Property Investment income that would otherwise be excluded from an exempt organization's unrelated business taxable income (see Exclusions under Income earlier) must be included to the extent it is derived from debt-financed property. Turbotax free file The amount of income included is proportionate to the debt on the property. Turbotax free file Debt-Financed Property In general, the term “debt-financed property” means any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness at any time during the tax year (or during the 12-month period before the date of the property's disposal, if it was disposed of during the tax year). Turbotax free file It includes rental real estate, tangible personal property, and corporate stock. Turbotax free file Acquisition Indebtedness For any debt-financed property, acquisition indebtedness is the unpaid amount of debt incurred by an organization: When acquiring or improving the property, Before acquiring or improving the property if the debt would not have been incurred except for the acquisition or improvement, and After acquiring or improving the property if: The debt would not have been incurred except for the acquisition or improvement, and Incurring the debt was reasonably foreseeable when the property was acquired or improved. Turbotax free file The facts and circumstances of each situation determine whether incurring a debt was reasonably foreseeable. Turbotax free file That an organization may not have foreseen the need to incur a debt before acquiring or improving the property does not necessarily mean that incurring the debt later was not reasonably foreseeable. Turbotax free file Example 1. Turbotax free file Y, an exempt scientific organization, mortgages its laboratory to replace working capital used in remodeling an office building that Y rents to an insurance company for nonexempt purposes. Turbotax free file The debt is acquisition indebtedness since the debt, though incurred after the improvement of the office building, would not have been incurred without the improvement, and the debt was reasonably foreseeable when, to make the improvement, Y reduced its working capital below the amount necessary to continue current operations. Turbotax free file Example 2. Turbotax free file X, an exempt organization, forms a partnership with A and B. Turbotax free file The partnership agreement provides that all three partners will share equally in the profits of the partnership, each will invest $3 million, and X will be a limited partner. Turbotax free file X invests $1 million of its own funds in the partnership and $2 million of borrowed funds. Turbotax free file The partnership buys as its sole asset an office building that it leases to the public for nonexempt purposes. Turbotax free file The office building costs the partnership $24 million, of which $15 million is borrowed from Y bank. Turbotax free file The loan is secured by a mortgage on the entire office building. Turbotax free file By agreement with Y bank, X is not personally liable for payment of the mortgage. Turbotax free file X has acquisition indebtedness of $7 million. Turbotax free file This amount is the $2 million debt X incurred in acquiring the partnership interest, plus the $5 million that is X's allocable part of the partnership's debt incurred to buy the office building (one-third of $15 million). Turbotax free file Example 3. Turbotax free file A labor union advanced funds, from existing resources and without any borrowing, to its tax-exempt subsidiary title-holding company. Turbotax free file The subsidiary used the funds to pay a debt owed to a third party that was previously incurred in acquiring two income-producing office buildings. Turbotax free file Neither the union nor the subsidiary has incurred any further debt in acquiring or improving the property. Turbotax free file The union has no outstanding debt on the property. Turbotax free file The subsidiary's debt to the union is represented by a demand note on which the subsidiary makes payments whenever it has the available cash. Turbotax free file The books of the union and the subsidiary list the outstanding debt as interorganizational indebtedness. Turbotax free file Although the subsidiary's books show a debt to the union, it is not the type subject to the debt-financed property rules. Turbotax free file In this situation, the very nature of the title-holding company and the parent-subsidiary relationship shows this debt to be merely a matter of accounting between the two organizations. Turbotax free file Accordingly, the debt is not acquisition indebtedness. Turbotax free file Change in use of property. Turbotax free file   If an organization converts property that is not debt-financed property to a use that results in its treatment as debt-financed property, the outstanding principal debt on the property is thereafter treated as acquisition indebtedness. Turbotax free file Example. Turbotax free file Four years ago a university borrowed funds to acquire an apartment building as housing for married students. Turbotax free file Last year, the university rented the apartment building to the public for nonexempt purposes. Turbotax free file The outstanding principal debt becomes acquisition indebtedness as of the time the building was first rented to the public. Turbotax free file Continued debt. Turbotax free file   If an organization sells property and, without paying off debt that would be acquisition indebtedness if the property were debt-financed property, buys property that is otherwise debt-financed property, the unpaid debt is acquisition indebtedness for the new property. Turbotax free file This is true even if the original property was not debt-financed property. Turbotax free file Example. Turbotax free file To house its administration offices, an exempt organization bought a building using $600,000 of its own funds and $400,000 of borrowed funds secured by a pledge of its securities. Turbotax free file The office building was not debt-financed property. Turbotax free file The organization later sold the building for $1 million without repaying the $400,000 loan. Turbotax free file It used the sale proceeds to buy an apartment building it rents to the general public. Turbotax free file The unpaid debt of $400,000 is acquisition indebtedness with respect to the apartment building. Turbotax free file Property acquired subject to mortgage or lien. Turbotax free file   If property (other than certain gifts, bequests, and devises) is acquired subject to a mortgage, the outstanding principal debt secured by that mortgage is treated as acquisition indebtedness even if the organization did not assume or agree to pay the debt. Turbotax free file Example. Turbotax free file An exempt organization paid $50,000 for real property valued at $150,000 and subject to a $100,000 mortgage. Turbotax free file The $100,000 of outstanding principal debt is acquisition indebtedness, as though the organization had borrowed $100,000 to buy the property. Turbotax free file Liens similar to a mortgage. Turbotax free file   In determining acquisition indebtedness, a lien similar to a mortgage is treated as a mortgage. Turbotax free file A lien is similar to a mortgage if title to property is encumbered by the lien for a creditor's benefit. Turbotax free file However, when state law provides that a lien for taxes or assessments attaches to property before the taxes or assessments become due and payable, the lien is not treated as a mortgage until after the taxes or assessments have become due and payable and the organization has had an opportunity to pay the lien in accordance with state law. Turbotax free file Liens similar to mortgages include (but are not limited to): Deeds of trust, Conditional sales contracts, Chattel mortgages, Security interests under the Uniform Commercial Code, Pledges, Agreements to hold title in escrow, and Liens for taxes or assessments (other than those discussed earlier in this paragraph). Turbotax free file Exception for property acquired by gift, bequest, or devise. Turbotax free file   If property subject to a mortgage is acquired by gift, bequest, or devise, the outstanding principal debt secured by the mortgage is not treated as acquisition indebtedness during the 10-year period following the date the organization receives the property. Turbotax free file However, this applies to a gift of property only if:    The mortgage was placed on the property more than 5 years before the date the organization received it, and The donor held the property for more than 5 years before the date the organization received it. Turbotax free file   This exception does not apply if an organization assumes and agrees to pay all or part of the debt secured by the mortgage or makes any payment for the equity in the property owned by the donor or decedent (other than a payment under an annuity obligation excluded from the definition of acquisition indebtedness, discussed under Debt That Is Not Acquisition Indebtedness, later). Turbotax free file   Whether an organization has assumed and agreed to pay all or part of a debt in order to acquire the property is determined by the facts and circumstances of each situation. Turbotax free file Modifying existing debt. Turbotax free file   Extending, renewing, or refinancing an existing debt is considered a continuation of that debt to the extent its outstanding principal does not increase. Turbotax free file When the principal of the modified debt is more than the outstanding principal of the old debt, the excess is treated as a separate debt. Turbotax free file Extension or renewal. Turbotax free file   In general, any modification or substitution of the terms of a debt by an organization is considered an extension or renewal of the original debt, rather than the start of a new one, to the extent that the outstanding principal of the debt does not increase. Turbotax free file   The following are examples of acts resulting in the extension or renewal of a debt: Substituting liens to secure the debt, Substituting obligees whether or not with the organization's consent, Renewing, extending, or accelerating the payment terms of the debt, and Adding, deleting, or substituting sureties or other primary or secondary obligors. Turbotax free file Debt increase. Turbotax free file   If the outstanding principal of a modified debt is more than that of the unmodified debt, and only part of the refinanced debt is acquisition indebtedness, the payments on the refinanced debt must be allocated between the old debt and the excess. Turbotax free file Example. Turbotax free file An organization has an outstanding principal debt of $500,000 that is treated as acquisition indebtedness. Turbotax free file The organization borrows another $100,000, which is not acquisition indebtedness, from the same lender, resulting in a $600,000 note for the total obligation. Turbotax free file A payment of $60,000 on the total obligation would reduce the acquisition indebtedness by $50,000 ($60,000 x $500,000/$600,000) and the excess debt by $10,000. Turbotax free file Debt That Is Not Acquisition Indebtedness Certain debt and obligations are not acquisition indebtedness. Turbotax free file These include the following. Turbotax free file Debts incurred in performing an exempt purpose. Turbotax free file Annuity obligations. Turbotax free file Securities loans. Turbotax free file Real property debts of qualified organizations. Turbotax free file Certain Federal financing. Turbotax free file Debt incurred in performing exempt purpose. Turbotax free file   A debt incurred in performing an exempt purpose is not acquisition indebtedness. Turbotax free file For example, acquisition indebtedness does not include the debt an exempt credit union incurs in accepting deposits from its members or the debt an exempt organization incurs in accepting payments from its members to provide them with insurance, retirement, or other benefits. Turbotax free file Annuity obligation. Turbotax free file   The organization's obligation to pay an annuity is not acquisition indebtedness if the annuity meets all the following requirements. Turbotax free file It must be the sole consideration (other than a mortgage on property acquired by gift, bequest, or devise that meets the exception discussed under Property acquired subject to mortgage or lien, earlier in this chapter) issued in exchange for the property received. Turbotax free file Its present value, at the time of exchange, must be less than 90% of the value of the prior owner's equity in the property received. Turbotax free file It must be payable over the lives of either one or two individuals living when issued. Turbotax free file It must be payable under a contract that: Does not guarantee a minimum nor specify a maximum number of payments, and Does not provide for any adjustment of the amount of the annuity payments based on the income received from the transferred property or any other property. Turbotax free file Example. Turbotax free file X, an exempt organization, receives property valued at $100,000 from donor A, a male age 60. Turbotax free file In return X promises to pay A $6,000 a year for the rest of A's life, with neither a minimum nor maximum number of payments specified. Turbotax free file The amounts paid under the annuity are not dependent on the income derived from the property transferred to X. Turbotax free file The present value of this annuity is $81,156, determined from IRS valuation tables. Turbotax free file Since the value of the annuity is less than 90 percent of A's $100,000 equity in the property transferred and the annuity meets all the other requirements just discussed, the obligation to make annuity payments is not acquisition indebtedness. Turbotax free file Securities loans. Turbotax free file   Acquisition indebtedness does not include an obligation of the exempt organization to return collateral security provided by the borrower of the exempt organization's securities under a securities loan agreement (discussed under Exclusions earlier in this chapter). Turbotax free file This transaction is not treated as the borrowing by the exempt organization of the collateral furnished by the borrower (usually a broker) of the securities. Turbotax free file   However, if the exempt organization incurred debt to buy the loaned securities, any income from the securities (including income from