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990T18

SELF-STUDY CONTINUING PROFESSIONAL EDUCATION

Companion to PPC’s

990 Deskbook

(800) 231-1860cl.tr.com

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2018 Thomson Reuters/Tax & Accounting. Thomson Reuters, Checkpoint, PPC, and the Kinesis logo aretrademarks of Thomson Reuters and its affiliated companies.

This material, or parts thereof, may not be reproduced in another document or manuscriptin any form without the permission of the publisher.

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Checkpointr ToolsPPC’s Practice AidstPPC’s WorkpaperstPPC’s Engagement Letter GeneratorrPPC’s Interactive Disclosure LibrariestPPC’s SMART Practice AidsrEngagement CSt

Checkpoint Learning is registered with the National Association ofState Boards of Accountancy (NASBA) as a sponsor of continuingprofessional education on the National Registry of CPE Sponsors.State boards of accountancy have final authority on the acceptanceof individual courses for CPE credit. Complaints regarding registeredsponsors may be submitted to the National Registry of CPE Sponsorsthrough its website: www.nasbaregistry.org.

Checkpoint Learning is also approved for “QAS Self Study”designation.

Registration Numbers:Texas: 001615New York: 001076NASBA Registry: 103166IRS Approved Provider: 0YC0C

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Interactive Self-study CPE

Companion to PPC’s 990 Deskbook

TABLE OF CONTENTS

Page

COURSE 1: FORM 990-T

Overview 1. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 1: Filing Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 2: Unrelated Business Income 23. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 3: Deductions Allowed in Determining Unrelated Business Taxable Income 83. . . . . . . . . .

Lesson 4: Form 900-T Tax Calculation 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Examination for CPE Credit 119. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Glossary 129. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Index 131. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COURSE 2: FORM 1023

Overview 135. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 1: Determining How and When to File for Exemption 137. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 2: Providing Information about the Organization and Its Activities and Operations 163. . .

Lesson 3: Determination of Public Charity versus Private Foundation Status 195. . . . . . . . . . . . . . . .

Lesson 4: Providing Financial Data 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


Glossary 253. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Index 255. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COURSE 3: SELECTED TOPICS RELATED TO FORM 990

Overview 259. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 1: General Filing Information—Form 990 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 2: Highlighting an Organization’s Accomplishments 285. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 3: Governance, Management, and Required Disclosure 303. . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Lesson 4: Reporting Functional Expenses 333. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 5: Preparing Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


Glossary 397. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Index 399. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ANSWER SHEETS AND EVALUATIONS

Course 1: Examination for CPE Credit Answer Sheet 405. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Course 1: Self-study Course Evaluation 406. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Course 2: Examination for CPE Credit Answer Sheet 407. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Course 2: Self-study Course Evaluation 408. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Course 3: Examination for CPE Credit Answer Sheet 409. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Course 3: Self-study Course Evaluation 410. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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INTRODUCTION

Companion to PPC’s 990 Deskbook consists of three interactive self-study CPE courses. These are companioncourses to PPC’s 990 Deskbook designed by our editors to enhance your understanding of the latest issues in thefield. PPC’s 990 Deskbook and other PPC products are available for purchase at tax.tr.com/ppcguidance.

To obtain credit for this course, you must complete the learning process by logging on to our Online GradingSystem at cl.tr.com/ogs or by mailing or faxing your completed Examination for CPE Credit Answer Sheet forprint grading by February 28, 2019. Complete instructions for grading are included below and in the TestInstructions preceding the Examination for CPE Credit.

Taking the Courses

Each course is divided into lessons. Each lesson addresses an aspect of taxation and Form 990. You are asked toread the material and, during the course, to test your comprehension of each of the learning objectives byanswering self-study quiz questions. After completing each quiz, you can evaluate your progress by comparingyour answers to both the correct and incorrect answers and the reason for each. References are also cited so youcan go back to the text where the topic is discussed in detail. Once you are satisfied that you understand thematerial, answer the examination questions at the end of the course. You may record your answer choices byprinting the Examination for CPE Credit Answer Sheet or by logging on to our Online Grading System.

Qualifying Credit Hours—NASBA Registry (QAS Self-Study)

Checkpoint Learning is registered with the National Association of State Boards of Accountancy (NASBA) as asponsor of continuing education on the National Registry of CPE Sponsors. State boards of accountancy have finalauthority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsorsmay besubmitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org.

Checkpoint Learning is also approved for “QAS Self Study” designation.

The requirements for NASBA Registry membership include conformance with the Statement on Standards ofContinuing Professional Education (CPE) Programs (the Standards), issued jointly by NASBA and the AICPA. As ofthis date, not all boards of public accountancy have adopted the Standards in their entirety. Each course isdesigned to comply with the Standards. For states that have adopted the Standards, credit hours are measured in50-minute contact hours. Some states, however, may still require 100-minute contact hours for self study. Your statelicensing board has final authority on acceptance of NASBA Registry QAS self-study credit hours. Check with yourstate board of accountancy to confirm acceptability of NASBA QAS self-study credit hours. Alternatively, you mayvisit the NASBA website at www.nasbaregistry.org for a listing of states that accept NASBA QAS self-study credithours and that have adopted the Standards. Credit hours for CPE courses vary in length. Credit hours for eachcourse are listed on the Overview page before each course.

CPE requirements are established by each state. You should check with your state board of accountancy todetermine the acceptability of this course. We have been informed by the North Carolina State Board of CertifiedPublic Accountant Examiners and the Mississippi State Board of Public Accountancy that they will not allow creditfor courses included in books or periodicals.

Obtaining CPE Credit

Online Grading. Log onto our Online Grading Center at cl.thomsonreuters.com/ogs to receive instant CPEcredit. Click the purchase link and a list of exams will appear. You may search for the exam using wildcards.Payment for the exam of $95 is accepted over a secure site using your credit card. For further instructions regardingthe Online Grading Center, please refer to the Test Instructions preceding the Examination for CPE Credit. Acertificate documenting the CPE credits will be issued for each examination score of 70% or higher.

Print Grading. You can receive CPE credit by emailing, mailing, or faxing your completed Examination for CPECredit Answer Sheet to Thomson Reuters (Tax & Accounting) Inc. for grading. Answer sheets are located at the

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end of the course PDFs. Theymay be printed from electronic products; they can also be scanned for email grading,if desired. The answer sheet is identified with the course acronym. Please ensure you use the correct answer sheetfor each course. Payment (by check or credit card) must accompany each answer sheet submitted. We cannotprocess answer sheets that do not include payment. Payment for emailed or faxed answer sheets is $95. There isan additional $10 charge for manual print grading, so please include a total of $105 with answer sheets sent byregular mail. Please take a few minutes to complete the Self-study Course Evaluation so that we can provide youwith the best possible CPE.

You may fax your completed Examination for CPE Credit Answer Sheet and Self-study Course Evaluation to(888) 286-9070 or email them to [email protected]. The mailing address is provided on theOverview and Exam Instructions pages.

If more than one person wants to complete this self-study course, each person should complete a separateExamination for CPE Credit Answer Sheet. Payment must accompany each answer sheet submitted ($95 whensent by email or fax; $105 when sent by regular mail). We would also appreciate a separate Self-study CourseEvaluation from each person who completes an examination.

Obtaining EA and NCRP Credit

To receive IRS Enrolled Agent (EA) or Non-Credentialed Return Preparer (NCRP) credit, you must provide yourPTIN to Thomson Reuters in one of two ways. Log on to cl.tr.com, select the “Settings” tab, and then “Edit MyMembership Information.” Select “IRS PTIN” from the drop-down menu, and input your PTIN. (Your PTIN shouldstart with a capital “P” and be followed by eight numbers.) Alternatively, if you are submitting your exam for printgrading, write your PTIN in the space provided on your answer sheet.

Retaining CPE Records

For all scores of 70% or higher, you will receive a Certificate of Completion. You should retain it and a copy of thesematerials for at least five years.

990T18 Companion to PPC’s 990 Deskbook

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COMPANION TO PPC’S 990 DESKBOOK

COURSE 1

FORM 990-T (990TG181)

OVERVIEW

COURSE DESCRIPTION: This interactive self-study course takes a look at topics related to Form 990-T.Lesson 1 discusses filing the Form 990-T. Lesson 2 looks at unrelated businessincome. Lesson 3 examines the deductions that are allowed in determiningunrelated business taxable income. Finally, the course concludes with Lesson 4,which discusses calculating the unrelated business income tax.

PUBLICATION/REVISIONDATE:

February 2018

RECOMMENDED FOR: Users of PPC’s 990 Deskbook

PREREQUISITE/ADVANCEPREPARATION:

Basic knowledge of nonprofit organizations

CPE CREDIT: 8 NASBA Registry “QAS Self-Study” Hours

This course is designed tomeet the requirements of the Statement on Standards ofContinuing Professional Education (CPE) Programs (the Standards), issued jointlybyNASBAand theAICPA. Asof this date, not all boardsof public accountancy haveadopted the Standards in their entirety. For states that have adopted the Standards,credit hours aremeasured in 50-minute contact hours. Some states, however, maystill require 100-minute contact hours for self study. Your state licensing board hasfinal authorityonacceptanceofNASBARegistryQASself-studycredit hours.Checkwith your state board of accountancy to confirm acceptability of NASBA QASself-study credit hours. Alternatively, you may visit the NASBA website atwww.nasbaregistry.org for a listing of states that accept NASBA QAS self-studycredit hours and that have adopted the Standards.

IRS Enrolled Agents (EA) and Non-Credentialed Return Preparers (NCRP):This course is designed to enhance professional knowledge for IRS EAs and IRSNCRPs. Checkpoint Learning is an IRS Continuing Education Provider that isapproved to deliver continuing education to IRS Enrolled Agents and IRSNon-Credentialed Return Preparers.

CTEC CREDIT: 8 CTEC Federal Tax Law Hours

IRS EA CREDIT: 8 Federal Tax Law/Tax Related Matters Hours

IRS NCRP CREDIT: 8 Federal Tax Law Hours

FIELD OF STUDY: Taxes

EXPIRATION DATE: Postmark by February 28, 2019

KNOWLEDGE LEVEL: Basic

Learning Objectives:

Lesson 1—Filing Form 990-T

Completion of this lesson will enable you to:¯ Identify circumstances in which Form 990-T is needed and the form’s basic preparation requirements.¯ Determine how to file a consolidated Form 990-T; file a return solely to claim a refund; deal with net operatingloss carryback; identify return due dates, tax payments, and extensions of time to file; file an amended return;

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make Form 990-T available for public inspection; complete the paid preparer information; and deal withpreparer penalties for Form 990-T.

Lesson 2—Unrelated Business Income

Completion of this lesson will enable you to:¯ Identify an unrelated trade or business, when activities are considered a trade or business, the definition of theterm regularly carried on, substantially related activities, activities excluded from the definition of an unrelatedtrade or business, and income excluded from unrelated business income.

¯ Determine how to report gross receipts or sales and gains and losses, deal with income from pass-throughentities, and report taxable rental income.

¯ Identify income from controlled organizations and agency relationships, associate member dues, manage-ment and administrative services fees, travel tours, and the operation of parking facilities; determine whatspecial rules apply to organizations described in IRC Sec. 501(c)(7), (9), and (13); and identify the correctmethod for completing Part I of Form 990-T.

Lesson 3—Deductions Allowed in Determining Unrelated Business Taxable Income

Completion of this lesson will enable you to:¯ Recognize the general rules for deducting expenses when determining unrelated business taxable income(UBTI) and how to deal with interest expense and charitable contributions.

¯ Determine the effects of depreciation, the Section 179 deduction, and the net operating loss deduction; howto amortize organizational and start-up expenses; and how to deal with qualified disaster expenses and lossesor credits from tax shelters.

Lesson 4—Form 990-T Tax Calculation

Completion of this lesson will enable you to:¯ Identify the proper rate schedule, how topay any taxdue, the tax credits available to reduceunrelatedbusinessincome tax.

¯ Identify how to address the proxy tax on lobbying expenditures, alternative minimum tax, and estimated taxpayments, as well as the requirements for mandatory electronic tax payments.

TO COMPLETE THIS LEARNING PROCESS:

Log onto our Online Grading Center at cl.tr.com/ogs. Online grading allows you to get instant CPE credit for yourexam.

Alternatively, you can submit your completed Examination for CPE Credit Answer Sheet, Self-study CourseEvaluation, and payment via one of the following methods:

¯ Email to: [email protected]¯ Fax to: (888) 286-9070¯ Mail to:

Thomson ReutersTax & Accounting—Checkpoint Learning990TG181 Self-study CPE36786 Treasury CenterChicago, IL 60694-6700

See the test instructions included with the course materials for additional instructions and payment information.

ADMINISTRATIVE POLICIES:

For information regarding refunds and complaint resolutions, dial (800) 431-9025 for Customer Service and yourquestions or concerns will be promptly addressed.


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Lesson 1: Filing Form 990-TIntroduction

Most tax-exempt organizations [including those described in IRC Sec. 501(c)(3)] must be organized and operatedexclusively for an exempt purpose. But, within certain limitations, an organization may engage in trade or businessactivities that are unrelated to its tax-exempt purpose without jeopardizing its tax exempt status. These activities arereported on Form 990, Part VIII, column (c), or Form 990-PF, Part XVI-A, column (b). If the requirements discussedin this lesson are met, organizations with unrelated business income must file Form 990-T (Exempt OrganizationBusiness Income Tax Return).


Completion of this lesson will enable you to:¯ Identify circumstances in which Form 990-T is needed and the form’s basic preparation requirements.¯ Determine how to file a consolidated Form 990-T; file a return solely to claim a refund; deal with net operatingloss carryback; identify return due dates, tax payments, and extensions of time to file; file an amended return;make Form 990-T available for public inspection; complete the paid preparer information; and deal withpreparer penalties for Form 990-T.

Determining When a Form 990-T Is Needed

Organizations Required to File Form 990-T

Organizations. The following organizations must file Form 990-T (Exempt Organization Business Income TaxReturn) if they have gross unrelated business income (UBI) of $1,000 or more as defined later in this lesson under“Gross Income Defined” or owe taxes other than the unrelated business income tax:

1. An organization exempt from tax under IRC Sec. 501(a) [and described in IRC Sec. 501(c) or (d); IRCSec. 401(a); or IRC Sec. 529(a)].

2. An organization liable for the proxy tax on lobbying and political expenditures. (See the discussion laterin this lesson under “Filing Form 990-T for Proxy Tax on Lobbying Expenditures.”)

3. A collegeor university (but not an elementary or secondary school) ownedandoperatedby a state or othergovernmental unit.

4. A corporation owned by a college or university described in item 3.

5. A tax-exempt trust forming part of a stock bonus, pension, or profit-sharing plan.

6. An organization that is liable for other taxes, such as the tax in connection with an excess distribution froma passive foreign investment company or recapture taxes (such as investment credit or low-incomehousing credit).

7. An applicable reinsurance entity, which is a not-for-profit organization created to help stabilize premiumsfor coverage in the individual and small group markets in a state during the first three years of operationof its American Health Benefit Exchange. It is intended to carry out the reinsurance program under theAffordable Care Act of 2010 by coordinating the funding and operation of risk-spreading mechanisms.Although otherwise exempt from tax, such entities are subject to the unrelated business income tax andmust write “Applicable Reinsurance Entity” across the top of Form 990-T.

8. Churches and conventions or associations of churches.

9. An organization operating a non-compliant hospital facility.


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Fiduciaries. For the following trusts, if the trust has over $1,000 of unrelated trade or business gross income, aForm 990-T must be filed. The following accounts are treated as separate trusts even if there is a single beneficiaryfor multiple accounts:

1. An individual retirement account (IRA).

2. An Archer medical savings account described in IRC Sec. 220(d).

3. A Roth IRA described in IRC Sec. 408A.

4. A simplified employee pension plan (SEP) described in IRC Sec. 408(k).

5. A simple incentive match plan (SIMPLE) described in IRC Sec. 408(p).

6. A Coverdell educational savings account described in IRC Sec. 530(b).

7. A health savings account (HSA) described in IRC Sec. 223(d).

Corporations that are instrumentalities of the United States and are both organized and tax-exempt as a result of anAct of Congress (e.g., the Federal Deposit Insurance Corporation and Federal National Mortgage Association) arenot required to file Form 990-T.

Gross Income Defined

To determine whether unrelated business income (UBI) meets the $1,000 filing threshold, gross income is definedas gross receipts or sales (net of any returns and allowances) less cost of goods sold. Cost of goods sold for thispurpose is determined using the method of accounting consistently used by the organization. Gross income alsoincludes any income the organization receives from investments and from incidental or outside operations orsources. For organizations conducting gaming activities, gross income includes the gross amount wagered. Prizesawarded are treated as Other Deductions reportable on Form 990-T line 28, not as cost of goods sold.

Do not reduce gross income for selling expenses, losses, or other items not ordinarily used in computing cost ofgoods sold. Amounts that a for-profit organization cannot claim as business expenses under IRC Sec. 162(c)(bribes, kickbacks, and similar payments), IRC Sec. 162(f) (fines and penalties), or IRC Sec. 162(g) (treble damagepayments under antitrust laws) are not deductible.

Example 1A-1 Gross income of at least $1,000 included in unrelated business taxable income.

The Movement for a Drug Free Environment, Inc. (MDFE), purchased baked goods for $1,500 and sold themduring the year for $2,250. The sales were an unrelated business activity. MDFE does not have to file Form990-T. Gross income is $750 ($2,250 − $1,500) which is less than the $1,000 gross income threshold forwhich a Form 990-T is required.

In the following year, MDFE received $4,000 from the sale of the baked goods, its cost of goods sold was$2,500, and it incurred selling expenses of $600. MDFE must file Form 990-T for this year because its grossincome for determining if it meets the filing requirements is $1,500 ($4,000 − $2,500). The selling expensesare not considered in this determination.

Net Loss from Unrelated Business Activities

The requirement to file Form 990-T is determined solely by the gross income test. An organization with a net lossfrom one or more unrelated business activities must file a Form 990-T if its gross income from such activities is$1,000 or more.

Example 1A-2 Net loss from an unrelated business activity.

Friends for a Drug Free Society (FDFS), a Section 501(c)(3) organization, has $8,500 of gross income from anunrelated business. Expenses of $9,000 were incurred in generating this income, resulting in a $500 net


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operating loss (NOL) for the year. FDFS must file Form 990-T because it has gross income included incomputing UBTI of $1,000 or more. In addition, by filing the return, the organization establishes the NOL andstarts the running of the statute of limitations.

Income or Loss from Partnership with UBI Activity

An organization may have UBI or loss as a member of a partnership if the partnership regularly engaged in a tradeor business that is an unrelated trade or business of the organization. The IRS position would appear to be thatgross income from the organization’s share of UBI should be determined by gross receipts less costs of goodssold, prior to any other deductions attributable to the UBI. However, many partnerships furnish net UBI withoutproviding additional details regarding the gross UBI and deductions on Schedule K-1. If an organization determinesit does not meet the $1,000 filing threshold based on the net income from its partnership investments, it seemslogical to assume that will satisfy the filing requirements, provided the organization has no other sources of UBI.

Example 1A-3 Flow-through income from a partnership investment.

The Movement for a Drug Free Environment, Inc. (MDFE) holds a partnership investment in Red RiverPartners, LP (RRP). MDFE receives a Schedule K-1 fromRRP indicating that its net unrelated business incomeis a loss of $4,000. MDFE has no other UBI to report. MDFE does not need to file Form 990-T because it doesnot meet the filing threshold. Alternatively, MDFE could file Form 990-T to track the NOL and to start the statuteof limitations.

If the Schedule K-1 fromRRP indicated that the gross income fromUBI was $10,000 and the loss was $14,000,then MDFE would be required to file Form 990-T.

Activity’s Income Supports an Organization’s Exempt Purpose

Using the net income from an unrelated business to further an organization’s exempt purpose has no effect on therequirement to file Form 990-T.

Example 1A-4 Net profit from an unrelated business that funds an exempt function activity.

Neighborhood Health Clinic (NHC), a Section 501(c)(3) organization, received $15,500 from unrelated busi-ness activities. It incurred expenses of $8,500 related to this income, resulting in $7,000 of net income. All ofthe income was used by NHC to further its tax-exempt purpose. NHCmust file Form 990-T because it satisfiesthe gross income test since it has $1,000 or more of gross income included in UBTI.

Filing Form 990-T for Proxy Tax on Lobbying Expenditures

Organizations that file Form 990-T solely to pay the proxy tax on lobbying and political expenditures must completethe following parts of the return:

1. Heading. Complete the heading above Part I, except items E, H, and I.

2. Part III. Enter the proxy tax on lines 37 and 40.

3. Part IV. Complete this section by following the instructions for each line.

4. Signature Area. Complete the signature area at the bottom of page 2 (including the paid preparer’s box,if applicable).

5. Statement. Attach a statement showing the proxy tax computation.

Statute of Limitations

Normally, the IRS must assess any UBI tax due within three years of the date Form 990-T is filed or, if later, withinthree years of when the return is due (when the return is filed before the actual due date). If a Form 990-T is filed that


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is neither fraudulent nor a willful attempt to evade tax, but underreports an organization’s gross UBI by more than25% (when compared to the income reported), the assessment period is six years. There is no time limit on theassessment of tax if—

¯ a Form 990-T is false or fraudulent,

¯ there is a willful attempt to evade tax, or

¯ no return is filed.

Disclosure Requirement. If the following conditions are satisfied, filing the Form 990 should begin the three-yearassessment period for a particular year (but see the warning following Example 1A-5 about IRS guidance on thisissue):

1. An organization determines in good faith it is an exempt organization and files Form 990 for the year.

2. The Form 990 states the nature of each income-producing activity in sufficient detail to determine whetherthe activity is related to the organization’s exempt purpose. In addition, the gross receipts of each activitymust be shown.

3. Form 990, Part V, line 3a, is answered “No.”

Example 1A-5 Effect of the statute of limitations on the requirement to file Form 990-T.

Assume NHC (see Example 1A-4) determines in good faith that all of its activities are related activities; thus,for 2015 it does not file Form 990-T. In its calendar-year 2015 Form 990 (filed on its due date of May 16, 2016),NHC properly disclosed all of its income-producing activities by type and amount of gross income. Thisinformation was sufficiently detailed. The IRS determined that, in fact, not all of NHC’s activities are related toits exempt purpose. Based on this determination, on July 21, 2019, the IRS issues an assessment related toNHC’s 2015 unrelated business income.

NHC should not be liable for the back taxes (nor interest and penalties) related to its 2015 UBI. The filing ofNHC’s 2015 Form 990 started the three-year statute of limitations against assessment of tax on its unrelatedbusiness income. This three-year period expired on May 15, 2019.

Change in Accounting Method

If the organization changes its accounting method, it must file Form 3115 (Application for Change in AccountingMethod). Some accounting method changes are included in the List of Automatic Accounting Method Changes inRev. Proc. 2017-30, while nonautomatic requests must follow the advance consent request procedures. Requestsfor an automatic change must be attached to the timely filed return for the year of the change. A duplicate copymust be filed with the IRS office in Covington, KY no earlier than the beginning of the year of the change and no laterthan the filing of the return for that year. No user fee is required. Requests for a non-automatic change must be filedon Form 3115 during the year of the change with the appropriate IRS office and include the appropriate user fee.

Organizationsmust make an adjustment to prevent items of income or expense from being duplicated or excluded;see IRC Sec. 481(a). This adjustment is made over one year for adjustments that reduce taxable income, and overfour years for adjustments that increase taxable income by more than $25,000.

A change in accounting method may not be retroactive.

Part V—Reporting Other Activities

Line 51 in Part V of Form 990-T is similar to Form 990, Part V, lines 4a and 4b, which also requests information aboutfinancial accounts in foreign countries.

Line 53 of Part V asks for the amount of any tax-exempt interest received or accrued during the tax year. Thereference to tax-exempt interest does not include interest that is exempt solely under the UBTI rules [i.e., interest


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exempt under IRC Sec. 512(b)(1)]. Rather, it refers to what is generally understood to be tax-exempt interest (e.g.,municipal bond interest).

Basic Preparation Requirements for Form 990-TCompleting the Header Portion of Form 990-T

Period Covered. File the 2017 Form 990-T for calendar year 2017 or any fiscal year beginning in 2017. The 2017Form 990-T can also be used if the organization has a tax year of less than 12months that begins and ends in 2018,if the 2018 Form 990-T is not available when the short period return is due. Show the 2018 tax year on the 2017Form 990-T and take into account any tax law changes that are effective for tax years beginning after December 31,2017. In general, an organization may change its accounting period simply by writing “Change in AccountingPeriod” at the top of the return. Rev. Proc. 85-58 requires that the return must be filed by the 15th day of the fifthmonth after the end of the new accounting period, which indicates that no extension is available for a short yearreturn resulting from a change in accounting period. If the organization has already changed its accounting periodwithin the previous ten years, then it must file Form 1128 (Application for Change in Accounting Period), with itsshort year return.

Name and Address. Use the same name and address on Form 990-T as the organization uses on its Form 990,990-EZ, or 990-PF. If the organization has changed its legal name since filing its last Form 990-T, check the box nextto “Name of Organization” and provide (as an attachment to the return) whichever of the following is appropriate forits legal form:

1. an amendment to its articles of incorporation reflecting the name change and proof that such amendmenthas been filed with the state of incorporation;

2. an amendment to its governing trust agreement, signed by the trustee(s); or

3. an amendment to its articles of association, constitution, by-laws or other organizing document, signed byat least two officer/members.

If the post office does not deliver mail to the street address and the organization has a post office box, show the boxnumber instead of the street address. If the organization’s address has changed since filing the last return, checkItem A.

IRC Section for Exemption. Indicate in Item B the IRC Section that governs the organization’s exempt status,which can be found on the exemption letter from the IRS. Organizations exempt under IRC Sec. 501 must completethe appropriate subdivision [e.g., 501(c)(3)]. If described in Section 1341(c)(1) of the Affordable Care Act of 2010,do not check a box and write “Applicable Reinsurance Entity” across the top of Form 990-T.

Asset Book Value. List the net book value of the organization’s assets at the end of the year in Item C. This amountshould agree with the amount shown on its Form 990, Part X, line 16, column (B), 990-EZ, Part II, line 25, column(B), or 990-PF, Part II, line 16, column (b).

Employer Identification Number (EIN). Enter the organization’s EIN in Item D. An organization that has notreceived an EIN by the return due date should write “applied for” in Item D. This should rarely apply since an EINcan be applied for online. Go to www.irs.gov and search for “Employer ID Numbers.” The online application is aquestion and answer process. The EIN will be issued immediately upon validation of the application information.Alternatively, request an EIN by mailing or faxing a completed Form SS-4 (Application for Employer IdentificationNumber) to the IRS.

Unrelated Business Income (UBI).In Item E, enter the UBI activity code(s) (up to two) that indicates the organiza-tion’s most significant UBI activity. The list of activity codes is included at the end of the instructions to Form 990-T.If the organization’s UBI activity is not described by a specific activity code, use a general code that best describesit. A comprehensive list of codes can be found at the NAICS website at www.census.gov/eos/www/naics.

The organization’s primary UBI activity should also be described in Item H. Attach a statement if more space isneeded for the description.


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Group Exemption. Enter the four-digit group exemption number (GEN) in Item F for an organization covered by agroup exemption. The GEN should not be confused with the organization’s nine-digit EIN. Note that the GENshould be included both on the parent organization’s return and on the group return for the subordinates.

Organization Type.Check the box in ItemG that describes the organization. Check either the “501(c) corporation”box or “501(c) trust” for a Section 529 qualified tuition program, depending on its legal form. In addition, Section529 qualified tuition programs should check the “529(a)” box in Item B. An applicable reinsurance entity should notcheck any of the boxes.

Affiliation. Check the “Yes” box in Item I if the organization is a corporation and it is either:

1. a subsidiary in an affiliated group of corporations (as defined in IRC Sec. 1504) but is not filing aconsolidated tax return for the year with that group; or

2. a subsidiary in a parent-subsidiary controlled group (as defined in IRC Sec. 1563). A corporation that is anexcluded member of a controlled group [see IRC Sec. 1563(b)(2)] is still considered a member of acontrolled group for Item I purposes.

Contact Person. Enter the name and telephone number of the person who has control of the organization’s booksand records in Item J. The organization should carefully consider who it designates as the contact person, not onlyfor IRS inquiries, but also for inquiries related to the public disclosure copy of the Form 990-T.

Organizations with $10,000 or Less of Unrelated Business Income (UBI)

Organizations with $10,000 or less of UBI [i.e., line 13 of column (A) is no more than $10,000] complete only thefollowing parts of the return.

1. Heading. Name and address lines, and lines A–J on page 1 of Form 990-T.

2. Part I. Column (A), lines 1–13, and columns (B) and (C), line 13 only.

3. Part II. Lines 29–34.

4. Page 2. Parts III–V and the signature area at the bottom of the page (including the paid preparer’s box, ifapplicable).

Filing Form 990-T to Pay Other Taxes

Organizations that are required to file Form 990-T only because they are, for example, liable for recapture taxes, theSection 1291(a) tax, or a hospital organization’s non-compliant facility income tax should only complete thefollowing parts of the return:

1. Heading. Complete the area above Part I, except items E, H, and I.

2. Parts III and IV. Complete the appropriate lines, as required.

3. Page 2. Complete the signature area at the bottom of the page (including the paid preparer’s box, ifapplicable).

4. Statements.Attach all appropriate forms and/or statements showing the computation of the applicable taxor taxes.


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SELF-STUDY QUIZ

Determine the best answer for each question below. Then check your answers against the correct answers in thefollowing section.

1. Which of the following entities must file Form 990-T?

a. Whammy Inc., a for-profit company with gross income of $10,000.

b. Open Hearts, an exempt Section 501(a) organization with $2,000 of unrelated business income (UBI).

c. Grandview Elementary, a school operated by the local school district with UBI of $5,000.

d. Blackwell simple incentive match plan (SIMPLE), a plan formed according to IRC Sec. 408(p) with UBI of$500.

2. Which of the following should an organization put in Item E when filling out the header portion of Form 990-T?

a. Its employer identification number (EIN).

b. Net book value of its assets as of the end of the year.

c. The IRC Section that governs its exempt status.

d. The UBI activity code related to its most significant UBI activity.


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SELF-STUDY ANSWERS

This section provides the correct answers to the self-study quiz. If you answered a question incorrectly, reread theappropriate material. (References are in parentheses.)

1. Which of the following entities must file Form 990-T? (Page 3)

a. Whammy Inc., a for-profit companywith gross incomeof $10,000. [This answer is incorrect. Form990 andForm 990-T apply to exempt entities. A traditional company operated tomake a profit does not fall into thiscategory. Therefore, no matter its income, Whammy Inc. will not need to file Form 990-T.]

b. Open Hearts, an exempt Section 501(a) organization with $2,000 of unrelated business income(UBI). [This answer is correct. Organizations exempt from tax under IRC Sec. 501(a) are one of thetypes that must file Form 990-T if their UBI is over $1,000. Since Open Hearts is exempt under thissection of the Code and has UBI of more than $1,000, it will need to file Form 990-T this year.]

c. Grandview Elementary, a school operated by the local school district with UBI of $5,000. [This answer isincorrect. Elementary and secondary schools do not have to file Form 990-T. However, if the entity underdiscussion was Grandview State, a college or university owned and operated by a state or othergovernmental unit, with this amount of UBI, it would have to file Form 990-T.]

d. Blackwell simple incentive match plan (SIMPLE), a plan formed according to IRC Sec. 408(p) with UBI of$500. [This answer is incorrect. A SIMPLE plan described in IRC Sec. 408(p), such as the Blackwell plan,would have to file Form 990-T if its UBI exceeded the $1,000 threshold. However, since that is not the casein this scenario, the Blackwell plan does not need to file form 990-T.]

2. Which of the following should an organization put in Item E when filling out the header portion of Form 990-T?(Page 7)

a. Its employer identification number (EIN). [This answer is incorrect. The organization should enter its EINin Item D. An organization which has not received an EIN by the return due date should write “applied for”in Item D.]

b. Net book value of its assets as of the end of the year. [This answer is incorrect. The organization shouldlist the net book value of the organization’s assets at the end of the year in Block C. This amount shouldagree with the amount shown on its Form 990.]

c. The IRCSection that governs its exempt status. [This answer is incorrect. Theorganizationshoulduse ItemB to indicate the IRC Section that governs the organization’s exempt status, which can be found on theexemption letter from the IRS.]

d. The UBI activity code related to its most significant UBI activity. [This answer is correct. Per Form990-T, in Item E, the organization should enter the UBI activity code(s) (up to two) that indicates theorganization’s most significant UBI activity. The list of activity codes is included at the end of theinstructions to Form 990-T.]


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Specifics for Filing a Consolidated Form 990-T

Qualifying to File a Consolidated Return

Affiliated tax-exempt organizations generally cannot report their unrelated business income (UBI) on a consoli-dated return, except for organizations having a Section 501(c)(2) title holding company (THC). Corporations qualifyto file a consolidated Form 990-T if the following five conditions are satisfied:

1. The common parent of the group owns at least 80% of the voting power and value of the stock of anothermember of the group.

2. At least 80% of the voting power and value of each member of the group (other than the common parent)is owned by another member of the group.

For these first twoconditions, if amember of thegroup is a nonstockorganization, it is not clear howcontrolshould be defined. It may be defined in the same way as the unrelated business income tax regulationsdefine control when determining whether income is from a controlled organization. Under theseregulations, a nonstock organization is controlled by an entity if at least 80% of the directors or trustees ofthe organization are either representatives of, or directly or indirectly controlled by, the entity.

3. All members of the group are exempt from tax under IRC Sec. 501(a).

4. At least one member of the group is a THC (i.e., its sole purpose is to hold title to property, collect incometherefrom, and turn over the income, net of expenses, to another tax-exempt entity).

5. Eachmember of the group that is not a THC receives income from a THC within the group (or would haveexcept that during the year the THC’s expense of collecting its income exceeded the income).

In the first year a consolidated return is filed, each member of the group, other than the common parent, mustconsent to filing a consolidated return by signing a Form 1122 (Authorization and Consent of Subsidiary Corpora-tion to be Included in a Consolidated Income Tax Return) and attaching it to Form 990-T. Form 851 (AffiliationsSchedule) must be attached to the return each year a consolidated return is filed. (See Example 1C-1 for moreinformation on this subject.)

Separate UBTI of a Group Member

Computing consolidated unrelated business taxable income (UBTI) begins with the separate UBTI of eachmemberof the group. A member’s separate UBTI is determined using the normal rules for calculating UBTI for a separateorganization except that:

1. Certain items [e.g., net operating loss (NOL) deductions, capital gains and losses, and Section 1231(businessproperty) gains and losses] are not considered (because they are computedat the consolidatedlevel).

2. The Section 512(b)(10) charitable contribution deduction is not considered at the separate level.

3. Variousother items (e.g., intercompany inventoryprofits) are adjusted inaccordancewith theconsolidatedreturn regulations applicable to for-profit corporations.

Consolidated UBTI

Consolidated UBTI is computed by aggregating the separate UBTI of each member of the group and making thefollowing adjustments:

1. Subtract any consolidated:

a. NOL; or


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b. charitable contribution deductions available as determined under Reg. 1.1502-24, subject to theSection 512(b)(10) limits as the lesser of:

(1) the sum of eachmember’s charitable contributions (even if not directly connected with carryingon an unrelated trade or business); or

(2) 10% of the consolidated UBTI, computed before deduction of the charitable contributiondeduction.

2. Add or subtract any consolidated net gain or loss from the:

a. disposition of debt-financed property, to the extent included in UBTI, and

b. cutting of timber, to the extent considered [under IRC Sec. 631(a)] as a sale or exchange of suchtimber.

The consolidated NOL of a group includes the group’s NOL carryforwards or carrybacks from other years in whicha consolidated return was filed. It also includes any separate NOLs sustained by members of the group in separatereturn years. However, the use of a member’s separate NOLs in a group return is subject to a special limitationbased on that member’s contribution to the UBTI of the group. When calculating the group’s NOL, only items ofincome and deduction considered in determining UBTI are considered.

Unrelated Business Income of a Title Holding Company

A special rule applies for determining if a title holding company (THC) has UBI. If a THC pays any amount of its netincome to an exempt organization (or would pay such an amount except that the expenses of collecting its incomeexceeded the income) and files a consolidated return with that organization, the THC is treated as organized andoperated for the same purposes as the exempt organization, as well as for its title holding purpose. Thus, if a THC’sincome is related to the exempt functions of the organization to which at least part of its income is paid, the incomeis not considered UBI if the THC and the organization file a consolidated return.

Example 1C-1 Filing a consolidated return with a title holding company.

Charitable Properties, Inc. (CPI), a Section 501(c)(2) tax-exempt THC, is controlled by, and its net incomemust be distributed to, United Charities (UC), a Section 501(c)(3) organization. During the year, CPI had$15,000 of UBI from real estate, $9,000 of which was from an activity related to UC’s exempt purpose and$6,000 from an activity unrelated to its exempt purpose or to UC’s exempt purpose. Also, UC conducted oneunrelated business activity (operation of a retail store) that lost $7,000.

CPI and UC qualify to file a consolidated Form 990-T because UC controls CPI, both entities are tax-exempt,and one entity is a THC while the other receives income from that company.

CPI and UC would benefit from filing a consolidated return. If separate returns are filed, CPI must report andpay tax on $15,000 of UBI, while UC has a $7,000 loss from an unrelated business activity. If a consolidatedreturn is filed, $9,000 of CPI’s UBI is no longer considered unrelated because it is related to an exemptfunction of UC. The remaining $6,000 is still UBI; however, no tax will be due because this income will be fullyoffset with UC’s $7,000 loss. UC made a $1,200 tax deposit with Form 7004.

If CPI and UC elect to file a consolidated return, they must follow the consolidated return rules that apply tofor-profit corporations, to the extent they are not inconsistent with tax provisions dealing with tax-exemptorganizations. Thus, a Form 851 (Affiliations Schedule) must be attached to the return each year a consoli-dated return is filed. In addition, a Form 1122 for CPI must be attached to the return for the first year aconsolidated return is filed.


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Specifics for Filing a Return Solely to Claim a Refund

Background

An organization may need to file a Form 990-T solely to claim a refund of taxes paid or refundable credits. In thesecircumstances, only a few lines on the return need to be completed.

Claim for Refund

If an organization is filing Form 990-T solely to claim a refund, the instructions for Form 990-T indicate only certainportions of the return should be completed, as follows:

1. Complete the heading portion above Part I (including the year if other than a calendar year), except itemsE, H, and I.

2. Enter -0- on line 13, column (A), line 34, and line 44.

3. On page 2 of the return, enter the credit or payment on the appropriate line (45a–45g).

4. Complete lines 46, 49, and 50.

5. Complete the signature area at the bottom of page 2, including the paid preparer’s information, ifapplicable.

Certain claims (described later in this lesson) have additional instructions for that claim. A Form 990-T filed solely toclaim a tax credit does not have to be made available for public inspection.

Erroneous Backup Withholding

Tax withholding is generally required for certain kinds of receipts (e.g., interest, dividends, and independentcontractor services), if the payee has not provided proper notice of a taxpayer identification number to the payor.Although exempt organization payees are not subject to this (backup) withholding provision, payors have a right torequest a Form W-9 (Request for Taxpayer Identification Number and Certification) from the organization. If anorganization fails to provide a Form W-9 when requested, or the payor otherwise erroneously withholds taxes, theorganization must file a request for a refund or credit of the withheld taxes.

For organizations that file Form 990, credit for any erroneous backup withholding is claimed on Form 990-T, evenif that return is not otherwise required. Follow the steps described previously in “Claim for Refund.” In addition, theamount of the erroneous withholding should be included on line 45e of Form 990-T. (Private foundations claimcredit for backup withholding on Form 990-PF on line 6d of Part VI.) Attach a copy of the Form 1099 showing thewithholding to the return.

IRA or Other Tax-exempt Shareholder in a Regulated Investment Company

A regulated investment company (RIC) normally avoids paying tax on its income by distributing that income to itsshareholders. The RIC has the option of retaining certain net capital gain income and paying the related income tax.In this situation, the RIC normally elects to treat the retained capital gain income (and a prorata portion of the taxpaid on that income) as distributed to its shareholders. As a result, an exempt organization that is a shareholder insuch a RIC receives a credit for taxes paid (for its share of the taxes the RIC paid on the retained capital gainincome), but it normally has no liability for tax on the income deemed distributed. Thus, the organization needs toclaim a refund of the tax it is deemed to have paid.

The organization should receive Form 2439 (Notice to Shareholder of Undistributed Long-Term Capital Gains) fromthe RIC. To obtain a refund of these taxes when a Form 990-T is not otherwise required, an organization shouldfollow the steps described previously in “Claim for Refund.” In addition, write “Claim for Refund Shown on Form2439” at the top of its Form 990-T and attach Copy B of Form 2439.


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Composite Form-990-T for IRA Trustee. A trustee of more than one IRA invested in a RIC may file a compositeForm 990-T to claim a refund for all taxes paid, instead of a separate Form 990-T for each IRA. An IRA trustee shoulduse the following guidance for filing a composite Form 990-T:

1. Apply for a special EIN on Form SS-4 (Application for Employee Identification Number). Write “Notice90-18” on the top of Form SS-4. This special EIN is effective only for filing a composite Form 990-T to claima refund on behalf of the IRAs administered by the trustee.

2. File one composite Form 990-T for each year a claim is made following the steps described previously in“Claim for Refund.”

3. Write “Composite Return per Notice 90-18” at the top of Form 990-T.

4. Attach a list of the IRAs for which the claim is beingmade. Include the names and social security numbersof the persons who established the IRAs as well as the allocated shares of tax paid by the RICs.

5. For the list, group the IRAs according to the RIC in which they made an investment and attach Form 2439for each RIC according to such grouping.

Credit for Federal Tax on Fuels or on Ozone-depleting Chemicals

Generally, the procedures discussed previously, under “Erroneous Backup Withholding,” should also be followedby an organization seeking credit for payment of federal tax on fuels or for credit on taxes paid on chemicals usedas propellants in metered-dose inhalers. However, there are two differences in the procedures:

1. In lieuof attachingaForm1099showing thebackupwithholding, theorganizationshouldattachForm4136(Credit for Federal TaxPaid onFuels) if seeking a refund of federal fuel tax. To claim a refund in the first threequarters of the tax year for excise taxes paid on Form 720, 730, or 2290, Form 8849 (Claim for Refund ofExcise Taxes) should be used.

2. The amount of the credit should be entered on line 45g of Form 990-T.

Credit for Small Employer Health Insurance

There is a health insurance tax credit available to eligible small employers that purchase health insurance for theiremployees.

The credit is a refundable credit for a tax-exempt employer, so even if the employer has no unrelated businesstaxable income, the employer is eligible for a refund (provided it does not exceed the income tax withholding andMedicare tax liability limitation described previously). The credit is calculated on Form 8941 (Credit for SmallEmployer Health Insurance Premiums).

If an organization is filing Form 990-T solely to claim a refund of the health care credit, write “Request for 45R CreditOnly” across the top of the form and complete certain portions of Form 990-T described previously in “Claim forRefund.” In addition, attach a copy of the Form 8941 showing the calculation of the credit to the return.

Carryback for Net Operating Losses

The instructions to Form 990-T do not fully explain how the carryback of a net operating loss (NOL) from anunrelated business activity is accomplished. The instructions state that an amended Form 990-T for the year towhich the NOL is carried must be filed. Form 1045 or Form 1139 cannot be used, although either may be attachedto the amended Form 990-T to show the NOL computation. It is a best practice to write the notation “AmendedReturn—Net Operating Loss Carryback” at the top of the Form 990-T. The amount of the NOL (limited to the amountof unrelated business taxable income on line 30) should be entered on line 31, Part II.

The notation “Carryback from (year)” and a statement should be included as part of the amended return thatprovides an explanation of why an amended return is being filed. The notation should be written on line 31 after thecaption for the line (net operating loss deduction). Recalculate the tax in Part III and complete Part IV accordingly.


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Attach a copy of the Form 990-T as filed for the year to which the NOL is carried and write on the bottom of eachpage “As Filed.” Attach a copy of the Form 990-T for the year that generated the loss, with the notation on each page“Attachment to Amended Form 990-T for (Year).” The Form 990-T with the carryback should be filed with the InternalRevenue Service Center, Ogden, UT 84201-0027.

Preserving the Carryover

An organization that claims an NOL deduction for any NOL carried through taxable years for which the organizationwas not required to file Form 990-T must show the amount of the deduction (and how it was computed), but theorganization need not file a Form 990-T in order to preserve an NOL carryover.

Carryback Period

An NOL must normally be carried back to the two years preceding the loss year and then forward to the 20 yearsfollowing the loss year. However, a taxpayer can elect to forgo the carryback of an NOL and carry it forward. Thiselection, which is irrevocable for the year made, must be made by the due date (including extensions) of Form990-T for the tax year of the NOL for which the election is to be effective. There are other exceptions to the NOLcarryback and carryover provisions, as discussed in Lesson 3.

How to Address Return Due Dates, the Payment of Tax and Extensions ofTime to File

Due Date of Return

For most tax-exempt organizations required to file an unrelated business income tax return (Form 990-T), the duedate of the return is the 15th day of the fifth month after the end of the tax year (i.e., May 15 for a calendar-yearentity)]. However, IRAs (including SEP-IRAs, SIMPLE IRAs, and Roth IRAs), employees’ trusts described in IRCSec. 401(a) that form a part of a stock bonus, pension, or profit-sharing plan, ESAs and Archer MSAsmust file Form990-T by the 15th day of the fourth month following the end of their tax year.

Payment of Tax

Organizations that owe tax when filing Form 990-Tmust deposit the balance due electronically using the ElectronicFederal Tax Payment System (EFTPS). Lesson 4 discusses the EFTPS rules; computing and paying any taxes dueas a result of an organization’s liability for tax on unrelated business income (UBI), including estimated taxpayments; and applying overpayments as a credit to the next year.

Extensions of Time to File

The IRS is authorized to grant an extension of time to file Form 990-T for a maximum of six months. To obtain anextension, an organization must file a request with the IRS before the expiration of the original deadline. Shortperiod returns caused by a change in accounting method are not eligible for extension.

All exempt entities request an extension to file Form 990-T by submitting Form 8868 electronically or by mail toDepartment of the Treasury, Internal Revenue Service Center, Ogden, UT 84201-0045, on or before the original duedate of the Form 990-T. If Form 8868 is properly completed, timely filed, and the balance of any tax due is paid bythe due date of the return for which the extension applies, the appropriate extension period is automaticallygranted. A copy of the extension(s) should be attached to Form 990-T when it is ultimately filed. No reason isrequired for requesting an automatic extension. The automatic extension period is six months.

Requesting an extension to file the return does not relieve the organization of its obligation to pay any taxes by theoriginal due date. It must deposit the payment electronically using EFTPS.

Example 1E-1 Request for an extension to file.

Neighborhood Health Clinic, Inc. (NHC), a tax-exempt corporate organization, has a June 30 tax year-end. Ithad unrelated business taxable income (UBTI) of $45,000 in the year ending June 30, 2018, and has been


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unable to gather the information necessary to file its return by the November 15 due date. During the year,NHC made four estimated tax payments of $1,650 each related to its total estimated tax liability of $6,750($45,000 × 15%), leaving a balance due of $150 [$6,750 − (4 × $1,650)].

To obtain an automatic six-month extension for filing its Form 990-T NHC must:

1. file Form 8868 on or before November 15, electronically or with the Internal Revenue Service Center,Ogden, UT 84201-0045, and

2. make a tax deposit of $150 electronically.

Since it is an automatic extension, only the original form should be submitted. (No copies are needed.) NHCshould secure and retain proof of the timely filing of the extension request. If mailed, it should be sent bycertified or registered mail, a return receipt should be requested, and the date-stamped receipt for thepostage paid should be retained. Alternatively, NHC can file the request by using an IRS approved privatedelivery service and retain the documentation provided to establish a filing date.

Where to File

Form 990-T cannot be filed electronically. A comprehensive list of where to file Form 990-T is beyond the scope ofthis course, but more information is available in PPC’s 990 Deskbook.

Interest and Penalties

A tax-exempt organization is liable for interest and penalties if it is late filing a return on which tax is due or fails topay any taxes due on a timely basis. The minimum penalty for a return that is filed 60 days late is the smaller of thetax due or $210. However, a penalty will not be imposed if the organization can show that the failure to file or pay ontimewas due to reasonable cause. If the organization files the return late, it should attach a statement explaining thereasonable cause unless the organization has already received a notice. If that has occurred, the organizationshould respond to the notice with a statement of reasonable cause.

How to File an Amended Return

If an organization discovers an error on a previously filed Form 990-T, it generally has until the later of three yearsfrom the date the original return was filed or two years from the date the tax was paid to file an amended return toclaim a credit or refund. The IRS has three years from the time a return is filed to assess additional tax. For theserules, a return filed before its original due date is deemed filed on the original due date. However, if an amendedreturn showing an increase in tax is received by the IRS within 60 days of the expiration of the statute period, the IRShas 60 days from the receipt of the return to assess the additional tax shown on the return. If the organization filesan amended return, the amended return must be the one made available for public inspection.

To amend a return, a new Form 990-T (using the appropriate year’s form) should be prepared using the correctinformation, and “Amended Return” should be written at the top of the return. Attach a statement identifying whichlines changed and explaining the reason for each change.

Example 1F-1 Correcting an error on a previously filed return.

I Love a Clean Environment, Inc. (ILCE), a calendar-year Section 501(c)(3) organization, filed a timely 2016Form 990-T on April 25, 2017. While preparing its 2017 return, ILCE noticed certain items of income wereinadvertently omitted from its 2016 Form 990-T.

To correct this error, ILCE should prepare and file an amended Form 990-T for 2016 and pay any additionaltaxes and interest due. ILCE may also be subject to a late payment penalty if additional taxes are owed.

If ILCE discovered it had overstated its unrelated business income in 2016, it can file an amended return toclaim a refund of overpaid taxes. Assuming ILCE paid all the tax shown as due on its 2016 return by the time


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the return was filed, it has until May 15, 2020, to file an amended return. This is the later of three years from thedate the return was filed (i.e., three years from May 15, 2017, the due date of the return) or two years from thedate the tax was paid.

Making Form 990-T Available for Public Inspection

Form 990-T filed by a Section 501(c)(3) organization, including the necessary schedules and attachments (state-ments), generally must be made available for public inspection for the three-year period beginning with the duedate of the return (including extensions). This includes a Form 990-T filed by a charitable organization, such as achurch, that is not otherwise subject to any disclosure rules. However, disclosure is not required for the return of anapplicable reinsurance entity and for any return filed solely to claim a credit or refund. If the organization files anamended return, the amended return must be the one made available for public inspection.

The following forms, when attached to a Section 501(c)(3) organization’s Form 990-T, are not required to be madeavailable for public inspection:

1. Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation);

2. Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations);

3. Form 8271 (Investor Reporting of Tax Shelter Registration Number);

4. Form 8594 (Asset Acquisition Statement Under Section 1060);

5. Form8621 (ReturnbyaShareholderofaPassiveForeign InvestmentCompanyorQualifiedElectingFund);

6. Form 8832 (Entity Classification Election);

7. Form 8858 (Information Return of U.S. Persons With Respect to Foreign Disregarded Entities);

8. Form 8865 (Return of U.S. Person With Respect to Certain Foreign Partnerships);

9. Form 8886 (Reportable Transaction Disclosure Statement);

10. Form 8913 (Credit for Federal Telephone Excise Tax Paid);

11. Form 8925 (Report of Employer-Owned Life Insurance Contracts); and

12. Form 8941 (Credit for Small Employer Health Insurance Premiums).

13. Form 8975 (Country-by-Country Report).

State colleges and universities (and their wholly owned corporations) are generally exempt from income tax underIRC Sec. 115 but must still report any unrelated business income on Form 990-T. Some of these entities also applyfor exempt status under IRC Sec. 501(c)(3). Those that are also Section 501(c)(3) entities must make Form 990-Tavailable for public inspection.

Other organizations continue to be exempt from this disclosure requirement. A copy of an organization’s Form990-T can be requested from the IRS by submitting a completed Form 4506-A (Request for Public Inspection orCopy of Exempt or Political Organization IRS Form).

Paid Preparer Information

Paid Preparer Signature

Generally, any non-employee paid preparer must complete the “Paid Preparer’s Use Only” area as follows:

1. Sign and date the return in the space provided.


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2. Complete the paid preparer information.

3. Provide a copy of the return to the organization.

If an employee of the organization prepared the return, do not complete the paid preparer information becauseemployees of filing organizations are not considered paid preparers. Additionally, if an officer or volunteer com-pleted the return, the paid preparer information should be left blank.

A paid preparer must enter his or her preparer tax identification number (PTIN). A preparer can apply for a PTINusing Form W-12 [IRS Paid Preparer Tax Identification Number (PTIN) Application] or by using the IRS’s onlineapplication system.

Permission to Discuss Form 990-T with Paid Preparer

An organization can authorize the IRS to discuss Form 990-T with the paid preparer who signed it by checking the“Yes” box in the signature area of the return on page 2. However, such authorization, if given, is limited, as follows:

1. The authorization applies only to the person who signed the return and does not extend to others in thefirm.

2. The IRS will only contact the paid preparer to request information that is missing from the return, not todiscuss technical issues related to it.

3. The authorizationpermits the paid preparer to contact the IRS: (a) for information regarding theprocessingof the return, the status of a refund claimed on the return, or tax paymentsmade; and (b) to respond to IRSnotices that the organizationhas sharedwith thepreparer about amatherror, offsets, or returnpreparation.

4. The authorization does not entitle the paid preparer to receive any refund check, bind the organization toadditional tax liability or in any other manner, or to otherwise represent the organization before the IRS.

Preparer Penalties Related to Form 990-T

Preparer penalties apply to preparers of Form 990-T for claiming an “unreasonable position” under IRC Sec.6694(a)(1). A tax position is generally considered to be any issue, position, or action taken or expected to be takenon a federal tax return, including the decision to exclude certain income or transactions from the return. Filingpositions that lack substantial authority (but for which there is a reasonable cause) should be disclosed. A detaileddiscussion of these penalties is beyond the scope of this course, but more information is available in PPC’s 990Deskbook.

Definition of Preparer

A tax return preparer is any person who prepares all or a substantial portion of any tax return (which includes Forms990, 990-EZ, 990-PF, and 990-T) for compensation or who employs one or more persons to do so for compensa-tion. Thus, there can bemultiple preparers of the same return. As discussed above, an employee of an organizationis not considered a paid preparer.

Preparers can be either signing preparers or nonsigning preparers. A signing preparer is the preparer who has theprimary responsibility for the overall substantive accuracy of the return or refund claim. A nonsigning preparer is apreparer who prepares all or a substantial portion of the return or refund claim but is not the signing preparer.


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SELF-STUDY QUIZ


3. Which of the following answer choices correctly states one of the five conditions that must be met for a groupof affiliated tax-exempt organizations to file a consolidated Form 990-T?

a. The group’s common parent owns at least 51% of the voting power and stock of all group members.

b. The majority of the group members are tax-exempt under IRC Sec. 501(c).

c. The group is made up predominantly of Section 501(c)(2) title holding companies (THCs).

d. Any non-THC group member must receive income from a group THC.

4. Plentiful Holidays (PH) has a net operating loss (NOL) to carry back in the current tax year. How will this affectthe organization’s Form 990-T?

a. Form 990-T for the current year will be affected, but not those filed previously.

b. The tax in Part III will need to be recalculated for the NOL.

c. If Form 990-T was not filed in the applicable year, one will need to be prepared to preserve the carryover.

d. With proper notification on Form 990-T, the NOL can be carried back 20 years.

5. Which of the following rules applies to filing an amended Form 990-T?

a. If the organization discovers an error, it must be corrected within twelve months.

b. The IRS has three years from the date a Form 990-T was filed to assess additional tax.

c. If a return is filed early, that is the date from which all deadlines are calculated.

d. The IRS has 120 days to assess additional taxes from the date it receives an amended return.

6. Jason prepares Common Corp’s Form 990-T. The company has Jason check the “Yes” box on page 2, whichauthorizes the IRS to contact Jason about Common Corp’s Form 990-T. Which of the following may occur?

a. Anyone in Jason’s firm may be contacted by the IRS in relation to Common Corp’s Form 990-T.

b. Jason should be prepared to field questions from the IRS about technical issues related to the form.

c. Jason is authorized to contact the IRS for information about the processing of this Form 990-T.

d. Jason will receive any refund check from the IRS to which Common Corp is entitled.


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SELF-STUDY ANSWERS


3. Which of the following answer choices correctly states one of the five conditions that must be met for a groupof affiliated tax-exempt organizations to file a consolidated Form 990-T? (Page 11)

a. The group’s common parent owns at least 51% of the voting power and stock of all groupmembers. [Thisanswer is incorrect. According to IRC Sec. 1504(e) and 1504(a), the common parent of the group mustown at least 80% of the voting power and value of the stock of another member of the group. Additionally,at least 80% of the voting power and value of each member of the group (other than the common parent)must be owned by another member of the group.]

b. The majority of the group members are tax-exempt under IRC Sec. 501(c). [This answer is incorrect. Tomeet the conditions described in IRCSec. 1504(e) and 1504(a), all members of the groupmust be exemptfrom tax under IRC Sec. 501(a).]

c. The group is made up predominantly of Section 501(c)(2) title holding companies (THCs). [This answeris incorrect. Per IRC Sec. 1504(e) and 1504(a), one of the conditions that must be met is for at least onemember of the group to be a THC described in IRC Sec. 501(c)(2) (i.e., its sole purpose is to hold title toproperty; collect income therefrom; and turn over the income, net of expenses, to another tax-exemptentity.]

d. Any non-THC group member must receive income from a group THC. [This answer is correct. IRCSec. 1504(e)and1504(a)outlines theconditions thatmust bemet for agroupof affiliated tax-exemptorganizations to qualify to file a consolidated Form 990-T. One of those conditions is that eachmember of the group that is not a THCmust receive income from a THC within the group (or wouldhave except that during the year the THC’s expense of collecting its incomeexceeded the income).]

4. Plentiful Holidays (PH) has a net operating loss (NOL) to carry back in the current tax year. How will this affectthe organization’s Form 990-T? (Page 14)

a. Form 990-T for the current year will be affected, but not those filed previously. [This answer is incorrect.The instructions of Form 990-T state that an amended Form 990-T for the year to which the NOL is carriedmust be filed. Therefore, the NOL affects at least one of PH’s prior-year forms.]

b. The tax in Part III will need to be recalculated for the NOL. [This answer is correct. The notation“Carryback from (year)” and a statement should be included as part of the amended return thatprovides an explanation of why an amended return is being filed. The notation should be written online 31 after the caption for the line (net operating loss deduction). Then the tax in Part III will needto be recalculated, and Part IV will need to be completed accordingly. Therefore, this recalculationwill be necessary for PH in this scenario.]

c. Form990-Twasnot filed in theapplicable year, onewill need tobeprepared topreserve thecarryover. [Thisanswer is incorrect. An organization that claims an NOL deduction for any NOL carried through taxableyears forwhich theorganizationwasnot required to fileForm990-Tmust show theamountof thededuction(andhow itwascomputed), butPHwill not need to file aForm990-T inorder topreserveanNOLcarryover.]

d. With proper notification on Form 990-T, the NOL can be carried back 20 years. [This answer is incorrect.According to IRC Sec. 172(b), an NOLmust normally be carried back to the two years preceding the lossyear and then forward to the 20 years following the loss year. Therefore, PH will not be able to carry theNOL back 20 years.]


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5. Which of the following rules applies to filing an amended Form 990-T? (Page 16)

a. If the organization discovers an error, it must be corrected within twelvemonths. [This answer is incorrect.According to IRC Sec. 6511(a), if an organization discovers an error on a previously filed Form 990-T, itgenerally has until the later of three years from the date the original return was filed or two years from thedate the tax was paid to file an amended return to claim a credit or refund.]

b. The IRS has three years from the date a Form 990-T was filed to assess additional tax. [This answeris correct. Per IRC Sec. 6501, the IRS has three years from the time a return is filed to assessadditional tax. Therefore, after the three years have passed, the organization should not receivesuch an assessment.]

c. If a return is filed early, that is the date from which all deadlines are calculated. [This answer is incorrect.Per IRC Secs. 6501(b)(1) and 6513(a), for the rules about filing an amended return, a return filed beforeits original due date is deemed filed on the original due date. Therefore, any deadlines or statutes oflimitation for the amended return will be calculated from the original due date, not the early date that theform was filed.]

d. The IRS has 120 days to assess additional taxes from the date it receives an amended return. [This answeris incorrect. According to IRCSec. 6501(c)(7), if an amended return showing an increase in tax is receivedby the IRS within 60 days of the expiration of the statute period, the IRS has 60 days from the receipt ofthe return to assess the additional tax shown on the return.]

6. Jason prepares Common Corp’s Form 990-T. The company has Jason check the “Yes” box on page 2, whichauthorizes the IRS to contact Jason about Common Corp’s Form 990-T. Which of the following may occur?(Page 17)

a. Anyone in Jason’s firm may be contacted by the IRS in relation to Common Corp’s Form 990-T. [Thisanswer is incorrect. The authorization by checking this box is limited. It applies only to the person whosigned the return and does not extend to others in the firm. Therefore, Jason is the onlymember of his firmthat the IRS can contact in relation to Common Corp’s Form 990-T.]

b. Jason should be prepared to field questions from the IRS about technical issues related to the form. [Thisanswer is incorrect. The IRS will only contact the paid preparer to request information that is missing fromthe return, not to discuss technical issues related to it. Therefore, Jason does not need to prepare for thistype of question from the IRS at this time.]

c. Jason is authorized to contact the IRS for information about the processingof this Form990-T. [Thisanswer is correct. By checking this authorization box, the paid preparer is permitted to contact theIRS (1) for information regarding the processing of the return, the status of a refund claimed on thereturn, or taxpaymentsmadeand (2) to respond to IRSnotices that theorganizationhas sharedwiththe preparer about a math error, offsets, or return preparation. Therefore, Jason is allowed tomakethis communication with the IRS.]

d. Jason will receive any refund check from the IRS to which Common Corp is entitled. [This answer isincorrect. The authorization does not entitle the paid preparer to receive any refund check, bind theorganization to additional tax liability or in any other manner, or to otherwise represent the organizationbefore the IRS. Therefore, Common Corp, not Jason, should receive any refund check under thesecircumstances.]


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Lesson 2: Unrelated Business IncomeIntroduction

The mere fact that an organization engages in a trade or business activity does not necessarily jeopardize itsexempt status. The organization may be subject to the unrelated business income tax (UBIT) if the activity isregularly carried on and is not substantially related (i.e., is unrelated) to the entity’s exempt purpose. The primarypurpose of UBIT is to put tax-exempt entities and “for profit” enterprises on equal footing with respect to their tradeor business activities. If the organization is a private foundation, it may also be subject to the excess businessholdings tax because of its business activities. This lesson discusses the rules that determine whether an organiza-tion is operating an unrelated trade or business and the circumstances under which the income from an unrelatedtrade or business is not taxable.


Completion of this lesson will enable you to:¯ Identify an unrelated trade or business, when activities are considered a trade or business, the definition of theterm regularly carried on, substantially related activities, activities excluded from the definition of an unrelatedtrade or business, and income excluded from unrelated business income.

¯ Determine how to report gross receipts or sales and gains and losses, deal with income from pass-throughentities, and report taxable rental income.

¯ Identify income from controlled organizations and agency relationships, associate member dues, manage-ment and administrative services fees, travel tours, and the operation of parking facilities; determine whatspecial rules apply to organizations described in IRC Sec. 501(c)(7), (9), and (13); and identify the correctmethod for completing Part I of Form 990-T.

The Definition of an Unrelated Trade or Business

An activity is an unrelated trade or business if all of the following conditions exist:

1. Trade or Business. The organization is conducting a trade or business for the production of income fromselling goods or performing services.

2. Regularly Carried on. The trade or business is regularly carried on.

3. Unrelated to Exempt Purpose. The activity is “not substantially related” to the carrying out of theorganization’s exempt purpose.

Although an activity is generally taxable if all of these conditions are met, certain activities are statutorily excludedfrom taxation even if they meet all three criteria.

The IRS provides guidance on what is considered an unrelated trade or business, including numerous examples,in IRS Pub. 598, “Tax on Unrelated Business Income of Exempt Organizations.”

Application of Rules to Trusts

Taxable Trusts. Taxable trusts are not subject to UBIT. However, the calculation of a hypothetical amount of UBI isnecessary to determine such trusts’ charitable contribution limit for the tax year. Thus, the definition of an unrelatedtrade or business is important even for taxable trusts. For these trusts, an unrelated trade or business is any tradeor business regularly carried on by the trust or by a partnership in which it is a partner. Unlike other organizations,such a trust’s trade or business activity is, by definition, always unrelated. For detailed guidance on completingfederal income tax returns for taxable trusts, see PPC’s 1041 Deskbook.

Tax-exempt Trusts. A tax-exempt trust forming part of a stock bonus, pension, or profit-sharing plan or forming partof a plan providing for payment of supplemental unemployment compensation benefits is subject to the unrelated


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business income tax (UBIT). Different rules apply to charitable remainder trusts (CRTs) in which a noncharitablebeneficiary holds a life or term interest and the remainder interest goes to charity. This type of trust normally is notsubject to the regular income tax because its income is either distributed and taxed to the income beneficiary oraccumulated for distribution to a charitable organization. However, a CRT is subject to a 100% excise tax on itsunrelated business income.

When Will an Activity Be Considered a Trade or Business?

Factors Indicating a Profit Motive

The term trade or business has the same meaning here as in IRC Sec. 162, which allows the deduction of ordinaryand necessary expenses incurred in carrying on a trade or business. The term includes any activity carried on witha profit motive from the sale of goods or the performance of services.

Relevant factors in determining whether an activity is engaged in for a profit include the—

1. manner in which the activity is carried on (i.e., adopting a business-like manner with proper accountingprocedures, conducting it similarly to a commercial business, changing operating methods to improveprofitability),

2. expertise of taxpayer and advisors (i.e., studying and using accepted business and economic practices,consulting with professionals),

3. time and effort expended (i.e., devoting considerable personal time, withdrawing from other activities,hiring qualified employees),

4. expectation that activity assets will appreciate (i.e., the profit motive appears to be from increased resalevalue rather than operations),

5. successful experience in carrying on the activity (i.e., profitable activities in past activitiesmay indicate themotive to earn profit in the current activity, even if it is unprofitable at present),

6. history of income or losses (i.e., losses beyond the initial start-up period may not indicate a lack of profitmotive if attributable to customary business risk and reversals or unforeseen circumstances such as anatural disaster),

7. amount of profit earned (i.e., the occasional modest profit on an activity that generally experiencessignificant losses would not generally prove that the activity has a profit motive, while the occasional largeprofit on an activity that generally experiences small losses would),

8. financial status of the taxpayer (i.e., whether there are other substantial income streams or capitalresources), and

9. elements of personal pleasure or recreation .(i.e., the personal appeal of an activity that generates lossesmay indicate that the activity lacks a profit motive, but the fact that other more profitable investmentopportunities are forgone does not).

Unprofitable Activities and/or Those without a Profit Motive

An unrelated business activity that is conducted with the intent to make a profit does not cease to be such merelybecause it is not profitable for a particular year. However, no intent to make a profit may indicate an activity is not atrade or business.

Example 2B-1 Activity lacking a profit motive.

The Crosstown Medical Society (Crosstown) publishes a quarterly journal containing articles on topics ofinterest to Crosstown’s members and related to Crosstown’s exempt function. It also contains advertising of


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vendors of medical products. The solicitation and selling of the advertising is handled by Crosstown’s solepaid employee. Crosstown has consistently lost money on its advertising activities for the entire 21-yearhistory of the journal. There has been no attempt to change these activities to make them profitable.

Crosstown could have avoided additional losses by discontinuing the advertising activity. Since it did not,Crosstown lacks a profit motive with respect to the advertising activity and, thus, the activity is not a trade orbusiness.

Example 2B-2 Activity sustains losses but contains a profit motive.

Uptown Medical Society (Uptown) employs several individuals to perform a variety of research projectsrelated to the development of new plastics and has patented several developments, but has recognized norevenue from the activity. The research is conducted on a regular, systematic basis. Uptown incurs fees tosecure consultation on its projects, and makes extensive efforts to market its developments over the courseof several years. It seeks to develop a durable plastic with the strength of steel, knowing that the potentialincome from such an invention would be significant. There does not appear to be any element of recreationor personal pleasure to the work, and it is unrelated to the exempt purpose of the Uptown. Althoughexperiencing losses for several years, Uptown is engaged in the activity for a profit.

If an activity is not a trade or business, its losses cannot offset profits from a profit-motivated endeavor.

The IRS released its “Colleges and Universities Compliance Project” report. Thirty-four organizations were selectedfor IRS examination during the project. The IRS disallowed net activity losses on 70% of the examined organizationsfor lack of profit motive due to recurring losses spanning several years.

Incidental Activities

Activities that are incidental to an organization’s exempt function are not considered a trade or business. Thisincludes the distribution of low-cost items that are incidental to the solicitation of charitable contributions if thesoliciting organization is described in IRC Sec. 170(c)(2) or (3). An incidental distribution is one made without therequest or express consent of the distributee and accompanied by a request for a donation and a statement that theitem distributed need not be returned, regardless of whether a contribution is made. Organizations described inIRC Sec. 170(c)(2) or (3) include most tax-exempt veterans’ organizations and all Section 501(c)(3) organizations,other than those involved in testing for public safety.

Example 2B-3 Incidental activity is not a trade or business.

Save Our Trees, Inc. (Trees) is a public charity whose tax-exempt purpose is to educate the public on the needto preserve and replant trees. It raises funds by mail solicitations. Trees sends a box of greeting cards printedon recycled paper with its appeals for donations. The cards cost Trees $2.50 per box. The cards attractcontributions and promote the use of recycled paper products. They are of the same quality and content ascards sold commercially.

The distribution of the cards is not a trade or business because: (a) the cards are low-cost items, (b) thepotential donor did not request or expressly consent to receiving them, and (c) each distribution is accompa-nied by a donation request and a statement indicating the cards may be kept, regardless of whether acontribution is sent.

Activity Carried on within a Larger Activity

An activity that produces or distributes goods or performs services for the production of income does not lose itsidentity as a trade or business merely because it is carried on within a larger group of similar activities or within alarger complex of other functions of the organization. This is true even if these other activities or functions arerelated to the organization’s exempt purpose.

Example 2B-4 Trade or business activity within a program service activity.

The Tri-County Hospital pharmacy fills drug prescriptions for the hospital’s patients. The pharmacy alsoregularly sells pharmaceutical supplies to the general public.


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The regular sale of pharmaceutical supplies to the general public is a trade or business, even though thepharmacy also furnishes supplies to the hospital and hospital patients in accordance with its exempt purpose.Although this activity is partially related to an exempt function (the sales to hospital patients), it is conductedon a larger scale than is reasonably necessary for the performance of that function. Thus, to the extent itexceeds the needs of the exempt function (i.e., to the extent of the sales to the general public), the activity isan unrelated trade or business.

Commerciality Test

An activity that is carried on in a manner similar to a commercial business may be considered a trade or business.This is sometimes referred to as the commerciality doctrine or test, which focuses on the type of operation beingconducted by the organization. An activity is likely to be considered a trade or business if a for-profit entity wouldwant to, and could, conduct it.

Generally, the IRS applies the commerciality test in determining whether an organization qualifies for tax-exemptstatus. However, the test means that an activity that could be substantially related to an organization’s exemptpurpose may become an unrelated activity if conducted in a commercial fashion.

Example 2B-5 Denial of exempt status under commerciality doctrine.

Give a Hand-Up Not a Hand-Out (GHUNHO) is formed with a mission to equip small businesses,entrepreneurs and nonprofit organizations with capacity-building strategies for growth, effectiveness, andsustainability. GHUNHO will provide software tools, tutorials, online instruction, networking, workshops onbusiness strategies, and assistance in developing business-related documents. The services are offeredusing the software and consulting services of a for-profit entity that is owned by the executive director ofGHUNHO.

GHUNHO’s activities further the private interests of both the executive director and the customers purchasingthe services. It advertises and sells products and services provided by specific private interests. GHUNHO isnot operating exclusively for an educational or charitable purpose. Even when the products are provided atcost solely to nonprofit organizations, the provision of managerial and consulting services on a regular basisfor a fee is a commercial activity in direct competition with for-profit businesses providing similar services.

At times, the operation of a nonprofit organization may directly benefit a commercial organization. When thedirectors of the nonprofit organization own or control the commercial organization, tax-exempt status may bedenied or revoked even if the payments to the commercial organization are reasonable and at arm’s length. InChurch by Mail, Inc., the 9th Circuit Court of Appeals wrote that the critical inquiry is not whether particularcontractual payments to a related for-profit organization are reasonable or excessive, but whether the entireenterprise is carried on in such a manner that the for-profit organization benefits substantially from the operation ofthe nonprofit organization.

Example 2B-6 Nonprofit organization operated to increase director’s commercial business.

Anja Odysseus is an officer and shareholder in Odysseus Travel Agency. Anja also founded and serves on theBoard of Directors of the Continuous Education Foundation (CEF), a nonprofit organization. CEF’s mission isto organize and sponsor continuing education seminars and symposia in Greece. CEF will use OdysseusTravel Agency for all its travel arrangements, including sightseeing and recreational activities.

CEF was formed, at least in part, to obtain customers for the founder’s commercial business, and therefore CEF’soperations increase the income of Odysseus Travel. Although CEF furthers other exempt purposes, it serves theprivate interests of its founder, rather than public interests. CEF’s tax-exempt status will be denied.

Defining the Term Regularly Carried on

Trade or business activities of exempt organizations are not subject to unrelated business income tax (UBIT) if theyare not regularly carried on. Business activities ordinarily are regularly carried on if they have a frequency and


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continuity and are pursued in a manner comparable to similar commercial activities of nonexempt organizations.This is consistent with the UBIT’s primary purpose of placing an exempt organization’s business activities on thesame tax basis as the endeavors of nonexempt businesses with which they compete. An exempt organization’sactivities are more likely to compete with those of a commercial operation if both entities offer their products orservices during the same times each year. Thus, the frequency necessary for determining whether an activity isregularly carried on varies with the activity involved.

Annual or Infrequent Activities

An annual fundraising event will generally not be treated as a regularly carried on business activity, nor willinfrequent fundraising events be regarded as regularly carried on merely because they are conducted as often asannually. However, if an event involves significant planning, preparation, and promotion that begins several monthsprior to the actual event, the activity can be considered to be regularly carried on.

Example 2C-1 Infrequent Activity regularly carried on.

A charitable organization has an annual directory prepared and distributed to its entire membership. Anindependent commercial firm under contract throughout the year sells advertising space and collects adver-tising fees. Although the directory is only published once a year, the activity is regularly carried on because theorganization works on the directory for several months before and after publication.

A troublesome application of the regularly carried on test has involved advertising activities. In NCAA the 10thCircuit Court of Appeals reversed the Tax Court and held that advertising contained in the NCAA’s Final Fourbasketball program was not UBI. The IRS contended that the advertising sold in the program was regularly carriedon because the time spent soliciting and preparing advertising for publication was virtually year-round. The Courtdisagreed, indicating that the advertising appeared before its intended audience during the few weeks of thetournament (in contrast to an annual directory, where the advertisements are viewed by the audience throughoutthe year). A discussion of the unrelated business income rules relating to advertising is beyond the scope of thiscourse, but more information is available in PPC’s 990 Deskbook.

Similar Activities. In addition, if an organization conducts events during the year that are similar, but not identical,in nature, the IRS has ruled that the frequency and continuity of the similar activities indicates that the overall activityis regularly carried on.

Example 2C-2 Similar activities regularly carried on.

A nonprofit organization conducts four different annual events: a spring baseball tournament, a summerbasketball tournament, a fall football tournament, and a winter hockey tournament. Although each event isonly held once a year, the organization is consistently and systematically organizing and promoting similarevents. It cannot be said that each separate activity is carried on discontinuously or periodically; the similaractivities must be considered together and are, thus, regularly carried on.

Normal Time Span of Activities

If an activity normally is conducted by for-profit companies on a year-round basis, conducting such an activity overa substantially shorter period of time is not considered the regular carrying on of a trade or business.

Example 2C-3 Conducting an activity over a short period of time.

The United Charities, Inc. (United) operates an ice cream stand at the county fair during the fair’s annualtwo-week run. Commercial ice cream stores are normally open year-round, or at least for a substantial part ofthe year. Thus, operating an ice cream stand for a two-week period once a year is not an activity that isregularly carried on, even if several more weeks are involved in preparation activities.

Seasonal Activities. An organization’s income-producing activity may be regularly carried on even though con-ducted only a few months each year when the activity is a kind normally undertaken by commercial organizationsonly on a seasonal basis.


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Example 2C-4 Seasonal activity can be regularly carried on.

The Tarrant Soccer Association (Soccer) operates four snow cone stands annually from Memorial Day untilLabor Day (i.e., approximately 25% of the year). Profits from the stands help offset the cost of soccer uniformsfor low income families.

Although the activity is only conducted during three months of each year, it is likely still regularly carried on.If commercial snow cone stands are open only during approximately the same three-month period, Soccer’sactivity should be considered regularly carried on. Alternatively, if most snow cone stands in the area are openyear-round, Soccer can argue its activity is not regularly carried on.

A short period of operation alone will not avoid the regularly carried on classification. The period of operation mustbe brief compared to similar commercial enterprises. For example, the commercial operation of a track for horseracing for only two weeks each year was considered regularly carried on because the horse racing season istypically short.

Activities Operated One Day a Week. An activity can also be regularly carried on even though conducted onlyone day each week throughout the year. However, activities conducted for a short period of time (e.g., one day ora single evening) on an annual basis should not be considered regularly carried on.

Example 2C-5 Operating an activity one day a week.

Public Charities, Inc. (PCI) owns a building and adjacent parking lot. The building is used as a prenatal careclinic for unwedmothers. The parking lot is reserved for workers and patients of the clinic on Monday throughFriday and half a day on Saturday (for a total of 50 hours per week). On Saturday evenings, PCI makes the lotavailable to patrons of the nearby convention center and charges fair market parking rates for this use. Suchcommercial use occurs about 45 times per year (for about four hours each time).

The parking lot is used 2,780 hours [(50 × 52 = 2,600) + (45 × 4 = 180)] during the year. Only 6% (180 ÷2,780) of this use relates to the commercial activity on Saturday evenings. Nonetheless, the parking lotoperation is regularly carried on because it occurs consistently throughout the year.

Irregularly Conducted Activities. Some business activities are only conducted intermittently throughout the year.In general, these activities will not be considered regularly carried on if they are conducted without the competitiveand promotional efforts typical of commercial endeavors. In contrast, the IRS found that an organization’s directorythat was only published every two or three years was regularly carried on because of the commercial nature inwhich advertising was solicited and because the activity had been conducted in the past and was planned for thefuture.

The appropriate test for an irregularly conducted activity is to compare the activity’s conduct with similar activitiesof for-profit entities. If an organization sells goods or services to further its exempt purpose or primarily for theconvenience of its members, students, patients, officers, or employees, casual sales to the public of the same typeof goods will not be a regularly carried on activity.

Example 2C-6 Casual sales are not regularly carried on.

The bookstore at Rockell University sells text books and supplies needed by university students. Although thebookstore does not advertise off campus or otherwise encourage sales to the general public, such salesoccasionally occur. Most are to individuals visiting the campus for a reason other than to shop at thebookstore. The sales should be considered casual. Thus, the resulting income will not be from an unrelatedtrade or business that is regularly carried on.

One-time Events. An isolated or one-time event will not be considered regularly carried on. In Ltr. Rul. 201024069,a church developed certain computer-related intellectual property rights as a by-product of conducting its religiousactivities and sold them to a commercial entity. The IRS ruled that although the sale was a trade or business, it wasnot regularly carried on, based on the absence of prior sales and the church’s representations that it had no plansfor future software development or sales.


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Identifying Substantially Related Activities

Contribute Importantly to Exempt Purpose(s)

To be substantially related to an organization’s exempt purposes, an activity that generates business incomenormally must “contribute importantly” (other than through the production of funds) and bear a substantial causalrelationship to achievement of those purposes. An activity cannot qualify as substantially related solely because itsincome is needed or used to fund the conduct of an exempt function.

Example 2D-1 An activity’s profits fund program services.

The Topeka Boys Club (T) operates a sports program for boys from low-income families. Most of the fundingfor this program comes from the profits of a year-round car wash facility the club owns. The car wash facilityis operated on a regular basis and is a trade or business. Although the funds from the activity provide criticalsupport for T’s program services, the car wash is not otherwise related to T accomplishing its exemptpurpose. Thus, the activity is an unrelated trade or business.

An organization’s exempt purpose(s) determines whether an activity is substantially related. For example, the saleof scientific books by an art museum had no causal relationship to the accomplishment of its exempt purpose toenhance public appreciation of art. The fact that the book sales could be related to the educational purpose ofsome other exempt organization was irrelevant.

Trade associations must seek to improve business conditions of one or more lines of business instead of perform-ing particular services for individuals (whether or not members of the association). Only those activities directedtoward improving business conditions can be considered substantially related to a business league’s exemptpurposes; all other activities are unrelated. The IRS has determined that a membership organization designed topromote business networking through referrals and professional contacts does not qualify for exemption under IRCSec. 501(c)(6) because it is organized and operated primarily to aid its members in their individual businessactivities. Such activities are not directed toward improvements in a particular line of business, but instead aredesigned to relieve members of the burden and expense of ordinary marketing and networking operations.Likewise, a membership organization that provides training exclusively for a certain manufacturer’s products isconferring a substantial private benefit to the members and to the manufacturer rather than to the industry as awhole. In contrast, income from testing and certification by a Section 501(c)(6) organization to a largemajority of anindustry regardless of membership status is not UBI if it furthers the quality, standards, and reputation of the entireindustry, ensures an improved consumer experience, and assists regulators in maintaining applicable safetystandards.

A Section 501(c)(4) social welfare organization’s exempt purpose is to promote community welfare. Becauseservices for its members and members’ guests do not promote community welfare, income from these services isunrelated to its exempt purpose.

Real estate development can sometimes be a related activity. One purpose of the organization in Ltr. Rul.200213027 was to promote the creation of jobs in an economically depressed area by developing new businesses.The organization proposed to accomplish this objective in part by developing, building, owning, and leasing anindustrial park to attract tenants needing low-skilled workers. These real estate activities were substantially relatedto the organization’s exempt purposes because they would help to create jobs and business expansion throughoutthe area.

For a public college or university (or related entity) described in IRC Sec. 511(a)(2)(B), an activity is substantiallyrelated if it contributes importantly to the accomplishment of any purpose or function described in IRC Sec.501(c)(3), even if unrelated to the school’s own purpose or function.

An activity that derives its income from charges for the performance of an exempt function is substantially relatedbecause it contributes importantly to the accomplishment of the organization’s exempt purposes.


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Example 2D-2 Income from the performance of an exempt function.

Rockell University operates a ski facility for its physical education program. The facility is also available forrecreational purposes to its students. For recreational purposes, students must pay slope and ski lift feescomparable to nearby commercial facilities. The operation of the ski facility for physical education classes andfor the recreational use of the students contributes importantly to the accomplishment of the school’s exemptpurpose. As a result, the income from the facility is not unrelated business income (UBI).

Assume the facility is used by members of the general public. This activity does not contribute to theaccomplishment of the school’s exempt purpose, and income from the general public is unrelated businessincome.

The operation of a recreational facility may be considered charitable if the facilities are available to the generalcommunity. If the fees are sufficiently high enough to restrict the use of the facilities to a limited number of themembers of the community, the operation of the facility does not accomplish its exempt purpose and is notconsidered charitable.

Example 2D-3 Substantially related activity.

A Section 501(c)(3) public charity provides a recreational ice rink to the general community, instruction in icehockey and skating, and facilities for the local high school and state college.

The charity rents the facility to a youth figure skating club and an adult ice hockey club. It charges anadmission fee to students attending physical education classes held by the local elementary school butwaives the fee if a student is unable to pay. The rink is available for open public skating a portion of each day.The rates and fees charged for these services are below the prevailing rates for other ice rink facilitieselsewhere in the region.

These activities are all charitable in nature. The facilities are available to the general public and are affordableto a significant segment of the community. The facility gives children the opportunity to participate in sports,combats community deterioration, and serves the recognized public purpose of combating juvenile delin-quency. The revenue is not UBI.

An athletic trade association’s income from the sale of discount certificates, which entitled the purchaser to playsports promoted by the association at deep discounts, was held to be UBTI because it did not bear a substantialcausal relationship to the organization’s exempt purpose and was essentially payment for advertising services.

Size and Extent of Activities

In determining whether activities contribute importantly to the accomplishment of an organization’s exempt pur-pose, consider the size and extent of the activities involved in relationship to the nature and extent of the exemptfunction they intend to serve. Thus, if an activity is conducted on a scale larger than reasonably necessary toperform the exempt function to which it relates, the excess is an unrelated business.

Example 2D-4 Conducting an activity on too large a scale.

The agriculture department of Ricetex University operates a dairy to facilitate its research in organic milkproduction. A 100-cow herd is reasonably sufficient to meet research needs. However, because of thepremium price commanded by organically produced milk, the department maintains a 250-cow herd.

Since only 40% of the herd is required for the conduct of the dairy operation’s exempt purpose, 60% of thedairy revenue is UBI.

Dual Use of Assets or Facilities

An asset or facility may be used for both exempt and unrelated commercial functions. When there is such dualusage, the use for exempt functions does not, by itself, make the commercial activities a related trade or business.The test is whether the activities contribute importantly to accomplishing the organization’s exempt purpose(s).


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Example 2D-5 Income from dual use of facilities.

The Modern Art Museum (M) has a theater auditorium designed for showing educational films to promote itsprogram of public education in the arts and sciences. The theater is a principal feature of M and operatescontinuously while M is open to the public. M also operates the theater as a movie theater for the public whenit is closed. The income from the educational films should be considered from a related purpose, and thus, notunrelated business income. The income from the commercial films will be UBI.

Example 2D-6 Identifying dual use facilities.

Red State University provides temporary living quarters for family members of students and faculty, potentialstudents visiting the campus, guest speakers, performers, and other members of the general public. Initially,the IRS determined that revenue from renting rooms to family members, potential students, guest speakers,and performers furthers the exempt purpose of a university. Only the rental income from the general publicwas UBI. The IRS later revoked its earlier private letter ruling and concluded that all income from rentingrooms to persons other than students is UBI. The ruling states that there is no substantial or causal relation-ship between the university’s exempt purpose and the rental of guest rooms to anyone other than students.

Selling Products of an Exempt Function Activity

Byproducts from an exempt activity, if sold in their original condition, generate related income. However, additionalprocessing of the byproducts prior to disposition will result in the entire sale being treated as unrelated businessincome.

Example 2D-7 Income from exempt function product sales.

The Dairymen’s Association, Inc. (DAI) is a public charity. Its exempt functions include studying and breedingdairy cattle to develop a breed that maximizes milk production. Milk is produced in the ordinary course ofperforming this exempt purpose and is sold in the same way and for the same price as sales by commercialdairies. Since the milk is the result of DAI’s performance of an exempt function and is sold without materialchange, its sale is substantially related to DAI’s exempt function and does not produce UBI.

However, if DAI processes the milk into ice cream to obtain a higher profit margin on its sale, income from icecream sales would not be substantially related. If a product is processed beyondwhat is necessary to disposeof it in the state it was in when the exempt function was completed, all income from its sale is UBI.

Example 2D-8 Thrift store operated as an exempt activity.

Kindwill Industries, Inc. (Kindwill), a public charity, operates a thrift store. The store is open during normalbusiness hours throughout the year and sells items obtained from the general public. Some items aredonated, but most are received on consignment. Substantially all of the work in operating the store isperformed by employees, and all profits go toward supporting Kindwill’s program services.

The store operation is a trade or business that is regularly carried on. However, Kindwill’s exempt purpose isto provide employment opportunities and job-training to disadvantaged and chronically unemployed individ-uals. Assuming that the scale of the store is reasonably necessary to accomplish the exempt function, therevenue from the thrift store is exempt-function income and is not UBI.

Activities That Can Be Exploited Commercially

An organization’s exempt function activities may produce goodwill or other intangibles that can be exploitedcommercially. Revenue from exploiting an organization’s exempt activities is considered UBI unless the businessoperation itself contributes importantly to the organization’s exempt purpose. It is not enough that the revenue is anoutgrowth of an exempt function. A common example is advertising revenue from a periodical when the publicationalso contains editorial material related to the accomplishment of an organization’s exempt purpose.


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Example 2D-9 Income from exploiting an organization’s goodwill.

Because Tagem Labs, Inc. (Tagem), an exempt scientific organization, has an excellent reputation in biologi-cal research, several laboratory equipment manufacturers pay Tagem to endorse their products. If not for theperformance of its exempt function, Tagem would presumably be unable to generate income from productendorsements. However, endorsing a manufacturer’s products does not contribute importantly to the accom-plishment of Tagem exempt purposes. Thus, the product endorsement revenue is UBI.

Museum Sales. Ltr. Rul. 9550003 provides guidance on how the IRS determines whether a museum’s gift shopsales and sales occurring outside of the museum itself (i.e., catalog or online website sales) are substantiallyrelated to the museum’s exempt purpose. If the primary purpose behind the production and sale of the item is tofurther the organization’s exempt purpose, the sale is related. If the primary purpose is to generate income, the saleis taxable. The determination must be based on the facts and circumstances of each case. Factors that should beconsidered include the degree of connection between the museum’s collection and the item, the extent to whichthe item relates to the form and design of the original article, and the overall impression conveyed by the item (if thedominant impression relates to the subject matter of the original article, picture, or likeness, substantial relatednesswould be established).

Income from the Dual Use of Facilities or Personnel versus Income from Exploiting an Exempt Activity

When an organization’s facilities or personnel are used for exempt activities as well as conducting an unrelatedbusiness activity, it is sometimes difficult to determine whether the resulting income is from the dual use of thefacilities or from exploiting an exempt activity of the organization. Even though in both cases the revenue producedby the unrelated business activity is UBI, the distinction is important because the answer determines the expensesdeductible in calculating unrelated business taxable income (UBTI). It also determines where the income andallowable expenses are reported on Form 990-T.

If UBI is generated from the use of facilities or personnel in an organization’s exempt purpose, expenses attribut-able to such facilities (e.g., depreciation and overhead) or personnel (e.g., salaries and payroll taxes) are allocatedbetween the two uses on a reasonable basis. Any expenses directly connected with the UBI are fully deductible(without allocation) to the same extent a deduction would be allowed to a taxable entity (e.g., as a trade or businessexpense under IRC Sec. 162 or as depreciation under IRC Sec. 167). However, expenses allocable to exemptpurposes are not deductible to any extent.

In contrast, if the UBI is from exploiting an exempt activity, expenses attributable to the conduct of the exemptactivity are deductible under certain circumstances. If the unrelated business is the kind carried on for profit bytaxable organizations and if the exploited exempt activity is normally conducted by taxable entities in that business,expenses attributable to such exempt activity are deductible in determining UBI, to the extent that:

1. the expenses exceed the income (if any) derived from, or attributable to, the exempt activity;

2. the excess expenses are allocated only to an unrelated business that exploits that exempt activity; and

3. the allocation does not produce a loss from the unrelated business.

Even when expenses of the exploited exempt activity are not deductible because these criteria are not met,expenses directly connected with the unrelated business itself, which would not have been incurred without thatbusiness, are deductible to the same extent they would be deductible by a taxable entity.

Example 2D-10 Reporting revenue and expenses related to exploiting an exempt activity.

Rockell University operates a golf course for its physical education program. Rockell annually contracts withBob Barnett to operate the course during the summer months when classes are not in session. For a fee,Rockell provides the golf course facilities, plus maintenance and pro shop personnel for Bob’s use inoperating the course. (These same facilities and personnel are employed by Rockell during the regularacademic year.) Under the contract, Bob is responsible for the course’s day-to-day operations and all pricing,advertising, and promotional decisions related to its use during the summer.


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The course attracts many golfers during the summer primarily because of its competitively priced green feesand its location near a popular vacation destination. Its location on the Rockell campus is of secondaryimportance, if a factor at all, in attracting golfers.

The income Rockell receives from Bob is UBI from the dual use of exempt facilities and personnel. It isreported on line 1a and 1c of Part I of Rockell’s Form 990-T. The related expenses are reported in Part II of theform. Any expenses related to both the exempt activity and the unrelated business activity must be allocatedbetween the two uses on a reasonable basis.

Rockell’s golf instructors are internationally known, and the course is considered one of the best in the nation.As a result, the primary reason golfers are attracted to the course during the summer months is the reputationof the course and its instructors. Thus, the UBI received from the course’s operation is income from exploitingan exempt activity.

Rockell received a total of $155,900 during the year from the fee it charged Bob and $268,108 from activitiesrelated to its physical education program. Rockell incurred a total of $45,390 in expenses it would not haveincurred if the course was closed during the summer. In addition, $62,429 of the total of $383,219 in othercourse expenses are allocable to the summer months of operation. The $62,429 includes expenses forwatering, general maintenance, and depreciation of the pro shop facilities that would have occurred even ifthe course was not open in the summer.

Income and expenses from exploiting exempt activities are reported on Form 990-T, Schedule I (except foradvertising reported on Schedule J).

Debt Management Plan Services

An organization that provides debt management plan services is considered engaged in an unrelated trade orbusiness unless it is a credit counseling organization that is exempt under IRC Sec. 501(q). Debt management planservices are services related to the repayment, consolidation, or restructuring of a consumer’s debt. Such servicesinclude the negotiation of lower interest rates with creditors, the waiver or reduction of fees, and the marketing andprocessing of debt management plans.

Activities That Are Excluded from the Definition of an Unrelated Trade orBusiness

Certain activities are statutorily excluded from the unrelated business income (UBI) rules, even though theymeet allthree tests of an unrelated trade or business, as discussed earlier in this lesson. In addition, case law providesvarious other exclusions for specific activities. The most common statutory exclusions include the following:

¯ Unpaid volunteer labor performs substantially all of the work.

¯ The activity is conducted primarily for the members’ convenience.

¯ Substantially all sales are from donated merchandise.

¯ Qualified public entertainment activities are conducted by a qualifying organization.

¯ Conventions and trade shows are carried on by a qualifying organization.

¯ Games of chance are operated by unpaid volunteer labor.

¯ Bingo satisfies the statutory requirements of IRC Sec 513 and is conducted by an exempt organization.

¯ Miscellaneous other activities (such as distributing low-cost items in return for donations).

See IRS Pub. 598 for examples of other excluded trade or business activities.


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Performed by Volunteer Labor

Any activity in which substantially all of the work is performed by unpaid volunteers is not an unrelated trade orbusiness. An organization’s paid staff may be directly involved with an activity that is exempt under this exception,provided sufficient volunteer effort is also present.

Example 2E-1 Activity staffed with volunteers.

Kindwill Industries, Inc. (Kindwill), a public charity, operates a thrift store. The store is open during normalbusiness hours throughout the year and sells items obtained from the general public. Some items aredonated, but most are received on consignment. Kindwill and the consignor agree on the retail price of theitem, Kindwill’s share of this price if the item is sold, and the disposition of the item if it does not sell within astated period. Substantially all of the work in operating the store is performed by volunteers, and all profits goto support Kindwill’s program services.

The store operation is a trade or business that is regularly carried on. Thus, assuming the operation of thestore is not substantially related to Kindwill’s exempt purpose, it meets the definition of an unrelated trade orbusiness. Nevertheless, store income is not UBI because substantially all of the work is performed by unpaidvolunteers.

Although the phrase substantially all is not defined in the context of volunteer labor, other areas of exemptorganization law use a guideline of 85% of the work (as measured by the number of hours worked). InWaco LodgeNo. 166, the 5th Circuit Court of Appeals ruled that the volunteer exception was not available where 21% of the workperformed was compensated, although the Court disagreed with the Tax Court that any nonmonetary payment, nomatter how small, was compensation. Therefore, providing free beverages, for example, to volunteers is notsufficient compensation to prevent classifying them as volunteers. In Ltr. Rul. 9544029, the substantially all criterionwas satisfied by a religious organization selling items with a biblical theme or message whose volunteers weresupervised by paid staff in a ratio of 10 to 1. Both the IRS and the courts seem to agree that a de minimis amountof compensation does not lead to a loss of the exemption for volunteer labor.

Example 2E-2 Volunteer work that generates rental income.

High State University operates a debt-financed hotel as part of its curriculum for a Hospitality Degree. Thehotel is operated on a scale much larger than necessary to perform the educational mission. The Universityclaims that the revenue from the hotel is not UBI because the hotel is staffed by unpaid students who functionas volunteers.

The income from the rental of hotel rooms is not from the rental of real property . The voluntary labor of thestudents is a material factor in producing the income. Even if guests do not rent rooms in the hotel becauseof the services provided by the volunteers, but rather to secure overnight accommodations, the volunteerexception applies.

The exclusion for volunteer labor activities also does not apply to exempt trusts, regardless of whether services area material income-producing factor.

Determining Volunteer Compensation. Reimbursement of reasonable out-of-pocket expenses (e.g., travelexpenses) under an accountable plan generally should not be compensation when determining if substantially allof the work in an activity is done by volunteers. However, reimbursement of expenses based on an hourly rate wascompensation, especially since payroll taxes were withheld, in Smith-Dodd Businessman’s Association, Inc.

Noncash remuneration can also be compensation. In Shiloh Youth Revival Centers, the food, clothing, shelter, andmedical care given by a nonprofit organization to its volunteers were held to be compensation. Similarly, workersare deemed compensated if they are eligible to receive goods or services (e.g., tuition reduction) from theorganization at a lower cost than nonworkers. Thus, an organization cannot use the volunteer exception to avoidUBI if it provides more than de minimis noncash remuneration to its volunteers. In contrast, in St. Joseph Farms OfIndiana, the Tax Court concluded that the volunteer exception was available where two uncompensated individualsprovided 91% of the labor, even though they received food, clothing, shelter, andmedical care. The Court ruled that


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the individuals would have been provided such living expenses even if the unrelated trade or business wasdiscontinued.

Gaming Activities. The IRS asserts that the volunteer exceptionmay not apply in gaming activities (discussed laterin this lesson) where workers receive tips from patrons, or an exempt organization sponsors pull-tab games at afor-profit establishment and tickets are sold by employees of the establishment. If a volunteer worker at a gamingactivity is permitted to receive tips from players and is subject to the direction and control of the exempt organiza-tion, the worker is considered a compensated employee.

In addition, a contribution made by the organization conducting the gaming activities to another exempt organiza-tion in return for the grantee’s providing volunteer labor must be considered compensation in applying thevolunteer labor exception.

Conducted Primarily for Members’ Convenience

An activity carried on by a Section 501(c)(3) entity or by a governmental college or university, primarily for theconvenience of its members, students, patients, officers, or employees is not an unrelated trade or business.

The line between an activity that is substantially related to an organization’s exempt purpose and one that is for theconvenience of its members, patients, etc., is not always clear. Often, a single activity passes both tests. However,the standard for meeting the second (convenience) test appears to be lower. To be substantially related, an activitymust contribute importantly to the organization’s exempt function, but to meet the convenience exception, anactivity only has to provide convenience.

Example 2E-3 Activity for the convenience of patients and their visitors.

Memorial Hospital (H) owns a parking garage adjacent to its facilities. Although public parking is available, thepurpose of the garage is to provide convenient, secure parking for H’s patients and their visitors. A fee ischarged for the use of the garage, and all profits are placed in H’s general operating fund. Because of theavailability of other parking nearby, the garage operation does not qualify as substantially related (i.e.,contributing importantly) to H’s exempt purpose.

Although H’s parking garage fails the substantially related test, it meets the convenience exception, and theactivity is exempt from the UBI rules. However, garage usage by private patients of doctors in an adjacentmedical building does not meet the convenience exception, and that income is UBI.

For the convenience exception, one court has defined members as “. . . any group of persons limited in size whoare closely associated with the entity involved and who are necessary to the achievement of the organization’s(exempt) purposes.” However, the IRS disagrees with the court’s use of this definition to find that a hospital’s staffphysicians are hospital “members.” But the IRS has ruled that a museum’s patrons are its members.

Rev. Rul. 68-376 provides guidance for the meaning of the term “patient” under the convenience exception. Theruling holds that an individual discharged from a hospital is still a “patient” of the hospital if, because of conve-nience, the person returns to the hospital pharmacy to obtain a refill of a prescription written during the hospital/patient relationship. However, the IRS has strictly interpreted the convenience exception in other contexts and heldthat a university’s golf course revenue from spouses, children, and their guests is UBI.

An activity does not need to be a necessary convenience to be exempt fromUBIT under the convenience exceptionin Reg. 1.513-1(e)(2). The IRS held, in a situation involving a college, that the convenience exception was satisfiedif the availability of the items sold by the exempt entity was a significant factor in avoiding student’s undueinconvenience. Ltr. Rul. 8025222 indicated that items with a useful life of more than a year that do not directly relateto the organization’s exempt purposes will generally not fit within the convenience exception. Furthermore, thecourt in St. Luke’s Hospital of Kansas City held there was no requirement to show that other alternatives wereunavailable to the members to meet the convenience exception. (In this case, an alternate facility was locateddirectly across the street from the organization’s facility.)


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Example 2E-4 Patient convenience exception.

A hospital is recognized as exempt under IRC Sec. 170(b)(1)(A)(iii). It serves a rural community designated bythe U.S. Department of Health and Human Services as a “medically underserved population.” The hospitalmakes laboratory services available 24 hours a day to both hospital patients and patients of private physi-cians. The nearest full-service commercial lab is miles away in another state, with a driving distance of severalhours. The turnaround time for results from the commercial lab is significantly longer than for results from thehospital lab.

Private physicians draw patient samples in their private offices. The samples are then picked up by anemployee of the hospital for testing at the hospital lab. The physicians view the reduced turnaround time fromthe hospital lab to be of critical medical importance, impactingmedication levels, surgery, or emergency care.

Rev. Rul. 85-110 generally provides that lab testing by an exempt hospital to nonpatients will be UBI. However,the lack of lab facilities within a reasonable distance make the commercial lab alternative inadequate.Therefore, providing lab services to nonpatients in the hospital’s underserved community furthers its exemptpurpose and is not UBI.

The IRS reached a different conclusion in Ltr. Rul. 201422027, where an exempt apartment complex providedwashing machines and dryers in most units and provided a small number of coin-operated machines on-sitefor use by tenants without in-apartment units. The ruling states, “while not uncommon in a residentialcomplex, it is a service for the convenience of the renters whose units do not include washers and dryers.Residents could use commercial laundry and cleaning establishments off-site. It is more convenient forresidents to have laundry facilities on-site, and Apartment complex generates income from the coin-operatedmachines in direct relationship to usage of the service. This income is unrelated business taxable income.”

Another rather limited provision of the convenience exception applies to certain activities of a Section 501(c)(4)local association of employees organized before May 27, 1969. Activities qualifying under this provision involveselling work-related clothes and equipment and items normally sold through vending machines, through fooddispensing facilities, or by snack bars, for the convenience of an association’s members at their usual places ofemployment.

Casual sales to the general public rather than to the limited groups specified in IRC Sec. 513(a)(2) should not bedeemed “regularly carried on,” provided such sales are not “systematically and consistently promoted.” Note,however, that FSA 200012051 ignored this provision by holding that sales to the general public were taxable eventhough the activity involved satisfied the convenience test.

Example 2E-5 Casual sales to nonmembers.

Capital City Free Zoo operates a cafeteria near its entrance on Main Street. The dining facility helps attractvisitors to the zoo exhibits and allows them to devote a greater portion of their day to the enjoyment of the zoothan if they had to leave the premises for meals. The cafeteria also enables zoo employees to remain on thepremises throughout the workday. The activity is related to the zoo’s exempt purpose and also is provided forthe convenience of the members (zoo visitors and employees). On rare occasions, pedestrians on MainStreet who are not visiting the zoo will purchase lunch in the cafeteria. Such casual sales will not beconsidered UBI because they are not regularly carried on, provided that the zoo is not actively and consis-tently promoting the use of the cafeteria to nonvisitors of the zoo.

Visitors can also purchase drinks and snacks from several vending machines located around the property.The machines are owned by an unrelated third party who is responsible for making sure the vendingmachines work properly and are stocked with food and drink. The zoo receives a percentage of each salefrom the vending machines. Income from the machines is not UBI.

Example 2E-6 Sales to Section 501(c)(8) nonmembers.

The Loyal Order of Royal Reindeer, a Section 501(c)(8) organization (i.e., fraternal society operating as alodge), fosters communion and cooperation among members for their mutual benefit and renders aid and


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assistance to its members, their families, and their beneficiaries. The lodge sells insurance products to itsmembers, including coverage for nonmember spouses and dependents.

Within one year of an insured member’s death, a spouse may purchase coverage on his or her own life andthe lives of the minor children. The spouse may name anyone as the beneficiary of the new policy.

Providing fraternal insurance is an expression of the fraternal ties and mutual interests among the membersand is not typical of the contractual relationship between a commercial insurance provider and its policyhold-ers. However, offering insurance coverage to a deceased member’s spouse is not providing benefits to themembers of the lodge. The fact that the beneficiary of the policy may be individuals who were not dependentsof themember indicates that the sale of these policies does not benefit themember’s dependents. In addition,the sale of such policies is not for the convenience of the members, nor is it substantially related to theorganization’s mission; thus, it is an unrelated trade or business.

Sale of Donated Merchandise

The sale of merchandise, substantially all of which has been received by the organization as a gift or contribution,is not an unrelated trade or business. (The discussion following Example 2E-1 regarding the phrase substantiallyall in relation to volunteer labor could also be applicable here.)

Example 2E-7 Activity involving the sale of donated merchandise.

Goodewell, Inc. (Goodewell), a public charity, operates a thrift store unrelated to its exempt purpose. Thestore is open to the public during normal business hours throughout the year and sells only donated items.Paid employees staff the store, and its prices are comparable to those of for-profit second-hand stores in thevicinity.

The store is a regularly carried on trade or business that is unrelated to Goodewell’s exempt purpose.However, the store’s income is not taxable because it sells only donated merchandise.

Operating Public Entertainment Activities

A qualified public entertainment activity is not an unrelated business when conducted by a qualifying organization[i.e., one described in either IRC Sec. 501(c)(3), (4), or (5) that regularly conducts, as one of its substantial exemptpurposes, an agricultural and educational fair or exposition]. A “qualified public entertainment activity” is one thatis traditionally conducted at fairs or expositions promoting agricultural and educational purposes (including activi-ties that help attract the public to such fairs or expositions or promote the breeding of animals or the developmentof products or equipment).

In addition to meeting these requirements, the public entertainment exemption from the UBI rules requires anactivity to be:

1. staged in conjunction with a fair or exposition,

2. operated under a state law that allows only qualifying organizations (see previous paragraph) or a statepolitical subdivision or agency to conduct the activity, or

3. conducted under a state law permitting a qualifying organization to receive a license to conduct not morethan 20 days of such activity on payment to the state of a lower percentage of the revenue from suchlicensed activity than the state requires from an entity that is not a qualifying organization.

Example 2E-8 Qualified public entertainment activity.

The Baxter County Fair Association (Baxter), a Section 501(c)(5) organization, annually conducts a county fairwith numerous agricultural and educational exhibits. To boost attendance and promote interest in the fair,Baxter stages horse races with pari-mutual betting each day of the fair.


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Even if the activity otherwise meets the definition of an unrelated trade or business, Baxter’s horse racingactivity is not an unrelated business because it is a qualified public entertainment activity. The horse racing isdesigned to boost fair attendance, is operated in conjunction with the fair, and is conducted by a Section501(c)(5) organization that regularly conducts agricultural and educational fairs.

Conducting Conventions and Trade Shows

Certain traditional convention and trade show activities carried on by a qualifying organization in conjunction witha qualified convention or trade show are exempt from the UBI rules. A qualifying organization is one described inIRC Sec. 501(c)(3), (4), (5), or (6) that regularly conducts, as one of its substantial exempt purposes, a qualifiedconvention or trade show.

A qualified convention or trade show is:

1. conducted by a qualifying organization (as described in the previous paragraph), at least partly foreducating its members, promoting products and services of its members’ industry, or educating personsattending the showconcerningnewdevelopmentsor products and services related to its exemptactivities;and

2. designed to achieve this purpose through the character of a significant portion of the event’s exhibits orthe character of the conferences and seminars held at the event.

Qualified convention or trade show activities are:

1. traditional convention or trade show activities (e.g., activities designed to promote the industry’s productsor to educate people about new products or services in the industry, or merely incidental activities suchas furnishing refreshments normally found at trade shows); and

2. carried out by a qualified organization (as described previously) in conjunction with a qualified conventionor trade show.

Example 2E-9 Convention or trade show activities.

The National Association of PC Dealers (NAPD) is a Section 501(c)(6) organization. NAPD conducts numer-ous trade shows around the country at which its members exhibit their products and services to promotepublic interest in personal computers. Potential customers are invited to the show. As a result, sales andorder(s) are regularly taken during shows. NAPD secures the exhibition facilities, plans and directs the shows,and maintains several exhibits to promote interest in personal computers. The shows generate revenue forNAPD from three sources: admission charges, rental of display space to exhibitors (both NAPDmembers andsuppliers to those members), and the operation of refreshment stands in exhibit areas.

Assuming NAPD’s trade show activities literally meet the unrelated trade or business definition, the income isnot UBI if the shows are qualified convention or trade shows, and the activities are qualified convention ortrade show activities. NAPD’s trade shows promote its members’ products and services through the variousexhibits at the shows. Thus, the shows are qualified trade shows.

All of NAPD’s activities at the trade shows are traditional trade show activities. Since NAPD is a qualifyingorganization and the shows are qualified trade shows, its activities are exempt from the UBI rules under thetrade show exemption.

Advertising income is not exempt from UBI when carried on in conjunction with a convention or trade showbecause advertising (as defined in Reg. 1.513-4(c)(2)(v)) is not a qualified convention or trade show activity. And,while a payment in connection with a qualified convention or trade show cannot be treated as a qualified sponsor-ship payment, that does not mean that sponsorship revenue from a trade show or convention is automaticallytaxable as UBI. Rather, it means that the sponsorship activity will avoid treatment as UBI if it meets the definition ofa qualified convention and trade show activity rather than the definition of a qualified sponsorship payment.


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A limited liability company (LLC) is not a qualifying organization per se even if all of its members are qualifyingorganizations. However, if an LLC elects to be a partnership for tax purposes, the taxability of its income isdetermined at the partner level. Such income retains its character for unrelated business income tax (UBIT)purposes when passed through to the partners (e.g., dividend income realized by a partnership is treated asdividend income in the partners’ hands). In Ltr. Rul. 200333031, three unrelated Section 501(c)(6) trade associa-tions pooled their resources to conduct a single trade show. To protect their respective assets from any state tortlaw claims that might arise from the future operation of this show, they proposed to conduct it through an LLC. TheIRS determined that the LLC’s activities would be qualified convention and trade show activities, and the revenuewould be attributed to the three trade associations under partnership rules. Since they were all qualifying organiza-tions, the revenue received by each from the LLC would not be UBI.

Example 2E-10 Trade association internet activity.

A Section 501(c)(6) trade association conducts an annual trade show to promote and stimulate demand forthe products of its industry. During the two weeks of the show, the association devotes a section of its websiteto product information, directories, and other visual displays available to members and the general public.Vendors pay a fee to have their information listed on the website. The section of the website serves to augmentand enhance the trade show and is ancillary to the show both in scope and time. Since both the traditionaltrade show and the website are designed to attract persons within the trade and to stimulate interest in anddemand for products of the industry, they are not UBI.

If the association were to display such website content without overlapping or coinciding with any convention,annual meeting, or trade show, the fees charged would not be excepted from UBI as a qualified convention ortrade show activity.

Offering Games of Chance

Exempt organizations frequently conduct games of chance such as bingo, pull tabs, raffles, video games, poker,and lotteries. To avoid having gaming activities classified as an unrelated trade or business, an organizationtypically operates the games with unpaid volunteers (see the volunteer labor exception earlier in this lesson) orconducts the games to qualify them as bingo (discussed later in this lesson). Only in North Dakota, however, do allgames of chance avoid classification as an unrelated trade or business, even if paid workers are used.

Outside of North Dakota, an organization’s conduct of a game of chance (except for bingo games) with paidworkers generally must rely on one of the other exceptions discussed in this lesson to avoid having the activityclassified as an unrelated trade or business. For example, horse racing with pari-mutual betting or gaming activitiesas part of qualified public entertainment activities (see the preceding topic in this lesson on public entertainmentactivities) would not be UBI. However, if none of the Section 513 exceptions apply, an organization may still avoida UBI tax problem if the gambling activity is only conducted on an infrequent basis or is substantially related to itsexempt purpose.

Even if the gaming activity meets an exception to UBI treatment, gaming wagers are never deductible as charitabledonations. The IRS considers the chance to win a prize to be full consideration. Even if the gaming activity isexcludible from UBI, the payment for a chance to win is not a charitable gift.

Example 2E-11 Pull tabs, raffles, and other games of chance.

The Loyal Order of Water Buffalos (LOWB), a Section 501(c)(10) organization, offers pull tabs, raffles, andother games of chance (none of which qualify as bingo) at its regular weekly meetings. To comply with statelaw, all of the games are conducted by LOWB paid staff members.

Providing social and recreational activities to members is one of the traditional functions of Section 501(c)(10)fraternal associations. Thus, to the extent of member participation, operation of a game of chance is substan-tially related to LOWB’s exempt social and recreational purposes.


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Bingo

Unlike other games of chance outside the state of North Dakota, an exempt organization’s conduct of a bingo gameis usually not an unrelated trade or business if the game is—

1. of a type inwhichwagers normally aremade,winners generally determined, andprizes typically disbursedin the presence of all players;

2. conductedwhere no commercial competition exists (this generallymeanswithin the same state; however,depending on state law, it can be limited to something as small as the local area where the games areconducted); and

3. legal under state and local law. (If a law prohibits bingo, but is not enforced against exempt organizations,the game will still fail this requirement.)

The Tax Court held that conducting instant bingo games is an unrelated trade or business that does not comeunder the general bingo exception to treatment as UBI because not all persons in the game are present whenwagers are placed, winners determined, and prizes distributed.

Example 2E-12 Instant bingo games not excluded from unrelated trade or business definition.

New Charity, Inc., operates instant bingo games. Instant bingo is a game of chance in which an individualplaces a wager by purchasing an instant bingo card preprinted with winning bingo patterns on the back. Thefront of the card has sealed tabs underneath which are numbers. The purchaser of the card lifts the tabs,compares the numbers on the front to the pattern on the back, and is a winner if the pattern matches. Prizesare collected from the cashier. New Charity’s instant bingo revenue does not meet the exception for bingogames.

Other Activities Excluded from Unrelated Trade or Business Definition

In addition to the exemptions discussed previously in this lesson, the following activities are normally exempt fromthe definition of an unrelated trade or business:

1. Distributions of Low-cost Items in Return for Donations.

2. Qualified Pole Rentals by a Mutual or Cooperative Telephone or Electric Company.

3. Charitable Organization’s Exchange or Rental of a Mailing List Containing Its Donors or Members. Theexchange or rental must bewith or to another charitable organization, whenboth entities are eligible underIRC Sec. 170(c)(2) or (3) to receive tax deductible contributions. A list containing an organization’sprospects (i.e., not members or donors) is not covered by this exception.

4. Furnishing Certain Services by One Hospital to Another.

5. Disposition of Brownfield Property. Brownfield property is property located in a brownfield site within themeaning of Section 101(39) of the Comprehensive Environmental Response, Compensation, and LiabilityActof1980 thatalsomeets the requirementsdetailed in IRCSec.512(b)(19). Theexemptorganizationmusthave acquired the property from an unrelated person and incurred certain remediation expenditures.

Income That is Excluded from Unrelated Business Income (UBI)

General Rules

In addition to certain activities being excluded from the definition of an unrelated trade or business, certain incomeis excluded by statute from being treated as unrelated business income (UBI), including—

1. interest, dividends, and similar income;


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2. royalties;

3. rental income;

4. gains and losses from the disposition of property; and

5. research income.

When an activity’s income is excluded from UBI, the deductions directly connected with such income are notallowed in calculating unrelated business taxable income (UBTI). Whether a particular item of income is excludeddepends on the substantive nature of the item rather than its form (i.e., a “facts and circumstances” test). Forexample, a payment classified as rental income that is in fact a payment of profits from the operation of a propertyfor the benefit of the tax-exempt organization cannot be excluded from UBI under the rental income exclusion.

Interest, Dividends, and Other Investment Income

Dividends, Interest, Annuities, and Income from Notional Principal Contracts. The exclusion also applies tosuch items as business interest on overdue open account receivables and to income from interest rate or currencyswaps. However, the exclusion does not apply to income from debt-financed property or interest or annuities froma controlled organization. The exclusion also does not apply if the recipient organization is a social club, voluntaryemployees’ beneficiary association (VEBA), or supplemental unemployment benefit trust (SUBT) unless certainconditions are satisfied.

Example 2F-1 Interest income from investments.

Understanding Cultural Problems (UCP), a Section 501(c)(3) organization, earned $75,000 from an unrelatedbusiness activity. Its board of trustees purchased a $50,000 certificate of deposit (CD) with the after-taxproceeds. UCP’s interest income is exempt from tax. The fact that the funds used to purchase the CD camefrom UBI has no bearing on the income’s taxability.

Rates on CDs jump by several points and UCP has the option of borrowing against its CD for two percentagepoints over the CD’s stated rate. UCP borrows against its existing CD and invests the borrowedmoney in newCDs. The new CDs are debt-financed property. Thus, the interest they earn is included in UBI, and the interestpaid is deductible in determining UCP’s UBTI.

Income from Loaned Securities. Payments received by an organization for loaned securities are also excludedfrom UBI. Payments for this purpose include any amounts received in lieu of dividends, interest, or other distribu-tions paid by the loaned securities; fees received for the loan of the securities; and any income earned from theinvestment of the loan’s collateral or from the collateral itself.

Example 2F-2 Income from loaning securities.

UCP (see Example 2F-1) owns stocks and bonds in its investment portfolio. Periodically, UCP lends some ofthese securities to its broker. UCP is compensated for the forgone interest and dividend income and alsoreceives a fee from the broker (computed based on the amount of securities and the time they are loaned) aspayment for entering into the loan transaction.

UCP can exclude such income from UBI if an agreement exists between UCP and the broker that—

1. contains reasonableprocedures toensure thebroker furnishesUCPwithcollateral that hasa valueat leastequal to the fairmarket value (FMV) of the loaned securities as of the close of the preceding business day;

2. allows UCP to terminate the loan by providing notice of not more than five business days;

3. provides, at the conclusion of the loan, for the return to UCP of securities identical to (i.e., the same classand issue as) those loaned;


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4. requires payments to UCP of amounts equivalent to the interest, dividends, and other distributions thatit would be entitled to receive if it held the securities as owner during the period the securities are loaned;

5. does not reduce UCP’s risk of loss or opportunity for gain as to the transferred securities; and

6. does not involve securities that are inventory or that are being held by UCP for sale to customers in theordinary course of a trade or business.

Loan Commitment Fees. Loan commitment fee income is excluded from UBI. A loan commitment fee is anonrefundable charge required of the borrower when the lender holds available a sum ofmoney with fixed terms fora specified period. The charge compensates the lender for the risks (e.g., interest rate changes) inherent incommitting to make a future loan.

Royalty Income

Royalty income generally is excluded from UBI. The organization’s retention of the right to approve the quality orstyle of a licensed product or service does not change this result. The exclusion does not apply to royalties—

¯ produced by debt-financed property,

¯ received from controlled organizations, or

¯ to an organization that is a social club, voluntary employees’ beneficiary association, or supplementalunemployment benefit trust.

To qualify as a royalty, a payment must relate to the use of a valuable right, such as a trademark, trade name, logo,or copyright. If an organization must render more than de minimis services as part of the agreement to receive apayment, the income is not royalty income. It can be difficult to hold services to the necessary minimum because ofa desire to control an activity. In Arkansas State Police Association Inc., the Association contracted with a publishingcompany to produce its magazine. The publisher bore all costs and was responsible for all major publicationactivities, including selling advertising, printing, and distribution. The Association authorized the publisher to use itsname and logo in these activities in exchange for a fixed annual fee plus a percentage of magazine advertisingproceeds. The Association actively participated in the magazine’s publication by retaining complete control over theeditorial content and collecting and reviewing the materials included in each issue. Consequently, the Tax Court ruledthat the incomewas taxable service income, not royalty income. On appeal, the 8th Circuit held that the income couldnot qualify as royalty income regardless of the level of the Association’s participation in publication activities. TheCourt stated that a royalty exists only if another entity (e.g. the publisher) uses an exempt organization’s name, logo,or other intangible asset to promote the user’s product or services. However, in this instance, the Court concludedthat the publisher used the Association’s name to promote the magazine, not the publisher’s business.

Example 2F-3 Receipt of exempt royalty income.

Civic League, Inc. (CLI), a Section 501(c)(4) entity, has a contract with Thrifty Industries (a commercial entity)whereby Thrifty can use CLI’s name in its thrift store business of salvaging and selling damaged goods. Foruse of its name, CLI receives 10% of the store’s gross sales each month. Since the payments relate to the useof a valuable right, CLI’s name, and are measured by the use of that right (i.e., a percentage of gross sales),they are royalties that are excluded from UBI.

Mineral Royalties. Mineral royalties, including overriding royalties, are excluded from UBI whether measured byproduction or by gross or taxable income from the property. However, if the organization’s ownership interest in amineral property must share operating costs (i.e., it is a working interest), the income from such an interest is notexcluded. For a discussion of the taxability of lease bonus payments, see “Mineral Lease Bonus” later in this lesson.

Timber Royalties. The sale of timber owned for one year or less (“first year timber”) cannot be treated as a sale orexchange under IRC Sec. 631(a) or (b). A discussion of the applicable rules when timber has been owned for morethan one year appears later in this lesson.) However, when first year timber is sold at a specified rate for each unitof timber cut (a “pay-as-cut” contract), payments received by the seller are royalty payments and are excludablefrom UBI.


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Mailing List Income. Income from mailing list rental is a form of royalty income because it represents a paymentfor the licensing of intangible intellectual property. Many exempt organizations routinely sell or rent their mailing/membership lists to other entities, both nonprofit and commercial. The consideration received is usually either a flatfee based on the number of members or a fee based on list usage. The income received from the rental orexchange of donor (or membership) lists between organizations, both of which are exempt under IRC Sec. 501 andto which contributions are deductible under IRCSec. 170(c)(2) or (3), is excluded fromUBI. The taxability of incomefrom the sale or rental of a mailing list that is not excluded from UBI under this rule is determined under the rulesapplicable to affinity income, discussed later in this lesson.

Example 2F-4 Mailing list income.

The Save the Whales Foundation maintains a large computerized list of the names and addresses of itsmembers, donors, and other supporters. The Foundation uses a list broker to promote the list to potentialcustomers. Customers regularly pay the list broker a fee to rent the Foundation’s mailing list, and the listbroker collects a commission before remitting the payment to the Foundation. The list broker customizes themailing list based on the customer’s requested criteria, such as gender, ethnicity, donation amount, or ZIPcode.

The list broker rents the mailing list to the Save the Salamanders Fund, a public charity, and to WhaleWatch-ers, Inc., a for-profit corporation. Because the mailing list is intangible property, the income the Foundationreceives from the Salamander Fund is excludible from UBI. Income from the for-profit corporation is UBI.

If the Foundation customized its mailing list, provided mailing labels or envelopes, or provided any othersignificant services to the customer, the income would be UBI as payment for services, not an excludibleroyalty.

Affinity Income. Many exempt organizations maintain affinity programs, which are basically structured in thefollowing manner. A nonprofit organization makes its membership list available to a commercial organization,which then solicits the members to enlist new customers. The commercial organization typically pays the nonprofitorganization a fee for each member enlisted plus a small percentage of the purchases members make.

The IRS originally sought to tax all affinity revenue. After repeated judicial setbacks, the IRS now argues that affinityincome and other mailing/membership income should be allocated when the income consists of both payment forproperty rights (royalties) and payment for services. In Planned Parenthood Federation of America, Inc., the TaxCourt ruled that activities that exploit and protect the taxpayer’s list, including promotion and billing, are roy-alty-related activities. The Court also ruled that the activities of the third party broker were not attributable to thetaxpayer, and that the absence of the safe harbor provision of IRC Sec. 513(h) did not preclude treatment as royaltyincome. The court observed that “a list owner has certain intangible information regarding the individuals andentities whose names and addresses appear on its list. Specifically, the list owner knows that such individuals andentities are responsive to direct mail and willing to support certain tax-exempt organizations. To exploit thatknowledge, the list owner must first let others know that the list is available.” The court reached the sameconclusion in Common Cause. These cases expanded and clarified the boundaries of what nonprofits can do andstill have such income classified as royalty income, as follows:

1. The owner of a mailing list may engage in activities, directly or through agents, which “exploit and protect”the list without causing the payment received to be for goods or services rather than a royalty. (The TaxCourt defined such activities as “royalty-related activities.”)

2. The activities of mailing list brokers are services provided to the list users solely for their convenience andare not royalty-related activities. (For example, such services include finding appropriate lists for a client;coordinating the rental transaction on behalf of the user; collecting payment from the user and remittingto the list manager or list owner; and analyzing the results of the mailing.) However, mailing list brokersnormally are independent contractors (whose activities will not be attributable to the list owner) rather thanagents of the list owner.

3. The absence of a written licensing agreement between the list owner and its agents is not critical todetermining whether a payment is a royalty.


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Based on current authorities, a nonprofit entering into an agreement to license its name or logo, or permit the useof its mailing list should follow these guidelines:

1. The agreement should state that the two parties are not forming a joint venture or partnership. The dutiesof each party should be explained, and the nonprofit should avoid having broad general responsibilitiesfor carrying out the entire activity. The nonprofit should not be liable for general expenses of the activity orshare in its net profit or loss (e.g., the royalty should be based on gross rather than net income).

2. The party paying the royalty should maintain the books and accounting records needed to determine theproper royalty (although the nonprofit will want to retain the right to review the records as needed).

3. The nonprofit should avoid providing anything other than inconsequential services in the royaltyagreement. In addition, the agreement should clarify that the other party to the agreement is not acting asthe nonprofit’s agent in the royalty generating activity.

4. If the nonprofit is to provide more than inconsequential services, the agreement should specifically statewhat is being paid for the use of the intangible assets (nontaxable royalty income) and for the services(taxable income). This allocation should be based on the FMV of each category.

Example 2F-5 Receipt of affinity income.

The Save the Whales Foundation agrees to allow WhaleBank Corporation to offer credit cards using theFoundation’s name and logo. The Foundation is obligated to email all of its members, donors, and supportersto encourage them to join the program. Furthermore, WhaleBank will get one free ad in each of the Founda-tion’s monthly magazines for the next six months. WhaleBank will pay the Foundation $7 for each newcustomer recruited through the program, plus 1% of what they spend on their credit cards for 12 months. Theincome is UBI as payment for services, not a royalty.

Assume the Foundation rented its mailing list to the bank, and the bank undertook the promotion expenseand effort. The Foundation is free to voluntarily promote the program through email or its periodical in orderto raise awareness among its members (increasing its potential income from the program). Nothing in thecontract obligates the Foundation to perform any significant action. The income would qualify as an exclud-able royalty.

If the services are substantial, the nonprofit should consider having separate contracts for the royalty income andthe service income. A better alternative is to set up a taxable subsidiary to perform the services. In related Ltr.Ruls. 199938041 and 200149043, the nonprofit licensed the use of its intangible assets (e.g., name, logo, andtrademark) and membership list directly to commercial entities. All related services were provided to the commer-cial entities by a wholly-owned subsidiary that received reasonable fees for the services. The IRS ruled that theincome received by the nonprofit was nontaxable royalty income. In some circumstances, a nonprofit organizationmay prefer to maintain control of the mailing list activity by choosing to mail its members directly, such as bysending an email to all members promoting the affinity relationship using content provided by the commercialorganization. Although taxable as a fee for services, the nonprofit is protecting the privacy and confidentiality of itsmembers.

Rental Income

Real Property Rents. Rent income from real property is excluded from UBI, except where—

1. the property is debt-financed;

2. the rent is from a controlled corporation;

3. the rent is calculated as a percentage of the tenant-lessee’s net income;

4. the payment includes compensation for services rendered to the lessee;


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5. more than 50% of the rent is attributable to personal property leased with the real property; or

6. the owner-lessor is a social club, voluntary employees’ beneficiary association, or supplementalunemployment benefit trust.

In Rev. Rul. 74-134, an organization rented out buildings that the tenant used as a retail store and paid rent basedon a percentage of its gross sales. In determining rents from real property, the tenant could deduct from its grosssales (1) merchandise returns and refunds; (2) transfers of merchandise from the tenant’s other store locations; (3)sales of used store fixtures; and (4) federal, state, and local sales or excise taxes included in “gross sales” but paidover to the taxing authority by the tenant.

Payments for the use or occupancy of rooms and other spacewhere services are also rendered to the occupant arenot considered rents from rental property. Services are considered rendered to the occupant if they are primarily forconvenience and are other than those customarily rendered in connection with the rental of rooms or other spacefor occupancy only. For example, maid service is deemed to be rendered to the occupant, while furnishing heat andlight; cleaning public entrances, exits, stairways, and lobbies; and trash removal are not considered servicesrendered to the occupant.

The IRS has ruled that where a school rented dormitory rooms to the public (i.e., persons having no other nexus tothe school) and provided maid services to those renting its facilities, the rents received were UBI.

Example 2F-6 Real property rental income.

United Charities, Inc. (United), a Section 501(c)(3) tax-exempt organization, owns a dining room facility usedon weekdays for its exempt purpose. The facility is rented to the public on weeknights and weekends. Unitedregularly rents the facility at fair market value. United’s only responsibilities in the rental agreements are toprovide utilities and janitorial services.

United’s rental activity is an unrelated business since it is regularly carried on and it is not related to its exemptfunctions. However, the income is not included in UBI because it is from the renting of real property (Rev.Rul. 69-178).

In addition to furnishing utilities and janitorial services, United also furnishes personnel to set up the room anda kitchen staff to prepare food for meetings held at the facility. Providing personnel for room set-up and thekitchen causes the income from leasing the facility to be UBI.

Under some circumstances, the lessor can provide services other than utilities and janitorial services withouttainting the rent income. In one situation, a Section 501(c)(3) lessor charged the lessee-tenant of its fairgroundproperty for security, a gatekeeper, and attendants, as well as for cleanup and dumpsters. These services weredeemed not to be for the occupant’s benefit and the amounts received by the lessor were held to be exempt fromUBI tax as part of the lessor’s rental income from real property. The charge for each service was separately statedin the lease agreement and this was significant in preventing the rent income from becoming UBI from services.

Example 2F-7 Providing services with rental of space.

The Colonial College Alumni Association (CCAA) is a public charity that is a supporting organization ofColonial College. It provides scholarships and financial aid to students, provides funds for library materials,and maintains the basketball arena. It also publishes an alumni newsletter and conducts social events toconnect students with graduates and community leaders.

CCAA’s primary source of revenue is a weekly “farmer’s market” in the parking lot of the campus. Vendorsoffer arts and crafts, produce, refreshments, and entertainment. Admission is free, but the vendors arecharged a rental fee for their space.

The farmer’s market is a trade or business that is regularly carried on. It is not substantially related to CCAA’sexempt function, other than through fundraising. Although CCAA speculates that the activity draws potentialstudents to the college, the court ruled in Living Faith Inc. that the speculative assertion that an activity furthersthe mission “doesn’t necessarily make it so.”


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CCAA claims that the revenue from the vendors is excludible as rent from real property. However, the vendorsare not paying for the use of the real property (an assigned space in the parking lot). Instead, they are payingfor the privilege of selling merchandise at an organized event that must be arranged, assembled, conducted,and disassembled each week. CCAA provides substantial services for the convenience of the vendors, suchas advertising, signage, traffic control, shuttle services, and insurance. Such services go well beyond thosecustomarily provided in connection with the rental of real property. Because of this, the income received isdeemed UBI.

Share-crop Leases. An organizationmay lease its land to a tenant farmer for either cash rent or a percentage of thefarm’s production in-kind (hence, the term share-crop lease). In a share-crop lease, the landlord organizationtypically pays certain agreed-upon expenses. Because of this expense-sharing arrangement, the IRS has tried tocharacterize the income as being from a partnership or joint venture (with the farmer) rather than from real propertyrental income that is excluded from UBI. However, the IRS has lost on this issue in the courts. Thus, such incomeshould qualify for exclusion from UBI as real property rental income.

Personal Property Rents. Income from the rental of personal property is included in UBI unless, when the propertyis placed in service:

1. it is leased in conjunction with real property, and

2. the rent received as a result of the personal property is incidental compared to the total rents received oraccrued over the life of the lease.

Unlike the rental of real property, the services, if any, an organization provides in leasing personal property have noeffect on whether the resulting income is excluded from UBI.

For a mixed lease (i.e., one that includes both real and personal property), all of the rental income is excluded fromUBI if the portion attributable to personal property is incidental to the total payments. Incidentalmeans 10% or lessof the total rents received or accrued under the lease.

Example 2F-8 Income from leasing real and personal property.

Wipe-out Disease, Inc. (WD), a tax-exempt organization, owns a furnished office building it acquired for cash.WD leases it under a five-year lease for $15,000 per year; $1,300 per year is attributable to the furniture andother personal property included in the lease. Since $1,300 is less than 10% of the $15,000 annual revenueWD receives, all of the rental income and directly related expenses are excluded from UBI.

$2,000 of the annual $15,000 rent is attributable to personal property. If the personal property portion of thetotal income from a mixed lease exceeds 10% (e.g., $2,000), it must be included in UBI. Thus, only $13,000($15,000 − $2,000) of WD’s annual rental income is excluded from UBI.

If more than 50% of the total rent received or accrued under a lease agreement is attributable to personal property,all of the payments received are included in UBI. Thus, the rental income from a lease that includes both real andpersonal property is:

1. totally excluded from UBI if 10% or less of the income received or accrued is attributable to the lease ofpersonal property,

2. partially excluded from UBI (to the extent attributable to the real property) if over 10% but not more than50% of the income is from personal property, and

3. fully included inUBI if over 50%of the lease income receivedor accrued is attributable topersonal property.

If additional personal property is added to a lease resulting in an increase of 100% or more in the rent attributableto personal property, or if the rental rate for the personal property included in the lease is changed, the percentageof income from the personal property portion of the lease compared to total income must be recalculated.


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To determine the percentage of rental income from personal property to total rental income under a lease, separatelease agreements of properties with an integrated use may have to be combined. For example, if an organizationenters into one or more leases for real property and one or more leases for personal property to be used with suchreal property, all of the leases are treated as one.

Personal Property Defined. For IRC Sec. 512, personal property is defined as any property described in IRCSec. 1245(a)(3)(B) (i.e., relating to depreciable property other than buildings and their components). This includesother tangible property, as defined in Reg. 1.48-1. Examples of other tangible property include oil and gas pipe-lines, railroad tracks, broadcasting towers, oil derricks, and fences used to confine livestock. Based on thisdefinition, the IRS has specifically ruled that rent income from the lease of space on an antenna tower was rentalincome from personal property.

Mineral Lease Bonuses. If an exempt organization receives a mineral lease bonus for the right to drill on itsdebt-financed property (i.e., property held for the production of income for which there is acquisition indebted-ness), the incomemay be UBI. A lease bonus is a form of rental income; however, manymajor oil companies reportthe bonuses as royalty income (not eligible for a depletion deduction). Although there appears to be no specificguidance on the taxability of lease bonus income from debt-financed property, it presumably would be taxableunder the general rules of Reg. 1.514(a)-1(a) and 1.514(b)-1(b). If the amount received is significant, the organiza-tion should consider obtaining a private letter ruling to determine whether such income is considered UBI.

Gains and Losses from Asset Dispositions

Gains and losses from property dispositions (including those from an involuntary conversion or casualty) aregenerally excluded from the computation of UBI, unless the property is debt-financed or is S corporation stock.Consequently, gains and losses from the sale of securities (e.g., stocks and bonds) normally are not included inUBI. This exclusion does not apply, however, to dispositions of items that would be classified as inventory if on handat year-end or to property held primarily for sale to customers in the ordinary course of a trade or business

The IRS has cited the following six factors for determining if a sale is made in the ordinary course of a trade orbusiness. No one factor controls, because a decision is based on all the facts and circumstances.

1. Purpose forWhich the PropertyWas Acquired. Themost favorable situation is whenproperty was acquiredfor use in the organization’s exempt purpose.

2. Frequency andSize of Sales. Infrequent, small sales aremore likely to be viewed asqualifying for exclusionfrom UBI.

3. Improvements Made to the Property. The less extensive the improvements, the more likely the sale willqualify for exclusion.

4. Extent of the Owner’s Activities in Improving and Selling the Property. The more limited the activities, themore likely the sale will qualify for exclusion.

5. Purpose for Which the Property Is Held. If used in the exempt purpose, it is more likely the sale will qualifyfor the exclusion.

6. Proximity of theSale to theAcquisition.The longer theperiodbetween theacquisitionand thesale, themorelikely the sale will qualify for the exclusion.

Example 2F-9 Determining when property is disposed of in the ordinary course of a trade orbusiness.

Good Deeds, Inc. (GDI), a Section 501(c)(3) organization, operates a shelter for abused children. GDIacquired 40 acres of land in 1992 to raise food for the shelter inhabitants. The land is adjacent to the mainfacility. In the current year, GDI decided to sell the land and use the proceeds to expand its program into aneighboring town. No improvements have been made to the property, and none are planned before the sale.GDI plans nomarketing other than the posting of for sale signs. The land will be sold as a single unit. No otherproperty sales have ever taken place.


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The six factors can be applied to GDI as follows: (1) GDI acquired the land to use for an exempt purpose; (2)no other sales of property have taken place; (3) no improvements have been made to the property; (4)minimal activity is planned by GDI to sell the property; (5) GDI held and used the land in its exempt activity;and (6) the purchase and sale are over 10 years apart. Thus, the sale of the land should not be considered asmade in the ordinary course of a trade or business.

Example 2F-10 Disposition of intellectual property.

A nonprofit organization supports internet information technology research and development. Years ago itreceived a donation of several million Internet Protocol (IP) addresses. The addresses were used to accom-plish the organization’s exempt purpose, and now the organization seeks to sell excess unused IP addresses.The intellectual property was not held “primarily for sale to customers in the ordinary course of a trade orbusiness regularly carried on by the taxpayer,” and income from the disposition is not UBI.

Gain or loss from the disposition of real property acquired from a financial institution that is in conservatorship orreceivership normally can be excluded from UBI even if the acquired property is held for sale to customers in theordinary course of a trade or business. However, certain limitations and conditions apply.

Gain or loss from the disposition of brownfield (environmentally impaired) property acquired from an unrelatedperson after December 31, 2004, is excluded from UBI if certain limitations and conditions are satisfied.

Tax-exempt social clubs, voluntary employees’ beneficiary associations, and supplemental unemployment benefittrusts can exclude gain on a disposition of property (under certain conditions).

Options. Gain from the lapse or termination of an option to buy or sell securities is excluded from UBI if the optionis written by the organization in connection with its investment activities rather than in the course of a trade orbusiness. This exclusion includes all gains and losses from (1) such options (whether or not they are written by theorganization); (2) options on real property; and (3) the forfeiture of good-faith deposits (that are consistent withestablished business practice) for the purchase, sale, or lease of real property.

Timber.Gains and losses from dispositions of timber held more than a year are excluded fromUBI if the dispositionis not considered under the Section 631(a) rules as a sale or exchange of timber. (Also, in Ltr. Rul. 9541002, the IRSruled that the periodic sale of timber by a social club was not UBI because the timber was used directly inperformance of the club’s exempt purpose. This is also discussed later in this lesson.)

Noncompete Agreements. Payment to a Section 501(c)(5) agricultural organization by a farmer’s cooperative fora noncompete agreement with the co-op did not result in UBI to the agricultural organization. Entering into anagreement not to compete is neither a trade or business nor a regularly carried on activity.

Recapture Provisions. The exclusion of most noninventory gains from an organization’s UBI does not apply tocertain recapture provisions in the Code. For example, an organization must recognize a gain if it disposes ofdepreciable personal property (used in an unrelated business) for more than its adjusted basis.

Example 2F-11 Sale of depreciable property.

National Wildlife Association (NWA) sold a truck it used in an unrelated business activity for $8,000. NWAoriginally paid $17,000 in cash for the vehicle and through depreciation had reduced its basis in the truck to$6,000 at the time of sale. NWA must include the $2,000 gain ($8,000 − $6,000) in its UBI. Although, theacquisition of the truck was not debt financed, and it is not an inventory item to NWA, the gain is still taxable.The depreciation recapture provisions override the general rule that an organization does not have to includegain from the disposition of property used in an unrelated business activity in UBI.

The truck was used by NWA in a related (rather than unrelated) business activity. The gain would then beexcluded because it is not part of an unrelated business activity. Thus, the depreciation recapture rule has noeffect.

More information on the ordinary income recapture provisions is provided later in this lesson.


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Research Income

Income earned by an organization from research for the United States, or any of its agencies or instrumentalities,or a state or political subdivision thereof, is generally excluded from UBI. The exclusion does not apply, however, tothe research income of tax-exempt social clubs, voluntary employees’ beneficiary associations, or supplementalunemployment benefit trusts.

Income from research is excluded when the organization is (1) a college or university, (2) a hospital, or (3) an entityoperated primarily to carry on fundamental research (the results of which are freely available to the general public).

When the UBI exclusion for research income was enacted, the Ways and Means Committee indicated the termshould “. . . include not only fundamental research but also applied research such as testing and experimentalconstruction and production.” In contrast, the IRS appears to exclude “applied” research (as compared to funda-mental research) from its own definition of the term when it states that research does not include activities of a typeordinarily carried on as part of a commercial or industrial operation (e.g., ordinary testing or inspection of materialsor products, or the design or construction of equipment or buildings).

However, the IRS has held that an organization receiving income from performing applied research could excludethat income from UBI if the research involved experimental construction, and the results of the research werenormally made available to the general public. In addition, for research organizations, the courts have ignored thedistinction between applied versus fundamental research and, instead, have focused on whether the researchperformed was related to the organization’s exempt purpose. Research does not include the ordinary testing orinspection of materials or products, nor design or construction activities with a commercial or industrial application.In Midwest Research Institute, the 8th Circuit Court of Appeals affirmed the decision of the District Court whichdefined research to be—

¯ a project supervised and designed by professionals,

¯ to solve a problem through a search for demonstrable truth,

¯ with the goal of discovering that demonstrable truth

The court defined testing as generally repetitive work done by scientifically unsophisticated employees for thepurpose of determining whether the item tested met certain specifications, as distinguished from testing done tovalidate a scientific hypothesis. Testing follows standard procedures rather than the scientific method, no intellec-tual questions are posed, the work is routine and repetitive and the procedure is a matter of quality control. Clinicaltesting, even when done by highly qualified professionals, is not scientific research because it is an ordinary part ofthe commercial operations of a pharmaceutical company.

Example 2F-12 Research income.

The Perfection Foundation (Perfection), a public charity, conducts research projects for commercial compa-nies. Tri-State Pharmaceutical Corporation (TSPS) engages Perfection to perform a clinical trial of an experi-mental drug. The tests are required in order to comply with Food and Drug Administration (FDA) requirementsfor safety and efficacy before the drug can bemarketed. Clinical testing is part of a pharmaceutical company’scommercial operations and is not scientific research. Until a drug is approved for marketing by the FDA, it isnot a “consumer product,” available for general use by the public. The clinical testing of a drug for safety andefficacy in order to enable the manufacturer to meet FDA requirements for marketing is not “testing for publicsafety” but is merely a service performed for the manufacturer. Such testing principally serves the privateinterest of the manufacturer rather than the public interest. Income from the research is UBI.

Perfection conducts scientific research programs for TSPC in various aspects of seed technology includingseed quality, disease control, and improved testing procedures. The activity is unrelated to Perfection’sexempt purpose. Income from the scientific seed research is UBI unless—

1. Perfection’s exempt purpose is to conduct impartial testing and research activities related to seedcertification;


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2. the results of the research tests are freely available for publication in various scientific journals madeavailable to the general public [the income is excluded under IRC Sec. 512(b)(9)];

3. the research isperformed for a federal, state, or local government [the income isexcludedunder IRCSec.512(b)(7)]; or

4. Perfection is a college, university, or hospital [the income is excluded under IRC Sec. 512(b)(8)].


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SELF-STUDY QUIZ


7. Which of the following is a condition that must be met for an activity to be considered an unrelated trade orbusiness?

a. The activity must produce a profit for the tax-exempt organization.

b. The activity must be done by the organization on a regular basis.

c. The activity must be related to the organization’s exempt purpose.

d. The organization performing the activity must be a taxable trust.

8. Income from which of the following would most likely be considered related to the organization’s exemptpurpose and, therefore, exempt from classified as UBI?

a. The activity is larger than necessary to achieve the organization’s exempt purpose.

b. The facility is used for both unrelated commercial functions and exempt functions.

c. Selling the byproducts of an organization’s exempt activity.

d. The organization provides debt management services.

9. Assuming all other qualifications are met, which of the following would be considered a qualified publicentertainment activity for the purposes of the UBI rules?

a. It is staged on its own, not in conjunction with another activity.

b. It is operated under a state law that allows qualifying organizations to conduct the activity.

c. It is operated under a state law that gives the qualifying organization a license to do the activity for aminimum of 30 days.

d. It is conducted by a 501(c)(3) organization with an exempt purpose related to environmental welfare.

10. State University is entering into an affinity agreement with Monster Credit, in which Monster Credit will use theuniversity’smailing list and its logo to solicit new customers. StateUniversitywill receive a fee for eachmemberof the mailing list who takes a new credit card and a percentage of their purchases. The agreement betweentheuniversity and the financial institution shoulddowhichof the following inorder toallow theuniversity tohaveas much income as possible excluded from UBI as royalties?

a. State that State University and Monster Credit are forming a partnership for this endeavor.

b. Monster Credit should maintain the books and accounting records related to the royalties.

c. State University should not provide services to Monster Credit as part of the agreement.

d. Without a written licensing agreement, State University cannot record any royalties.


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SELF-STUDY ANSWERS


7. Which of the following is a condition that must be met for an activity to be considered an unrelated trade orbusiness? (Page 23)

a. The activity must produce a profit for the tax-exempt organization. [This answer is incorrect. According toReg. 1.513-1(a)–1(d), the organization must be conducting a trade or business for the production ofincome from selling goods or performing services. According to IRC Sec. 513(c), an unrelated businessactivity that is conducted with the intent to make a profit does not cease to be such merely because it isnot profitable for a particular year; therefore, the actual profit is not a consideration for this determination.]

b. The activity must be done by the organization on a regular basis. [This answer is correct. Per Reg.1.513-1(a)–1(d), to be considered an unrelated trade or business, an activity must meet threespecific conditions. One of those conditions is that the trade or business is regularly carried on.]

c. The activity must be related to the organization’s exempt purpose. [This answer is incorrect. If the activityis “not substantially related” to the carrying out of the organization’s exempt purpose, it could beconsidered an unrelated trade or business under Reg. 1.513-1(a)–1(d).]

d. The organization performing the activity must be a taxable trust. [This answer is incorrect. Taxable trustsare not subject toUBIT, though the determination ofwhat is considered anunrelated tradeor business canbe important for other reasons. However, whether or not an entity is a taxable trust is not one of theconditions that must be met under Reg. 1.513-1(a)–1(d) to determine whether an activity is an unrelatedtrade or business.]

8. Income from which of the following would most likely be considered related to the organization’s exemptpurpose and, therefore, exempt from classified as UBI? (Page 29)

a. The activity is larger than necessary to achieve the organization’s exempt purpose. [This answer isincorrect. According to Reg. 1.5.13-1(d)(3), if an activity is conducted on a scale larger than reasonablynecessary to perform the exempt function to which it relates, the excess is an unrelated business.]

b. The facility is used for both unrelated commercial functions and exempt functions. [This answer isincorrect. An asset or facility may be used for both exempt and unrelated commercial functions. Whenthere is such dual usage, the use for exempt functions does not, by itself, make the commercial activitiesa related trade or business. The test is whether the activities contribute importantly to accomplishing theorganization’s exempt purpose(s). Therefore, it is still a possibility that there will be unrelated trade orbusiness income in this scenario.]

c. Selling the byproducts of an organization’s exempt activity. [This answer is correct. According toReg. 1.513-1(d)(4(ii), byproducts fromanexempt activity, if sold in their original condition, generaterelated income. However, additional processing of the byproducts prior to disposition will result inthe entire sale being treated as unrelated business income. Therefore, since that did not happen inthis situation, this income is the most likely to be considered related to an organization’s exemptpurpose.]

d. The organization provides debt management services. [This answer is incorrect. According to IRC Sec.513(j), an organization that provides debt management plan services is considered engaged in anunrelated trade or business unless it is a credit counseling organization that is exempt under IRC Sec.501(q). Since that is not specified in this scenario, it is more likely that income from this service will beclassified as unrelated.]


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9. Assuming all other qualifications are met, which of the following would be considered a qualified publicentertainment activity for the purposes of the UBI rules? (Page 33)

a. It is staged on its own, not in conjunction with another activity. [This answer is incorrect. According to IRCSec. 513(d)(2)(B), to be exempt from the UBI rules as a qualified public entertainment activity, the activitymust be staged in conjunction with a fair or exposition.]

b. It is operated under a state law that allows qualifying organizations to conduct the activity. [Thisanswer is correct. A qualified public entertainment activity, according to IRC Sec. 513(d)(2), is onethat is traditionally conducted at fairs or expositions promoting agricultural and educationalpurposes (including activities that help attract the public to such fairs or expositions or promote thebreeding of animals or the development of products and equipment). In addition to meeting thoserequirements, that the public entertainment exemption from the UBI rules under IRC Sec.513(d)(2)(B) requires, among other things, for the activity to be operated under a state law thatallows only qualifying organizations or a state political subdivision or agency to conduct theactivity.]

c. It is operated under a state law that gives the qualifying organization a license to do the activity for aminimum of 30 days. [This answer is incorrect. According to IRC Sec. 513(d)(2)(B), qualified publicentertainmentactivitiesmustbeconductedunderastate lawpermittingaqualifyingorganization to receivea license to conduct not more than 20 days of such activity on payment to the state of a lower percentageof the revenue from such licensed activity than the state requires from an entity that is not a qualifyingorganization.]

d. It is conducted by a 501(c)(3) organizationwith an exempt purpose related to environmental welfare. [Thisanswer is incorrect. To be a qualifying organization for the purposes of qualified public entertainmentactivities, per IRCSec. 513(d)(1), the organizationmust be one described in either IRCSec. 501(c)(3), (4),or (5) that regularly conducts, as one of its substantial exempt purposes, an agricultural and educationalfair or exposition. This is a different exempt area than environmental welfare.]

10. State University is entering into an affinity agreement with Monster Credit, in which Monster Credit will use theuniversity’smailing list and its logo to solicit new customers. StateUniversitywill receive a fee for eachmemberof the mailing list who takes a new credit card and a percentage of their purchases. The agreement betweentheuniversity and the financial institution shoulddowhichof the following inorder toallow theuniversity tohaveas much income as possible excluded from UBI as royalties? (Page 40)

a. State that State University and Monster Credit are forming a partnership for this endeavor. [This answeris incorrect. Based on current authorities, the agreement should state that the two parties are not forminga joint venture or partnership. Thedutiesof eachparty shouldbeexplained, and thenonprofit should avoidhaving broad general responsibilities for carrying out the entire activity.]

b. Monster Credit should maintain the books and accounting records related to the royalties. [Thisanswer is correct. According to the current authorities, the party paying the royalty (in this case,MonsterCredit) shouldmaintain thebooks andaccounting recordsneeded todetermine theproperroyalty.]

c. State University should not provide services to Monster Credit as part of the agreement. [This answer isincorrect. Per current authorities, thenonprofit shouldavoidprovidinganythingother than inconsequentialservices in the royalty agreement; however, that does not mean if State University performs any servicesat all the funds are no longer considered royalties. However, if State University provides more thaninconsequential services, the fees would need to be allocated between the royalties and services.]

d. Without a written licensing agreement, State University cannot record any royalties. [This answer isincorrect. According to the findings in Common Cause and Planned Parenthood Federation of America,Inc., the absence of a written licensing agreement between the list owner and its agents is not critical todetermining whether a payment is a royalty. Therefore, it would be possible for State University to claimroyalties from this agreement either way.]


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Reporting an Entity’s Gross Receipts or Sales

Retail Sales

Depending on the particular facts, certain sales are not deemed UBI because the sale furthers the organization’smission, meets the convenience exception, or meets some other qualification exempting the sale from UBI.Alternately, retail sales may be deemed from an unrelated trade or business, thus potentially subject to UBIinclusion.

Example 2G-1 Retail sales.

Large City Zoo (Zoo) is widely known for its collection of animals, birds, and reptiles. It operates a gift shop onits premises. Some of the items sold by the shop are—

1. stationery, desk accessories, jewelry, tote bags, and clothing that bear detailed images of the animals;

2. film, videotape, and batteries;

3. sundries such as newspapers, magazines, candy, and aspirin;

4. stuffed animals; and

5. items on the website.

The UBI implications of Zoo’s gift shop sales present problems because each item must be examined todetermine whether its sale contributes importantly to Zoo’s exempt purposes or otherwise satisfies anexemption from UBI treatment.

Putting a picture of a Zoo animal on jewelry, clothing, and other items having a utilitarian function is generallynot enough to cause their sale to be a substantially related activity. To minimize the likelihood that such saleswill be UBI, Zoo should include an educational pamphlet with each item that provides information about thepictured animal and also explains Zoo’s exempt purpose.

In contrast, the sales of stuffed animals do no not produce UBI because they serve an educational, nonutilitar-ian purpose. The online sale of gift shop merchandise also is excluded from UBI.

Amuseummay sell artwork and reproductions from its collection in its gift shop.When the items contain descriptiveliterature describing the artistic, cultural, or historical significance of the items, the income is not UBI. The absenceof such literature may mean that the sale fails to advance the educational mission of the museum. Even so, itemsthat designed for a different use than originally intended may lack an educational purpose even if they containdescriptive literature.

¯ The sale of a small broach of an Egyptian beetle accompanied by descriptive literature, where the design ofthebroach isderived fromancient religiousdepictionsofbeetles in themuseum’scollection, isnotUBIbecausethe sale advances the museum’s educational purpose of enhancing the appreciation of art and history.However, pasta noodles sold in the shape of beetles do nor advance the educational mission, even ifaccompanied by an informative pamphlet.

¯ A brass candlestick has a utilitarian purpose. But if it is a reproduction of an original held in the museum’scollectionand includesdescriptive literature, it servesaneducationalpurpose regardlessof theutilitarianvalue.The same may be true for neckties featuring patterns taken from the art collection, jewelry patterned after adesign in ancient architecture, an umbrella printed with a tile design from an archeological site, a tableclothdesigned after a Turkish prayer rug, or a scarf with an Impressionist painting printed on it.

Sales Deemed Not UBI. If a significant relationship exists between a tax-exempt organization’s exempt purpose ormission and the merchandise it sells, the income from such sales is not UBI. For example, an organization whosepurpose was to promote public awareness of breast cancer did not realize UBI from the sale of apparel, jewelry,and other items that promoted awareness and early detection of breast cancer through their color and design.


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Certain commonplace items such as camera film, flash bulbs, batteries, umbrellas, and food products can alsoescape UBI tax in appropriate circumstances. (See Example 2G-1.) As long as the primary purpose for selling aparticular item (even an item such as jewelry that has a utilitarian function) is in furtherance of an exempt purpose,the sale will not result in UBI.Organizations that sell items having both a utilitarian function and cultural or historicalsignificance have successfully avoided UBI by accompanying the sale with an explanation of such significance.

Income from a tax-exempt hospital’s gift shop should be exempt from UBI tax under the convenience exception ofIRC Sec. 513(a)(2) since the shop operates for the convenience of the hospital’s patients and visitors. Schoolbookstores can also operate tax-free under the convenience exception, including the sale of items that carry theschool logo (mugs and pennants).

Generally, the sale of children’s interpretive teaching items that include artistic themes, such as jigsaw puzzles,kites, and games, are in furtherance of educational purposes. Even games for adults may serve an educationalpurpose when they include literature and educational information concerning the connection to the organization’smission. The sale of items that are designed to develop fine art skills or a child’s awareness of his or her artisticability relates directly to educational purposes. Such items, however, should provide instruction in the fine arts,such as paint sets, coloring books, art supplies, maps, and jewelry making sets. It is not sufficient that they onlygenerally develop a child’s motor skills, such as baby toys or cooking utensil playsets, but do not develop theuser’s artistic abilities.

The IRS has determined that stuffed animals “provide an incentive for children to think and learn about the variousphysical attributes of different animals. As such, the primary purpose of these items is to educate the public onappearance and anatomy of wildlife which contributes importantly to the organization’s exempt purpose. Theutilitarian or souvenir aspect is merely incidental to the organization’s educational purposes.” While items of ageneral educational nature are not necessarily related to the organization’s exempt purpose, the sale of toyspertaining to the mission “contribute importantly to [the] exempt purpose and do not constitute unrelated businessincome.”

The IRS has held that the sale of greeting card reproductions of art works by an art museum exempt from tax underSection 501(c)(3) was not an unrelated trade or business. Each card is imprinted with the name of the artist, the titleor subject matter of the work, the date or period of its creation, if known, and the museum’s name. The art museumsold these cards through a shop in the museum and through a catalogue that solicited mail orders. The rationaleis that the card sales contribute importantly to the achievement of the museum’s exempt educational purposes bystimulating and enhancing public awareness, interest, and appreciation of art. Although the cards may be pro-moted and sold in a clearly commercial manner at a profit, competition with commercial greeting card publishersdoes not alter the fact of the activity’s relatedness to the museum’s exempt purpose.

Rev. Rul. 74-399 held that the operation of a dining room, cafeteria, and snack bar by an exempt art museum for useby the museum staff, employees, and members of the visiting public was not an unrelated trade or business. Therevenue ruling gives three reasons for this holding:

1. The facilities attract visitors by providing in-house dining.

2. The operation of these facilities allows visitors to devote more time to the museum’s educational exhibitsthan if they had to seek outside eating facilities.

3. These facilities enhance the efficient operation of themuseumby enabling staff and employees to remainon the premises throughout the workday.

Likewise, a private operating foundation’s operation of a coffee shop in a community cultural center, also ownedand operated by the foundation, is not UBI. The coffee shop will not advertise to the general public and is onlyaccessible by entering the cultural center. Although it is a trade or business, it is not UBI because it is intended tobe a convenient eating location for visitors and employees of the cultural center.

Sales Deemed UBI. The gift shops of museums, zoos, aquariums, and other tax-exempt entities frequently sell awide variety of items. Each type of merchandise sold potentially can result in UBI. There is no exemption for deminimis sales of unrelated items. Therefore, each type of merchandise must be tested to see whether its salesubstantially contributes to the seller’s exempt purposes.


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Rev. Rul. 73-105 held that the sale of scientific books and city souvenirs by a museum of folk art exempt from taxunder Section 501(c)(3) was an unrelated trade or business even though other items sold in the museum shop arerelated to its exempt function. The revenue ruling describes an exempt museum of American folk art that offers forsale in its shop four categories of items:

1. Reproduction of artworks from the museum’s collection and from other art collections that take the formof prints suitable for framing, postcards, greeting cards, and slides.

2. Metal, wood, and ceramic copies of American folk art objects from its collection and other collections.

3. Instructional literature concerning the history and development of art, particularly folk art.

4. Scientific books and various souvenir items relating to the city in which the museum is located.

All of its reproductions are imprinted with the name of the artist, the title or subject matter of the reproduced work,and the museum’s name. It was concluded that categories (1), (2), and (3) contribute importantly to the achieve-ment of the folk art museum’s exempt educational purposes by making works of art familiar to a broader segmentof the public, thereby enhancing the public’s understanding and appreciation of art. The sale of scientific booksand souvenirs described in category (4) was deemed to be an unrelated trade or business because the objects hadno causal relationship to art or to artistic endeavor and thus did not contribute importantly to the accomplishmentof the folk art museum’s exempt purposes.

While designs derived from themuseum’s collectionmay be affixed to souvenir and convenience items, affixing themuseum’s logo to an article of clothing, plate, ashtray, coffee mug, umbrella, or tote bag does not enhance theeducational mission. Items sold solely for the convenience of the organization’s members (including patrons,visitors, and guests), such as film, batteries, bottled water and refreshments, are not considered an unrelated tradeor business. However, the sale of items that do not enhance the visitor experience do not fall within the convenienceexception, including newspapers, magazines, and food items meant to be taken home and consumed.

Likewise, income from restaurant sales to the public (those restaurant sales to individuals who patronized therestaurant and did not pay an admission fee required of those who visit the facilities, or were not visitors oremployees) would be subject to the unrelated business income tax. In order to remain exempt, such facilitiesshould not treat restaurant patrons any differently from other patrons, should not provide facilities that are largerthan necessary to serve the members and guests, and should not advertise to the general public.

The sale by a school bookstore of clothing with a useful life of more than one year that does not have the schoolemblem and is not used in school activities is UBI. Sales of personal computers to students or professors are nottaxable; although sales to the general public may create UBI.

Sales made by an exempt organization to the public through its website, print catalog, and through unrelated retailoutlets were deemed UBI where the sales did not contribute importantly to the organization’s mission. The sales inquestion closely resembled items sold in an exclusively commercial fashion and imparted little or no mis-sion-related content.

Reporting—General Rules

Report an organization’s gross receipts or sales from an unrelated trade or business in Part I, Form 990-T, on line1a. Report related returns and allowances (i.e., any reductions in sales price allowed because of returned ordeficient merchandise) on line 1b, entering net sales on line 1c. If the income is described in lines 4–12 of Part I,report it on the appropriate line, rather than on line 1.

Social clubs, voluntary employees’ beneficiary associations, and supplemental unemployment benefit trustsshould report revenue from exploiting an exempt activity, including an activity that produces advertising revenue,on line 1 rather than lines 10 and 11.

Example 2G-2 Gross receipts of a country club.

The Shady Valley Country Club (SVCC), a Section 501(c)(7) tax-exempt organization, publishes a monthlymember newsletter. Each month’s letter produces advertising revenue from local merchants that is UBI.


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Although most organizations with UBI from advertising income report this revenue on line 11 of Part I,organizations such as SVCC include the income on line 1a with gross sales. In addition, SVCC is not requiredto complete Schedule J of Form 990-T.

Accounting Methods

Tax-exempt organizations must compute their UBI using the rules applicable to taxable corporations. Thus, theygenerally compute their UBI under the method of accounting (e.g., cash or accrual) regularly used for keeping theirbooks and records. In addition, they normally must follow any tax accounting rules applicable to specific items ofUBI or related deductions. More detailed guidance on tax accountingmethods is available inPPC’s 1120 Deskbook(for corporations) and PPC’s 1041 Deskbook (for trusts).

Reporting Gains and Losses

A discussion of the taxability of “Gains and Losses from Asset Dispositions” appeared earlier in this lesson.

Asset Transfers to Exempt Entities

Regulations under IRC Sec. 337(d) explain the tax treatment of either transfers of assets or conversion of status toa tax-exempt entity by a taxable corporation. These regulations contain the following general rules.

Asset Sale Rule. A taxable corporation (including an 80% owned subsidiary corporation) that transfers all orsubstantially all of its assets to one or more tax-exempt entities must recognize gain or loss as if the assetstransferred were sold at their fair market value.

Change in Status Rule. A taxable corporation that changes its status to a tax-exempt entity generally is treated ashaving transferred all of its assets to a tax-exempt entity immediately before its change in status becomes effectiveand is subject to the asset sale rule discussed in the prior paragraph.

UBI Rule. The asset sale rule does not apply if the transferred assets are used by the tax-exempt entity in an activitythat produces UBI. When such assets are disposed of or cease to produce UBI, gain will be included in UBI.

Three-year Rule. The change in status rule does not apply if the corporation formerly was tax-exempt and thechange in status is within three years of the later of (1) the corporation first filing a return as a taxable corporation,or (2) a final determination that the corporation had become a taxable corporation.

In addition to these general rules, several exceptions and clarifications apply.

Exceptions to the Asset Sale Rule. Transactions that qualify as like-kind exchanges under IRC Sec. 1031 or asinvoluntary conversions under IRC Sec. 1033 are excluded from the asset sale rule. Under these circumstances,the appreciation is preserved in the replacement property. Additionally, homeowners associations (HOAs) andpolitical organizations described in IRC Sec. 527 are not treated as tax-exempt entities for purposes of IRCSec. 337(d). The HOA exclusion recognizes that HOAs have the statutory right to make an annual election to betaxable or tax-exempt.

Exceptions to the Change in Status Rule. Social clubs that convert to Section 501(c)(7) tax-exempt status withinseven tax years after the year of formation and certain types of insurance and utility companies are excluded fromthe change in status rule. The exclusion for social clubs is intended to offer relief to residential real estatedevelopers who set up a club for the homeowners in their developments. Typically, the club is initially owned andcontrolled by the developer until most of the lots are sold. Then control is turned over to the members, and the clubcan become tax-exempt. Since it may not be feasible for a developer to transfer control for several years, theallowance of a seven-year period to become tax-exempt can be vital to this type of social club.

Clarifications to the Asset Sale Rule. The asset sale rule does not apply to a corporation’s gift of a portion of itsassets to charity and does not affect the shareholder’s tax treatment when transferring all or part of the corpora-tion’s stock to charity.


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Clarifications to the UBI Rule. A taxable corporation must recognize the same percentage of gain or loss as thenon-unrelated business use percentage bears to 100%. Further, the regulations prescribe general rules for allocat-ing the use of an asset to unrelated business activities as well as rules to be followed when the unrelated businessusage declines.

Recapture Income

Several provisions of the Internal Revenue Code convert what would otherwise be nontaxable gain on the propertydisposition into gain (i.e., recapture income) that is includable in UBI. These provisions apply to the extent anorganization has benefited from claiming certain deductions in computing either (1) UBTI or (2) taxable incomewhile it (or a predecessor) was not exempt.

Section 1245 Property. The most common type of recapture income on a property disposition is Section 1245recapture, which applies only to certain property used in an unrelated business activity. “Section 1245 property”means property that is (1) depreciable (or amortizable), and (2) one of the specific types set forth in IRCSec. 1245(a)(3) and Reg. 1.1245-3.

When an organization disposes of Section 1245 property (by sale, exchange, or involuntary conversion), the gaintreated as ordinary income and thus subject to tax is the lesser of the following amounts:

1. The sum of all allowable (or allowed) depreciation or amortization deductions related to the property thatwere used in calculating:

a. unrelated business taxable income (UBTI), or

b. taxable income for a period when the organization (or a predecessor) was not tax exempt.

2. Gain realized on the disposition [or, for certain tax-free and other transactions listed in IRC Sec. 1245(b),gain recognized].

Example 2H-1 Taxable gain on the sale of Section 1245 property.

Several years ago, Beyond Basics, Inc. (BBI), a Section 501(c)(3) organization, paid $1,500 cash for a drinkmachine (Section 1245 property) for the employees’ lounge at the warehouse where it operates an unrelatedbusiness activity. The machine was sold in the current year for $700, when its adjusted basis was $550.

BBI has $150 of gain ($700 − $550) on the sale of the drink machine. The portion of the gain that must beincluded in UBI is the lesser of:

1. $950 ($1,500 − $550), the depreciation claimed in calculating BBI’s UBTI; or

2. $150, the gain realized.

Thus, all of the gain is subject to the UBI tax. The sale of the machine is reported on Form 4797 (Sales ofBusiness Property), which becomes an attachment to Form 990-T.

Example 2H-2 Loss on the sale of Section 1245 property.

Assume the same facts as in Example 2H-1. In addition, BBI purchased a second drink machine for $1,800that was originally used in an exempt function activity. During this use, $350 of depreciation was claimed onthe machine. When BBI later converted it to use in an unrelated business activity, the machine’s adjustedbasis was $1,450 ($1,800 − $350), but its FMV was only $1,300.

If property is converted from a tax-exempt use to a taxable use, its unadjusted basis for calculating deprecia-tion becomes the lesser of the property’s FMV or its adjusted basis at conversion (generally original cost lessdepreciation taken to the date of conversion). Thus, BBI’s basis for calculating UBI depreciation is $1,300.


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Assume BBI claimed $500 of depreciation on themachine during its use in the unrelated business activity andthen sold it for $600, resulting in a loss of $200 [$600 − ($1,300 − $500)]. In this case, the loss is notdeductible in determining UBTI. Generally, gains and losses are excluded from UBI [IRC Sec. 512(b)(5)]. IRCSec. 1245 overrides this rule for Section 1245 property sold at a gain, but it has no effect on property sold ata loss. Since the machine was sold at a loss, the sale is not reported when completing BBI’s Form 990-T andForm 4797.

Example 2H-3 Change in use of Section 1245 property.

Friends, Inc., a Section 501(c)(3) organization, purchased a copying machine two years ago. The machinehas been used exclusively in an unrelated trade or business. On January 1 of the current year, Friendsconverted the machine to use in an exempt activity.

The conversion of the machine to use in an exempt activity is not considered a disposition subject to theSection 1245 recapture rules. A tax-exempt organization only recaptures depreciation on property transferredfrom an unrelated business use to an exempt purpose in certain circumstances. Section 1245 recapture isrequired if the property was originally acquired in a transfer in which the organization’s basis was determinedfrom the transferor’s basis in a (generally tax-free) transaction (such as a merger or other reorganization).A similar rule applies to Section 1250 property under IRC Sec. 1250(d)(6).

Section 1250 Property. Another common type of recapture income is Section 1250 recapture (that applies to“Section 1250 property”). Section 1250 property is simply any depreciable real property that is not classified asSection 1245 property.

If real property is classified as Section 1245 property (rather than Section 1250 property) at any time during its usein an unrelated business activity (or at any time when the organization, or a predecessor, was a for-profit entity), theproperty remains Section 1245 property, even if its use changes and it no longer meets the definition of Sec-tion 1245 property. This rule can be disadvantageous since the income included in UBI under the Section 1245rules may be more than what must be included under the Section 1250 rules.

If Section 1250 property is disposed of at a loss, the recapture rules do not apply, and the loss normally cannot beclaimed in computing UBI. In contrast, gain realized on the disposition of Section 1250 property (used in anunrelated business activity) is included in UBI to the extent of the lesser of:

1. the gain realized, or

2. the additional depreciation taken on the property.

Additional depreciation for Section 1250 property held one year or less is all depreciation taken on such property.This same definition of additional depreciation also applies to nonresidential real property placed in service after1980 and depreciated under an accelerated depreciation method. For residential rental property acquired after1975 and held for more than one year, and nonresidential real property acquired before 1981, additional deprecia-tion is the excess of the depreciation taken in computing UBTI over what depreciation would have been if thestraight-line (SL) method had been used. Residential rental property purchased before 1976 is subject to specialrules, as is certain other real property used to provide low-income housing.

Often, an organization’s Section 1250 recapture will be zero because the use of SL depreciation is fairly commonfor real property, especially after 1986 when the use of SL depreciation for such property became a requirement.Any gain on Section 1250 property in excess of the amount treated as Section 1250 recapture income is not subjectto the UBI tax unless the debt-financed or Section 291 rules apply.


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Example 2H-4 Taxable gain on the sale of Section 1250 property.

BBI (see Example 2H-1) sold the buildings it used for the operation of its unrelated business activities for$500,000 each. Neither building was subject to debt. The following information is provided for the buildings:

DateAcquireda Cost

AccumulatedDepreciation

AdjustedBasis

Building #1 12/1985 $ 145,000 $ 145,000 $ NonebBuilding #2 8/2009 327,000 81,054 245,946

Notes:

a Residential rental property and nonresidential real property under MACRS (placed in service after1986) must be depreciated using the straight-line method. Therefore depreciation recapture is notrequired.

b $145,000 − $145,000 = $0.

The Section 1250 gain subject to tax is as follows:

Total Gain Section 1250 Gain

Building #1 $500,000 ($500,000 − $0) $ NoneaBuilding #2 $254,054 ($500,000 − $245,946) Noneb

Notes:

a The lesser of (1) 100% of the additional depreciation taken, or (2) the gain realized, is subject torecapture for real property placed in service from 1981–1986 if an accelerated depreciationmethod is used. Since the building has been held for its full depreciable life, the depreciation takenunder any accelerated method is the same as the amount that would have been taken had the SLmethod been used over the building’s depreciable life. There has been no additional depreciationand, therefore, there is no Section 1250 recapture.

b Real property acquired after 1986 is depreciated using the SL method; therefore, no portion of thegain is subject to Section 1250 recapture.

Section 291 Recapture. Corporate organizations (but not trusts) must include in their UBI additional gain from thedisposition of Section 1250 (real) property over the amount required by Section 1250. Section 291 causes 20% ofthe excess of the gain that would be included in UBI if the property were Section 1245 property, over the amount ofgain actually included (because of Section 1250), to be added to UBI.

Example 2H-5 Section 291 recapture from the sale of Section 1250 property.

Assume the same facts as in Example 2H-4. The following income must be included in UBI because ofSection 291 recapture:

Gain

PotentialSection 1245Recapturea

AdditionalSection 1250Recapture Difference

Additional(Section 291) UBI

Building #1 $ 500,000 $ 145,000 $ — $ 145,000 b $ 29,000 cBuilding #2 254,054 81,054 — 81,054 d 16,211 e

$ 45,211

Notes:

a The total depreciation deducted.


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b $145,000 − $0 = $145,000

c $145,000 × 20% = $29,000

d $81,054 − $0 = $81,054

e $81,054 × 20% = $16,211

Section 291 recapture is reported in Part III of Form 4797 (which becomes an attachment to Form 990-T).

Other Recapture Income. Treatment similar to that given Sections 1245 and 1250 property applies to gainincluded in an organization’s UBI from the disposition of the following kinds of property used in an unrelatedbusiness activity:

1. Farmland when soil and water or land clearing expenses have been deducted (Section 1252 property).

2. Oil, gas, geothermal, or other mineral properties when intangible drilling costs, depletion, or explorationand development expenses have been deducted (Section 1254 property).

3. Property that was acquired, improved, or otherwise modified by nontaxable payments received from agovernment entity for the primary purpose of conserving soil, protecting or restoring the environment,improving forests, or providing a habitat for wildlife (Section 1255 property).

Gain on Sale of Timber

An organization that has owned timber for more than one year may elect to treat the cutting of timber (for sale or foruse in the organization’s trade or business) as a sale or exchange. The election is made by reporting the timbercutting as a sale on the organization’s return for the year of the election. An amended return may not be used tomake the election. Once made, the election is binding for all future years unless revoked, upon showing of unduehardship, with the permission of the IRS.

Deductibility of Capital Losses

An organization’s capital losses from an unrelated activity normally are excluded from UBI. However, capital lossesof social and recreational clubs, voluntary employees’ beneficiary associations (VEBAs), and supplemental unem-ployment benefit trusts are deductible to the extent of capital gains included in UBI. For other tax-exempt organiza-tions, this is true only if the loss results from the disposition of a debt-financed capital asset.

If an organization is a trust (rather than a corporation), it may offset up to $3,000 of otherwise allowable net capitallosses against its other income.

Income That Comes from Pass-through Entities

Partnership Income

An organization’s ownership of a partnership interest may generate unrelated business income (UBI) if the partner-ship’s activity is an unrelated business activity with respect to the organization or if the partnership hasdebt-financed property. Additionally, although the holding of a limited partnership interest is a passive investmentsimilar to owning a rental property or royalty interest, the income is still included in UBI.

Example 2I-1 Including partnership income in UBI.

Beyond Basics, Inc. (BBI), a Section 501(c)(3) organization, is a general partner in MBG Partners. MBGoperates a business on a regular basis that is unrelated to BBI’s exempt function. MBG also receives dividendincome from corporate stock. During the year, BBI received $5,000 in partnership distributions. According toits Schedule K-1 from MBG, BBI’s share of the partnership’s net income for the year was $8,750. Its share ofMBG’s dividend income was $347.


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MBG is regularly engaged in a business that is an unrelated trade or business with respect to BBI. Thus, BBImust include its share of the partnership’s gross income from the activity (whether or not distributed) in UBI.It may deduct its share of the partnership’s deductions attributable to this income. In computing includableincome or loss, BBI may also make the adjustments discussed earlier in this lesson. As a result, BBI’s shareof the dividends received by MBG ($347) should be excluded from UBI.

If BBI was a limited, rather than general, partner in MBG, the treatment of the partnership incomewould be thesame.

The organization should report on Form 990-T, Part I, line 5 its share of partnership income and loss from anunrelated trade or business, unless it has sufficient details to report capital gains on line 4, rental income on line 6,debt-financed income on line 7, and income from a controlled organization on line 8.

If an exempt organization’s tax year differs from that of the partnership of which it is a partner, it reports its share ofthe partnership’s income and deductions for the tax year of the partnership that ends with or within its tax year.

At-risk and Passive Loss Limitations.Generally, passive activities include trade or business activities in which theorganization did not materially participate and rental activities regardless of the level of participation. Losses frompassive activities cannot be used to offset income from nonpassive activities. For example, interest, annuities,royalties, and rent from a controlled organization are nonpassive UBI, as is gain from the sale of debt-financedinvestment property.

IRC Sec. 469(k) requires that the passive activity losses from each publicly traded partnership (PTP) owned mayonly be used to offset the income from the same PTP. In addition, the passive activity loss rules are also affected bythe at-risk and basis limitations. IRS Pub. 925 contains detailed guidance on such limitations and is available atwww.irs.gov (search “Pub. 925, Passive Activity and At-Risk Rules”).

S Corporations Income

Qualified plan retirement trusts and tax-exempt charitable organizations (“qualified tax-exempt entities”) can beS corporation shareholders.

An S corporation’s income, losses, deductions, and credits flow through to a qualified tax-exempt entity share-holder in basically the same way partnership income flows through to partners. While partnership items retain theircharacter in a partner’s hands for UBI purposes, (e.g., partnership interest income is treated as interest income tothe partner) S corporation items do not. Instead, a qualified tax-exempt entity (other than an employee stockownership plan) must treat its entire share of S corporation income as UBI (S corporation capital gains and lossesare reported on line 4 and all other items are reported on line 5). In addition, a qualified tax-exempt entity mustinclude in UBI any gain or loss on the sale or other disposition of its S corporation stock on line 4a, Part I, ofForm 990-T. Therefore, this is an exception to the general rule that excludes gain or loss on the sale of assets fromUBI. Special basis adjustment rules are applicable to calculate basis for gain or loss purposes.

Reporting an Entity’s Taxable Rental Income

Organizations Required to Complete Schedule C (Form 990-T)

Much of the unrelated rental income an organization receives is excluded from unrelated business income (UBI)because it is passive in nature. If the rental income is included, all but four types of organizations (discussed laterin this lesson) must complete Schedule C (Form 990-T) to report rental income and expenses. (A discussion of thetypes of rental income included or excluded from UBI appeared earlier in this lesson.)

Rental Income from Real Property. Rental income and directly related expenses from real property is reported onSchedule C of Form 990-T. Totals from Schedule C are then reported on Form 990-T, columns (A) and (B) of line 6,page 1. However, if the rental income is received or accrued from a controlled organization or earned as a result ofdebt-financed property, the income and directly related expenses are not reported on Schedule C. Instead, theyshould be reported on Form 990-T, Schedules F and E, respectively.


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Rental Income from Personal Property Leased with Real Property. Rental income from personal property thatis leased with real property is reported on Schedule C of Form 990-T in the samemanner as rental income from realproperty.

Rental Income Solely from Personal Property. Gross rental income solely from personal property is reported online 12 of Form 990-T, Part I, rather than on Schedule C of Form 990-T. The income should be described in aschedule attached to Form 990-T. The related expenses are reported on Form 990-T, Part II, lines 14–25, plus line28.

Example 2J-1 Reporting a Section 501(c)(3) organization’s rental income.

Beyond Basics, Inc. (BBI), a Section 501(c)(3) organization, leases its excess property. All of the leasingactivities are unrelated to its exempt function, and each activity generates revenue that must be included inUBI. Information for the year on each lease is as follows:

1. Lease #1. Three computers BBI originally acquired to use in its administrative offices were leased duringthecurrent year for a total of $1,980.BBI is entitled todepreciationof $1,440on themachines. Its onlyotherexpense during the year directly connected with the lease was $110 for insurance.

2. Lease #2. The lease of a small building that formerly housed BBI’s offices generated $13,104 of rentalincomeduring theyear.BBI couldnot finda tenantwilling to lease thepropertyateither a flatmonthly rentalrate or a percentage of gross revenue. Thus, BBI’s lease agreement with the yogurt shop occupying thebuilding calls for BBI to receive rent payments equal to 25% of the yogurt shop’s net income. BBI’sout-of-pocketexpenseson theproperty totalled$2,145 ($1,788 forproperty taxesand$357 for insurance),while depreciation related to the property was $2,360.

3. Lease #3. BBI leases the excess portion of its current office building for $1,800 per month. The space isfurnished with office furniture that is not currently being used by BBI. Without the furniture, the lease ratewould be $1,400 per month (a decrease of $4,800 per year). BBI’s only expenses related to the lease areinsurance of $850 ($700 related to the office and $150 for the contents), $2,465 for utilities, janitorialservices of $1,800, and depreciation of $4,350 ($3,590 on the offices and $760 on the furniture).

Income from a lease involving solely personal property is reported on line 12 of Form 990-T, Part I, anddescribed in a schedule attached to the return. Thus, BBI includes $1,980 (from lease #1) on line 12 andreports the related depreciation and insurance expense in Part II of Form 990-T (on lines 21 and 28, respec-tively).

BBI must also complete Schedule C, Form 990-T, to report the remainder of its taxable rental income fromleases #2 and #3. Totals from this schedule are then reported in columns (A) and (B) of line 6, Part I, Form990-T. For lease #3, only the revenue and expenses related to renting the personal property (i.e., the officefurniture) are included. If the revenue related to this portion of the lease had been 10% or less of the total leaserevenue, BBI could have excluded the entire lease from UBI. Alternatively, if more than $900 of the monthlyrent (i.e., more than 50%) was attributable to the personal property, all the revenue and expenses would beincluded on Schedule C. (More guidance on when rental income from the lease of personal property must beincluded in UBI was provided earlier in this lesson.)

Organizations Not Required to Prepare Schedule C (Form 990-T)

The following organizations are not required to prepare Schedule C of Form 990-T:

1. Social clubs.

2. Voluntary employees’ beneficiary associations (VEBAs).

3. Supplemental unemployment benefit trusts (SUBTs).

Organizations described in IRC Sec. 501(c)(7), (9), or (17) must include in UBI all rents received, other than thosethat qualify as exempt function income. (A definition of exempt function income for this purpose appears later in thislesson.)


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Any of these entities with rental income that is not exempt function income report it on Form 990-T in Part I, line 6[columns (A) and (C)]. The directly related expenses are reported in Part II, on lines 14–25, plus line 28.

Example 2J-2 Rental income of a social club.

Assume the same fact as in Example 2J-1, except that BBI was a tax-exempt country club [i.e., a Sec-tion 501(c)(7) organization] rather than a public charity. The full $21,600 (12 × $1,800) of revenue on lease#3is included in UBI, and all of the directly related rental expenses (not just the ones related to the leasedpersonal property) are deductible in determining UBTI. In addition, all rental income (including income froma lease involving solely personal property) is reported directly on page 1 of Form 990-T [line 6, columns (A)and (C)]. Rental expenses are also reported on page 1, lines 14–25, plus line 28. Schedule C is not required.

A Section 501(c)(3) organization that owns a facility financed with tax-exempt [qualified 501(c)(3)] bonds is treatedas having UBI to the extent the facility is used in a trade or business of a person other than a Section 501(c)(3)organization or a governmental unit. The UBI subject to tax is the greater of the (1) actual rental income or (2) fairrental value of the portion of the building used by a non-Section 501(c)(3) person. This revenue is reported as“Other Income” on line 12 of Form 990-T rather than on Schedule C, while related allowable deductions (excludinginterest expense on the bonds) are reported in Part II.


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SELF-STUDY QUIZ


11. Harken Inc., a taxable corporation, transfers all of its assets to Angels Among Us (AAU), a tax-exempt entity.AAU uses the transferred assets to perform activities related to its tax-exempt purpose. Harken Inc. has neverbeen a tax-exempt organization itself. Which of the following rules applies?

a. The asset sale rule.

b. The change in status rule.

c. The UBI rule.

d. The three-year rule.

12. When should an organization report rental income and directly related expenses on Form 990-T, Schedules Fand E?

a. It comes from personal property leased with real property.

b. It is earned from debt-financed property or a controlled organization.

c. It comes solely from personal property.

d. The organization is a voluntary employees’ beneficiary association (VEBA).


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SELF-STUDY ANSWERS


11. Harken Inc., a taxable corporation, transfers all of its assets to Angels Among Us (AAU), a tax-exempt entity.AAU uses the transferred assets to perform activities related to its tax-exempt purpose. Harken Inc. has neverbeen a tax-exempt organization itself. Which of the following rules applies? (Page 57)

a. The asset sale rule. [This answer is correct. According to Reg. 1.337(d)-4(a)(1), a taxablecorporation (such as Harken Inc.) that transfers all or substantially all of its assets to one or moretax-exempt entities must recognize gain or loss as if the assets transferred were sold at their fairmarket value. This is the asset sale rule, and Harken Inc. would need to adhere to this rule in thescenario described above.]

b. The change in status rule. [This answer is incorrect. Under the change in status rule, which is describedin Reg. 1.337(d)-4(a)(2), a taxable corporation that changes its status to a tax-exempt entity generally istreated as having transferred all of its assets to a tax-exempt entity immediately before its change in statusbecomeseffective, and then itwouldbesubject toanother rule.However, sinceHarken Inc. didnot changeits status (as AAU was an entity that already existed), the change in status rule does not apply.]

c. TheUBI rule. [This answer is incorrect. As discussed in Reg. 1.337(d)-4(b)(1), the normal rule for reportinggains and losses does not apply if the transferred assets are used by the tax-exempt entity in an activitythat produces UBI. When such assets are disposed of or cease to produce UBI, gain will be included inUBI. This is knownas theUBI rule, but it does not apply in this scenario, asAAUuses the transferred assetsfor activities that further its exempt purpose.]

d. The three-year rule. [This answer is incorrect. According toReg. 1.337(d)-4(a)(3), the change in status ruledoes not apply if the corporation formerly was tax-exempt and the change in status is within three yearsof the later of (1) the corporation first filing a return as a taxable corporation or (2) a final determination thatthe corporation had become a taxable corporation. However, as Harken Inc. has always been a taxablecorporation, the three-year rule does not apply.]

12. When should an organization report rental income and directly related expenses on Form 990-T, Schedules Fand E? (Page 62)

a. It comes from personal property leased with real property. [This answer is incorrect. Rental income frompersonal property that is leased with real property is reported on Schedule C of Form 990-T in the samemanner as rental income from real property.]

b. It is earned from debt-financed property or a controlled organization. [This answer is correct. If therental income is received or accrued from a controlled organization or earned as a result ofdebt-financed property, the income and directly related expenses are not reported on Schedule C.Instead, they should be reported on Form 990-T, Schedules F and E, respectively.]

c. It comessolely frompersonal property. [This answer is incorrect.Gross rental incomesolely frompersonalproperty is reported on line 12 of Form 990-T, Part 1, rather than on Schedule C of Form 990-T.]

d. The organization is a voluntary employees’ beneficiary association (VEBA). [This answer is incorrect.VEBAs with rental income that is not exempt function income report it on Form 990-T in Part I, line 6{columns (A) and (C)}. The directly related expenses are reported in Part II, on lines 14–25, plus line 28.]


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Income That Comes from Controlled Organizations and AgencyRelationships

General Rules for Income from Controlled Organizations

Generally, an organization’s portfolio income (e.g., interest and dividends) and passive income from rental realestate is excluded from unrelated business income (UBI). However, specified payments [interest, annuities, royal-ties, and rents (net of any directly connected deductions)] received or accrued (directly or indirectly) from acontrolled entity are generally included in the controlling organization’s unrelated business taxable income (UBTI)to the extent the payment reduces the taxable income (or increases any taxable loss) of the controlled entity.Dividends received from controlled entities are not subject to IRC Sec. 512(b)(13).

Additionally, qualifying specified payments received or accrued are included in UBTI for the amount that exceedswhat would have been paid or accrued if the payment had been determined under the principles of IRC Sec. 482.(Under IRC Sec. 482, the IRSmay reallocate the gross income, deductions, credits, and other allowances of relatedtaxpayers in order to clearly reflect the income of the related organizations or to prevent tax evasion.) Qualifyingspecified payments include interest, annuities, royalties, or rents received or accrued (net of any directly connecteddeductions) from the controlled organization after December 31, 2005, pursuant to a binding written contract thatwas in effect on August 17, 2006, or is a renewable contract under similar terms of a contract in effect on August 17,2006.

Control Defined

A stock corporation is controlled for purposes of the income inclusion rule if a tax-exempt organization owns (byvote or value) more than 50% of its stock. In the case of a partnership, ownership of more than 50% of the profitsinterests or capital interests is considered control. In any other case, ownership of more than 50% of the beneficialinterests in the entity is considered control. The 50% amount is determined by the greater of voting power or value.Control of a tax-exempt organization can be established through the power of appointment.

Calculation of Income Included in UBI

The tax-exempt owner of a controlled corporation must report as UBI any payments from a controlled corporationto the extent such payments either reduce the “net unrelated income” or increase the “net unrelated loss” of thecontrolled corporation. If the controlled entity is tax-exempt, net unrelated income or loss is the amount of thecontrolled entity’s unrelated business taxable income or loss. If the controlled entity is taxable, net unrelatedincome is the portion of its taxable income that would be unrelated business taxable income or loss if it weretax-exempt and had the same exempt purposes as the controlling organization.

This income inclusion rule prevents tax-exempt organizations from converting taxable UBI into nontaxable passiveincome (by placing the unrelated business in a separate entity and sheltering that entity’s income by having it makedeductible payments in the form of interest, annuities, rent, or royalties back to its tax-exempt parent). Thus, thisrule does not apply to dividends received from a controlled corporation since, unlike the payment of interest,annuities, royalties, or rents, the payment of dividends does not generate a deduction for the paying corporation.The issuance of warrants to acquire additional stock in a controlled corporation is payment for the use of valuablerights and generates UBI in the tax-exempt parent if the control test is met.

Example 2K-1 Receipt of income from a tax-exempt controlled organization.

Beyond Basics, Inc. (BBI), a Section 501(c)(3) organization has the authority to appoint 75% of the directorsof Charities, Inc., another Section 501(c)(3) organization. During the year, BBI rents a small office building toCharities for $1,250 per month, pursuant to a written binding lease that was in effect on August 17, 2006. BBI’stotal deductions for the leased property are $3,000: $1,000 for maintenance and $2,000 for depreciation.Charities’ unrelated business taxable income (UBTI) for the year is $100,000 after deducting the rent paid toBBI.


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Because BBI controls Charities (through power of appointment), it must complete Schedule F of Form 990-Tto report the UBTI. BBI has net rental income of $12,000 from Charities ($15,000 income less $3,000 directexpenses).

Assume the lease payments are $3,500 per month, the total lease payments Charities made to BBI exceededfair market value by $25,000, and the UBTI (net of direct deductions) totals $100,000. The amount of UBTI thatCharities must report for the year is $125,000 [$100,000 of UBTI (net of direct deductions) + $25,000 excessqualifying specified payments].

Example 2K-2 Receipt of income from a taxable controlled organization.

Assume the same facts as Example 2K-1, except that BBI also has the authority to appoint 75% of the directorsof New Opportunities Corporation (NOC), a nonexempt organization. NOC leases a factory and a warehousefrom BBI for a total annual rent of $100,000. During the year, NOC has $500,000 of taxable income afterdeducting the rent paid to BBI: $150,000 from an activity related to BBI’s exempt purpose and $350,000 fromthe operation of the factory (a business unrelated to BBI’s exempt purpose). If NOC were tax-exempt andcomputing its unrelated business taxable income, $70,000 of the rental payment to BBI (the portion related tothe factory) would be considered directly connected with the production of UBI of $350,000. BBI’s deductionsfor the year for the leased property are $4,000 for the warehouse ($2,500 of depreciation and $1,500 ofproperty taxes) and $16,000 for the factory ($9,500 of depreciation and $6,500 of property taxes).

The net rental income included by BBI in determining its UBI and reported on Schedule F of Form 990-T iscomputed as follows:

NOC’s taxable income (after deducting rent paid to BBI) $ 500,000Less taxable income from the activity related to BBI’s exempt purpose (150,000)

Net unrelated income $ 350,000

Rent received by BBI from NOC that would reduce NOC’s UBTI $ 70,000Less deductions directly connected with such income (16,000)

Net rental income included by BBI in computing its UBTI $ 54,000

Impact of Agency Rules on Unrelated Business Income

Federal tax law relies heavily on common law treatises, most notably the Restatement (Second) of Agency (1958),to determine whether someone is acting as the agent of another. The Restatement defines agency as the fiduciaryrelationship that arises when one person (the principal) agrees with another (the agent) that the agent shall act onthe principal’s behalf and subject to the principal’s control. Consequently, intent and control are the central featuresof an agency relationship. Whether the agreement specifically defines the relationship as being principal-agent isimmaterial. The IRS and courts will look at the substance. If the relationship exists, the acts of the agent areattributed to the principal. On the other hand, if an exempt organization has neither actual nor constructive controlover a person (or entity), it is improbable that such person will be deemed the exempt organization’s agent.

A finding that there is an agency relationship between an exempt organization and another party that is a revenuesource for the exempt organization potentially creates unrelated business income (UBI) problems. Nonprofitorganizations should carefully review contractual language to ensure that an agency relationship is not beinginadvertently created.

Income That Comes from Associate Member Dues

Tax-exempt membership organizations generally are supported by annual membership fees or dues. When thisincome is paid by all members in general support of an organization’s exempt purposes and activities, it is relatedto the organization’s exempt purpose and is not from the conduct of an unrelated trade or business.

An organization may seek additional income by providing unrelated products or services while at the same timerestricting its membership to those truly interested in its exempt purposes. Organizations commonly establish an


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associate or limited membership category for those primarily interested in obtaining the unrelated products orservices. Typically such associate members have no direct contact with the exempt functions of the organization.They have limited or no voting power and participate solely for the benefits (insurance, credit cards, reduced ratetelephone service, etc.) an organization can offer because of its large membership.

Section 501(c)(5) and (c)(6) organizations can have UBI from the receipt of associate member dues if the associatemember joins primarily to get the benefits offered by the organization. Organizations may have categories ofassociate members without generating unrelated business taxable income (UBTI) if these members are activeparticipants in the organizations’ exempt activities.

The IRS will not treat dues from associate members of a Section 501(c)(5) organization as UBI unless, for therelevant period, the associate member category was for the principal purpose of producing UBI. However, Rev.Proc. 95-21 contains no guidance on how to determine whether the associatemember category was formed for theprincipal purpose of furthering the organization’s exempt purpose or producing UBI. It says only that the IRS willlook to the purposes and activities of the organization rather than its members when making the determination.

Ltr. Rul. 9847001 elaborates on the criteria the IRS will consider in such cases, such as whether associatememberscan participate in the organization’s exempt activities and receive equal privileges and treatment, including votingand holding office. If there is real involvement by associate members in policy and decision making, then theprincipal purpose of an associate member category may not be to generate UBI.

Example 2L-1 Income from associate member dues.

The BasketWeaving Association, a Section 501(c)(6) trade association, creates a newmembership classifica-tion for individuals who are not active or retired basket weavers. These “Friends of Weavers” (Friends) paydues to the Association to obtain access to the Association’s health insurance plan, a quarterly newsletter,group legal services, and the right to participate in the Association’s travel, credit card, eyewear, andlong-term care insurance programs. Friends are allowed to elect only onemember of the nine-member board.The benefits, products, and services are not substantially related to the Association’s mission of improvingworking conditions for basket weavers. The membership dues paid by Friends are UBI.

Rev. Proc. 97-12 retroactively applies the principles of Rev. Proc. 95-21 to Section 501(c)(6) entities. It also confirmsthat Rev. Proc. 95-21 continues to apply to associate member dues of Section 501(c)(5) organizations not coveredby IRC Sec. 512(d) (i.e., agricultural and horticultural organizations whose associate member dues exceed the$100 inflation-adjusted limit and labor organizations, regardless of the size of their dues).

Income That Comes from Management and Administrative Services Fees

General Rules

Providing services (e.g., management, administrative, consulting, and other) to other exempt organizations for afee on a regular basis is an unrelated business activity that will generate unrelated business income (UBI) unlessthe services are insignificant in relation to the performing organization’s other activities. Under some circum-stances, however, performing services for another exempt organization may further an exempt purpose of theservice provider, in which case, the income will not be considered UBI. Additionally, income from services that areunique and otherwise unavailable commercially will apparently not be UBI.

To demonstrate that furnishing services furthers an exempt purpose of the provider, they must be provided atsubstantially below cost. Simply discounting charges is insufficient to satisfy this test.

Relationships between Organizations

A relationship between the services provider and the services recipient does not per se permit the provider’s fee tobe excluded from UBI. The services must still accomplish an exempt purpose of the provider. For example, in Ltr.Rul. 9811001, a Section 501(c)(6) business league received income for services to a related Section 501(c)(3)organization. However, the business league’s activities should be directed to improving business conditions of one


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or more lines of business rather than performing particular services for individual persons. Therefore, theseservices resulted in UBI even though provided to a related exempt organization because they did not further thebusiness league’s exempt purpose. Similarly, fees for services to members of a business league or trade associa-tion are also UBI.

Controlled Groups. Groups of affiliated exempt organizations are common in the health care industry. Often, oneof the exempt affiliates provides management and administrative services for its affiliates. The IRS has consistentlyruled that services provided by an exempt member of the group to other exempt members will not be UBI becauseall the members are under the common control of a single member. Control can apparently be indirect as well asdirect.

Example 2M-1 Services for controlled affiliates.

Three tax-exempt acute care hospitals and a tax-exempt home health care agency form a tax-exempt support-ing organization that will coordinate the delivery of home health care services. The supporting organizationwill provide management, personnel, purchasing, and administrative services. The organizations are relatedthrough common control and are part of an integrated home health care system. Providing services andsharing assets, personnel, facilities, and services among these organizations will increase efficiency indelivering home health care services and thus will not be UBI.

Services to a taxable affiliate in a controlled group generally result in UBI. However, incidental services to a taxableaffiliate that further an exempt purpose of the service provider do not result in UBI.

Income That Comes from Travel Tours

General Rule

The income derived from a travel tour will not result in unrelated business income (UBI) to the exempt organizationif the tour is substantially related to an organization’s exempt purpose, not regularly carried on, or conducted withvolunteer labor. Typically, such tours are conducted by an educational organization. GCM 38949 lists variousfactors in determining that an educational tour did not generate UBI, including (1) relationship of the tour to theorganization’s exempt activities; (2) use of qualified study leaders; (3) existence of organization contacts at the areathat enhance the tour’s educational value; (4) relationship of present tour to prior tours, lectures, or classes of theorganization; and (5) careful structuring of the tour to maximize educational goals and contents.

Based on seven examples included in Reg. 1.513-7(b), the IRS apparently will focus on two key elements inmakingits determination: the types of activities scheduled during a tour and the time devoted to those activities. Theemphasis seems to be on organized study, preparation of reports, lectures, instruction, and oral readings duringthe tour. Only limited time should be available for social and recreational activities.

Example 2N-1 Travel tours.

State University (SU) is organizing a tour of Eastern Europe to study the conquests of Attila the Hun. SU’sHistory Department will provide educational lectures at each point of interest in the two-week tour. Theprofessors will be tour guides and lecture a minimum of six hours a day at each location. Examinations will begiven at the end of the tour to cover the subject matter. A passing grade is required to earn college credit. Thisincome will not be UBI to SU.

The educational emphasis of the tour furthers SU’s exempt educational purpose. If there were limited educa-tional opportunities during the tour with emphasis on social and recreational activities, the income would beUBI.

Documentation Requirements

Written contemporaneous documentation, beginning with the planning stage, is critical to successfully demon-strate that a tour was substantially related to the sponsor’s exempt purpose. The examples in the regulations


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illustrate that contemporaneous documentation showing how an organization develops, promotes and operatesthe travel tour is relevant to the facts and circumstance analysis. Such documentation should show, among otherthings, how the destination chosen and each aspect of the planned itinerary promote the accomplishment of theorganization’s exempt purpose. Documentation should also show that the actual conduct of the tour followed theplanned itinerary.

Income That Comes from the Operation of Parking Facilities

General Rule

Operating a parking lot or parking garage that is open to the public generally results in unrelated business income(UBI) unless the activity satisfies one of the exemptions from UBI. Some of the general issues addressed in parkinglot or garage operations are discussed in the following paragraphs.

Substantially Related to Exempt Purpose. Ltr. Rul. 200124022 involved a Section 501(c)(3) organization whoseexempt purposes included the revitalization and rebuilding of the downtown area in a particular city. The organiza-tion believed that affordable parking was necessary to promote economic growth in the area and proposed topurchase and operate a parking garage and two parking lots. The IRS ruled that operating the parking facilitieswould be substantially related to the organization’s exempt purposes and reasoned that without adequate parking,people would be discouraged from going to the area, thereby preventing the organization from accomplishing itspurposes.

Parking Operations Can Be Charitable Activity. For purposes of Section 501(c)(3), the term charitable includesactivities that lessen the burdens of government or combat community deterioration. Although cities typically leavethe provision of public parking to private enterprise, the success of a city’s efforts to halt deterioration and revitalizean urban area may depend in part on the adequacy of public parking. If the parking furnished by for-profit entitiesis inadequate, the city may attempt to alleviate the shortage by enlisting the aid of nonprofit organizations. Underthese circumstances, the operation of parking facilities by a Section 501(c)(3) organization would be a charitableactivity because it would lessen the burdens of government.

“Not Regularly Carried On” Exemption. If an exempt organization opens its parking garage or lot to the generalpublic for only a few days annually (for example, when a major convention or state fair is in town), the resultingincome should not be taxable. Furthermore, if a parking facility is open sporadically throughout the year, the incomeshould not be UBI if the operation is conducted without the competitive and promotional efforts typical of commer-cial endeavors (for example, there is no advertising or other efforts to promote parking by the public). However, ifthe parking facility is open to the public one or more days each week throughout the year, the activity will beconsidered regularly carried on and, therefore, potentially taxable.

Convenience Exemption. An activity carried on by a Section 501(c)(3) entity, or by a governmental college oruniversity primarily for the convenience of its members, students, patients, officers, or employees, is not anunrelated trade or business. Thus, the income from a parking facility operated by an exempt hospital for theconvenience of its patients and their visitors or by an exempt school for its students, faculty, and other employeesis not taxable. Similarly, the income from a parking facility operated by an exempt museum, zoo, or aquariumprimarily for its visitors should not be taxable. (The IRS has ruled in Ltr. Rul. 8735004 that visitors to such entities areconsidered “members.”)

Rental of Real Property Exemption. Rental income from real property is generally exempt from UBIT. However,Reg. 1.512(b)-1(c)(5) provides that payments for the use or occupancy of space in parking lots or garages are notrent from real property if services are rendered to the user. The IRS relied on this regulation in concluding that theoperation of parking facilities would not be taxable when there was no attendant on duty. However, the IRS nowasserts, citing legislative history, that the direct operation of a parking facility never produces “rent” within themeaning of IRC Section 512(b)(3), regardless of whether any services are rendered. The legal underpinning ofsuch position is that parking creates a bailment (a delivery of property for a particular purpose), not a landlord-ten-ant relationship.


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Example 2O-1 Parking space included in tenant’s rent.

Declan Senior Living, Inc. is a Section 501(c)(3) organization that operates a 22-unit apartment building toprovide low-income housing to seniors. The town of Declan requires all apartment complexes to provide twooff-street parking spaces per unit. Parking is not available to the general public. The tenants’ monthly rentincludes the parking spaces, and the organization does not record parking revenue separately.

The operation of the apartment complex falls within the definition of rent from real property. The parking spaceis incidental to the occupancy, and the portion of the rental revenue attributable to the parking is excludedfrom UBI as rent from real property.

The parking space is not included in the rental income. Tenants pay an additional monthly fee for parking. Thegarage is also available to the general public at an hourly rate. The income from the tenants may be excludedfrom UBI under the convenience exception, but the income from the general public is UBI.

The taxpayer in Ocean Pines (OPA) argued that its income from operating parking lots was rent from real propertybecause the services provided were not substantial. OPA merely provided guards to open its lots and checkparking decals. The Tax Court, as affirmed by the Fourth Circuit, ruled that the level of services is not dispositive; theproper test is whether the services are (1) primarily for the convenience of the lot user, rather than the generalpublic, and (2) are “other than those usually or customarily rendered in connection with the rental of rooms andother space for occupancy only.” If so, the income is not rent from real property. However, neither the Tax Court northe 4th Circuit Court of Appeals adopted the IRS’s position that parking lot income could never be rent from realproperty.

Volunteer Services Exemption. An unrelated trade or business does not include an activity in which “substantiallyall” (generally 85% or more) of the work is performed by unpaid volunteers. But this exclusion is subject to aqualifier not apparent from the statutory language. The IRS position is that the performance of services must be amaterial income-producing factor in order for the volunteer-services exemption to apply. Since services generallyare not a material income-producing factor in a parking operation, the activity apparently cannot avoid UBI taxsolely because all of the work involved is performed by volunteers (except perhaps when it is a valet parkingoperation, where services would be material).

Third-party Operators. Instead of operating a parking facility directly, an organization can lease the facility to athird-party operator. The IRS has ruled that lease income was exempt rent from real property even though theexempt organization lessor provided maintenance, repairs, cleaning, and lighting to the lessee. The rationale wasthat these services are normally rendered in connection with the rental of parking lots to third-party operators and,therefore, are not services that taint the rental income.

Special Rules That Affect Organizations Described in IRC Sec. 501(c)(7),(9), or (17)

Unrelated business taxable income (UBTI) is computed differently for the following three types of entities than forother tax-exempt organizations:

1. Social and recreational clubs.

2. Voluntary employees’ beneficiary associations (VEBAs).

3. Supplemental unemployment benefit trusts (SUBTs).

For these organizations, UBTI generally means gross income (other than exempt function income) less deductionsdirectly related to that income.Whenmaking this calculation, the exceptions, modifications, and excluded activities(e.g., those staffed with volunteer labor) discussed earlier in this lesson do not apply.

Exempt Function Income

The primary adjustment that social clubs, VEBAs, and SUBTs make in determining their UBTI is to reduce grossincome by exempt function income. Exempt function income means gross income from dues, fees, charges, or


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similar amounts paid by members for goods, facilities, or services (for themselves, dependents, or guests) thatfurther the exempt function of the entity.

Example 2P-1 Calculating unrelated business income (UBI) for a social club.

The City Club (CC), a Section 501(c)(7) organization, operates a restaurant, bar, and health club for membersand their guests. CC admits nonmembers only if accompanied by amember. CC is supported by annual duesand revenues from the restaurant and bar. In addition, CC received $27,000 of interest and dividends duringthe year, $1,500 of which was from state and local bonds. (No expenses were incurred on any of theinvestment income.)

Although most charges for food and beverages are collected once a month when members are billed, CCallows cash payments when the items are served. Thus, nonmembers sometimes pay their own expenses.(During the current year, $8,000 in restaurant and bar receipts were received from nonmembers. Expensesdirectly connected with this income included $4,000 related to cost of goods sold.)

CC’s UBI is calculated as follows:

Food and beverage revenue from nonmembers $ 8,000Interest and dividend income 27,000Gross unrelated income 35,000Less:Tax-exempt state and local bond interest (1,500 )Cost of goods sold for the sales to nonmembers (4,000 )

UBI $ 29,500

Set-aside Income

Social clubs, VEBAs, and SUBTs are permitted to set aside income for the following purposes and have it treatedas exempt function income (i.e., not subject to tax):

1. Religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to childrenor animals.

2. Payment of life, health, or accident insurance, or other benefits [but only if the organization is a VEBA oran SUBT, and certain funding limits in IRC Sec. 512(a)(3)(E) are followed].

3. Reasonable administration costs directly attributable to items described in 1 or 2.

Example 2P-2 Set aside income treated as exempt function income.

The Geneva Zebra VEBA (GZV), a Section 501(c)(9) organization, was formed to provide life insurancebenefits to Geneva Zebra Society employees. In the current year, GZV determines that its set-aside amountsexceed what is actuarially calculated to be necessary to pay future claims. In order to avoid paying UBIT onthe investment income that exceeds the account limit, GZV intends to provide discounted lifetime member-ship dues to members who pay policy premiums, and donate funds to a local orphanage.

Amounts set aside for a charitable purpose, such as a grant to be made to an orphanage, are treated asexempt function income and are not subject to UBIT. However, providing discounts to members is not acharitable purpose, but rather are a rebate of policy premiums. Such amounts are not considered to beset-aside, and are subject to UBIT to the extent the investment income exceeds the account limit.

Incomemay not be set aside if derived from an unrelated trade or business regularly carried on by the organization.Funds set aside as exempt function income must be designated (e.g., by segregating them on the financials) orplaced in a separate account. A formal setting aside of funds is not required if the organization maintains adequaterecords to identify the amount set aside and the purpose for which it is to be used. In Confrerie de la Chaine Des


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Rotisseurs, the Tax Court found that an organization’s lack of formal recordkeeping was a problem. In this case,investment income was commingled with the club’s receipts from other sources. Its records did not show thatinvestment income had been “ear marked” for use in its exempt function.

The amount a VEBA or SUBT may set aside is limited to the amount that is actuarially calculated to be needed tofund the plan’s liabilities for future claims, plus a reserve for post-retirement medical and life insurance benefits (theaccount limit). Reg 1.512(a)-5T provided that the VEBA or SUBT would recognize UBI to the extent that the totalamount set aside exceeded the account limit (without regard to the reserve for postretirement benefits), but not toexceed the organization’s income for the year (excluding contributions from members). The IRS took the positionthat the excess is UBI regardless of whether income was used to pay benefits or reasonable administrative costsduring the year.

In Sherwin-Williams, the 6th Circuit Court of Appeals ruled that UBI does not include amounts spent during thecourse of the year, and that only set-aside amounts accumulated and unspent at the end of the year are subject toUBI. In CNG Transmission Management, the U.S. Court of Federal Claims disagreed with the Sherwin-Williamsdecision, and concluded that investment income could never be allocated to the payment of welfare benefits beforethe close of the tax year. Due to a conflict in the courts, the IRS has issued Prop Reg 1.512(a)-5, which provides thatthe investment income of a VEBA or SUBT that causes year-end assets to exceed the account limit is subject toUBIT regardless of whether the incomewas set aside or spent to provide benefits and pay administrative expenses.The IRS does not acquiesce with the Sherwin-Williams decision, and will follow this proposed regulation, and willnot treat Sherwin-Williams as precedent, except in the Sixth Circuit.

Set-aside incomemay be temporarily invested or accumulatedwithout losing its exempt function income classifica-tion if the amount and duration are not unreasonable. However, in Northrop Corp., a VEBA was not allowed to treatits investment income that it allocated to the payment of member benefits as exempt function income.

Set-aside income generally may be excluded from gross income only if set aside in the tax year it otherwise wouldbe included in gross income. However, the instructions for Schedule G of Form 990-T state that an election may bemade to set aside a portion of the prior year’s gross income to the extent such amount could have been set asidein the prior year and actually is set aside on or before the due date (including extensions) of the organization’sForm 990-T for the prior year.

Any income set aside and later spent for purposes other than those for which the income was set aside must beincluded in the organization’s UBTI for that later year.

Example 2P-3 Exclusion of set-aside income from UBI.

Assume the same facts as in Example 2P-1. The City Club’s 2017 return shows UBTI as follows:

UBI $ 29,500Less:Expenses directly connected with such income (and not deducted in determining UBI) (3,500 )Specific deduction (1,000 )

UBTI $ 25,000

The clubmay elect to treat a portion of its gross income from 2017 as set aside for a qualified purpose (i.e., fora religious, charitable, scientific, literary, or educational purpose, or for the prevention of cruelty to children oranimals), to the extent such an amount could have been set aside in 2017 and actually is set aside no laterthan the due date (including extensions) of the club’s 2017 Form 990-T.

Assume the club wants to lower its UBTI to zero by setting aside $25,000 (which represents all but $500 of thetaxable interest and dividend income earned during the year). The monies will be used to sponsor a charitysoccer tournament for underprivileged children in the fall of 2018 or the spring of 2019.

A formal election is not required; a properly completed Schedule G (Form 990-T), including the requiredschedule detailing set-aside income, should be sufficient. The $25,000 should be earmarked in the club’s


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financial records either by an accounting entry or by placing the funds in a separate account before the duedate of Form 990-T (including extensions). In addition, the minutes of the board of directors should indicatetheir discussion and approval of setting aside the income.

Suppose the club properly sets aside the $25,000, but instead of sponsoring the soccer tournament directly,it gives the money to a Section 501(c)(3) public charity with the stipulation that the funds be used to sponsorsuch a tournament. In this situation, the club made a valid set-aside. Whether funds set aside for religious,charitable, etc., purposes are spent for such purposes directly by the organization or granted to a Sec-tion 501(c)(3) organization to use for such purposes, the IRS has concluded that the set-aside qualifies asexempt function income.

Reporting Requirements

All Section 501(7), (9), and (17) organizations report their investment income (including debt-financed investmentincome) and the deductions directly connected with the production of that income on Schedule G of Form 990-T.Other taxable income of these organizations (i.e., income that is not exempt function income or investment income)is reported elsewhere on Form 990-T, depending on the type of income.

Example 2P-4 Reporting a social club’s UBTI.

Although The City Club (see Examples 2P-1 and 2P-3) reduced its UBTI to zero by setting aside $25,000 for acharitable purpose, it must still complete Form 990-T. The $8,000 in sales to nonmembers is reported on lines1a and 1c of Form 990-T, Part I. The $4,000 cost of goods sold is reported on line 2 and Schedule A. The other$3,500 of expenses directly related to nonmember sales are reported on lines 14–25, plus line 28, asappropriate.

The $25,500 ($27,000 − $1,500) of potentially taxable investment income is reported on Schedule G.

Taxable Investment Income

In calculating taxable investment income, a deduction is allowed for all expenses directly connected with the pro-duction of that income and for the income set aside in accordance with the procedures underIRC Sec. 512(a)(3)(B), previously discussed in this lesson. However, even when part of this income is from divi-dends, the dividends received deduction available to taxable entities is not allowed because it is not considered adirectly connected expense. In addition, if an allowable deduction relates to both an investment activity and anexempt activity, it must be allocated between the two, and only the portion related to the investment activity isdeductible on Form 990-T. (See Lesson 3 for how to allocate deductions.)

Social clubs can offset losses on sales to nonmembers against investment income only when the nonmembersales have a profit motive. In addition, the court held that an organization was not entitled to use one method forallocating fixed expenses when determining if an activity is “for profit” and a second method when computing theactivity’s actual profit or loss. (Profit for this purpose is defined as revenue minus both variable direct expenses andan allocable portion of fixed indirect expenses.) Even though losses on nonmember activities lacking a profit motivemay not reduce investment income, the Tax Court has allowed such losses to offset income from other nonmemberactivities.

Example 2P-5 Offsetting investment income with losses from nonmember activities.

The Sweetwater Golf Club (SGC), a Section 501(c)(7) organization, has three sources of potential UBI: (1)food and beverage sales to nonmembers; (2) nonmember golf days; and (3) investment income of $19,000.The nonmember activities were both profitable considering only variable direct expenses. However, afterdeducting an allocable portion of SGC’s fixed indirect expenses, the food and beverage activity lost $18,400,while the golf days showed a net profit of $5,500 for the year. Prices charged to nonmembers for food andbeverages are higher than those charged to members. In spite of this, the activity has consistently lost moneyeven though the sales revenue has always exceeded the club’s variable expenses related to those sales.


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SGC’s UBTI is $6,100, calculated as follows:

Investment income $ 19,000Nonmember sales (net of expenses):Food and beverage sales $(18,400 )Golf days 5,500 (12,900)a

Specific deduction —

UBTI $ 6,100

Note:

a SGCmay offset a net loss fromnonmember activities against investment income only if it conductsthe nonmember activities with an intent to make a profit. Despite a consistent lack of profit (afterdeducting fixed and variable expenses) on its nonmember food and beverage activity, it appearsthis undertaking has profit motive, since the direct revenue exceeds the direct costs andnonmember prices are higher thanmember prices. In addition, the profit motive defense would bestrengthened if SGC could show circumstances beyond its control for why the activity wasunprofitable and explain why, given these circumstances, it failed to discontinue the activity.

Sales of Property

Because of the narrow definition of exempt function income, a Section 501(c)(7) social club [as well as anorganization described in IRC Sec. 501(c)(9) or (17)] is normally subject to tax on the sale of property, even whenit is used in an exempt function. However, an organization can defer this tax liability if it acquires other property ituses in the performance of its exempt function. This replacement property must be acquired within a four-yearperiod that begins one year before the sale and ends three years afterwards. When these requirements are met,gain realized on the sale of property used in an exempt function is recognized only to the extent the sales price ofthe old property exceeds the cost of the replacement property. For this purpose, sales price is the contract priceless selling expenses.

The property sold must have been physically used directly in the performance of the organization’s exemptfunction. This use requirement must be satisfied even if the property was acquired to enable the club to carry outits exempt purposes. For example, in Ltr. Rul. 200104038, a country club was forced to purchase extra land in orderto acquire the land on which its golf course was located. However, the proceeds from the sale of this surplus landcould not be reinvested tax-free in exempt activity assets because the land was never actually used by the club inexempt activities. Similarly, the Tax Court has held that a tax-exempt country club that subdivided and sold a portionof its property as homesites realized UBI because the property was never used for recreational activities. The factthat the club immediately reinvested the proceeds in new recreational facilities was irrelevant.

The new property need not be similar in nature or in use to the property sold (although, both properties must beused directly in the performance of the organization’s exempt function). For example, a painting that had hung ina club’s dining room for many years was deemed used in its exempt function. Consequently, the proceeds from thesale of the painting could be reinvested in other property used in the club’s exempt function. In another example,the IRS ruled that the sale of timber by a Section 501(c)(7) hunting and fishing club was not UBI since the clubplanned to reconstruct or improve several dams to enhance its fishing activities. In addition, gain realized as a resultof the destruction (in whole or in part), theft, seizure, requisition, or condemnation of qualified property is eligible tobe deferred in the same way as gain from an actual sale of property. In another ruling, the IRS determined that thesale by a social club of a conservation easement to the city department of environmental protection was the sale ofproperty used directly in performing the club’s exempt function. The easement removed the club’s ability toconstruct new paved roads, create new buildings, or store hazardous materials. The proceeds were used toimprove the club’s boathouse and tennis courts and to purchase an icemaker, dishes, stemware, silverware, and anew bar. The improvements to real property and the purchase of personal property were considered reinvestmentsin property used directly in the performance of the club’s exempt function.


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Example 2P-6 Deferring gain on the sale of exempt function property.

The ABC Social Club sold its clubhouse (with an adjusted basis of $80,000) for $350,000 this year. Withinthree years of this sale, it completed construction of a new clubhouse at a cost of $675,000. ABC pays no taxon the $270,000 ($350,000 − $80,000) gain from the sale of its old clubhouse. The cost of the new propertyexceeds the sales price of the old, and construction was started and completed on the new clubhouse withinthree years of the sale of the old property. (Property that is constructed or reconstructed is treated aspurchased property for the gain deferral.) Thus, the $270,000 of realized gain is not currently recognized.However, the basis of the new clubhouse must be reduced by the deferred gain to $405,000 ($675,000 −$270,000).

Although none of the gain is taxable, the authors recommend reporting the sale of the old clubhouse on astatement attached to the return for the year of the sale. In addition, when replacement property has not beenacquired (or fully constructed) when that return is due, it is a best practice to attach a second copy of thestatement to the return for the year the acquisition of replacement property is completed.

The club only spent $300,000 on its new clubhouse because of declining membership. It also purchased anadditional $25,000 of property used in performing its exempt function during the period beginning August 24of Year 0 (i.e., one year before the sale of the old clubhouse), and ending August 23 of Year 4 (three years afterthe sale).

ABC will pay tax on $25,000 in Year 1. This is the lesser of the gain realized ($270,000) or the excess of thesales price of the old clubhouse over the replacement cost of the new qualifying assets [$350,000 −($300,000 + $25,000) = $25,000]. The $25,000 gain is reported in Schedule G, columns 1 and 2.

In a private letter ruling based in part on Atlanta Athletic Club, the IRS attempted to limit application of the gaindeferral rule by restricting the definition of property that qualifies as “used directly in the performance of the exemptfunction of an organization.” The ruling indicated that only minimal use of property for an exempt purpose willpreclude it from being qualified property. Thus, it appeared an additional requirement had been created for theprivilege of deferring gain. Not only must the property sold and the replacement property both be used directly inperformance of an exempt function, they must be used continuously and regularly for such purpose. However, the11th Circuit Court of Appeals disagreed with this new requirement (overturning that portion of the Tax Court’sdecision in Atlanta Athletic Club) and held that the statute does not require continuous or regular use of theproperty. It remains to be seen whether the IRS will continue to assert its position outside the 11th Circuit.

Sale and Liquidation

When it becomes impractical for a club to continue its exempt activities, the sale of its assets to facilitate liquidationis considered incidental to its exempt purposes. Therefore, a club is still considered operated exclusively forexempt purposes through the date of sale and the distribution of the sales proceeds to its members. However,liquidation obviously precludes the use of the proceeds to purchase replacement property. Thus, the IRS ruled thatthe gain on the sale of a liquidating club’s exempt function assets would be UBI because they were not reinvestedin exempt function assets.

A VEBA formed to provide benefits to a nonprofit organization’s employees can, upon dissolution of the VEBA,distribute its assets as a taxable lump sum payment among its plan participants. Since the nonprofit employernever took a tax deduction under IRC Sec. 419 for contributions made to the VEBA, the lump sum payments toparticipants do not result in a disqualified benefit causing the employer to be liable for excise tax.

A VEBA formed to provide benefits to employees of a taxable organization can, upon dissolution of the VEBA,distribute its assets to unrelated public charities if there are no remaining participants in the plan and there are nooutstanding benefit claims or liabilities. Although the employer deducted its contributions for plan benefits in a prioryear and now intends to expend those purposes for a different purpose, there is no reversion for the benefit of theemployer. There is no disqualified benefit, and the employer is not liable for excise tax.


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How to Complete Part I of Form 990-T

An organization’s unrelated business income (UBI) is reported in Part I of Form 990-T if the gross income from aregularly carried on unrelated trade or business is $1,000 or more. Often, as indicated on the appropriate lines ofForm 990-T, a separate schedule must be completed to support the amounts provided in Part I. However, threekinds of organizations—(1) social clubs, (2) voluntary employees’ beneficiary associations, and (3) supplementalunemployment benefit trusts—are given special guidance in the Form 990-T instructions regarding completion ofcertain schedules in the return. The following table summarizes this guidance:

Form 990-TSchedule Special Instructions for Sections 501(c)(7), (9), and (17) Organizations

C(Rents)

Do not complete this schedule. Report gross unrelated rental income on Part I, line 6,columns (A) and (C), and applicable expenses on Part II, lines 14–28.

E(Debt-financed)

Do not complete this schedule. Report debt-financed income on line 9 of Part I and onSchedule G.

I(ExploitedActivity)

Do not complete this schedule. Report income from exploiting an exempt activity on PartI, line 1a or another appropriate line for the particular kind of income.

J(Advertising)

Do not complete this schedule. Report advertising revenue on line 1a of Part I.

Example 2Q-1 illustrates the completion of Form 990-T, Part I, for a tax-exempt organization other than onedescribed in IRC Sec. 501(c)(7), (9), or (17). The organization in the example may be in danger of losing its taxexemption because of the amount and diversity of its UBI.

Example 2Q-1 Reporting an organization’s UBI.

Beyond Basics, Inc. (BBI), a Section 501(c)(3) tax-exempt organization, received the following UBI during theyear.

Amount Source of the UBI

$ 1,191,476 Gross revenue (net of $10,324 of returns) from a manufacturing operation unrelated toBBI’s exempt purpose.

45,361 Ordinary income recapture on the disposition of depreciable property used in anunrelated business activity. (See Examples 2H-1, 2H-4, and 2H-5.)

8,403 Taxable income from a partnership involved in an activity unrelated to BBI’s exemptfunction. (See Example 2I-1.)

19,884 Taxable rental income. (See Example 2J-1.) Reported on lines 6 and 12.85,000 Income from controlled organizations. (See Examples 2K-1 and 2K-2.)

$ 1,350,124


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SELF-STUDY QUIZ


13. Which of the following statements best describes agency rules and their effect on UBI?

a. Control and intent are the most important features of an agency relationship.

b. Agreements must specifically define a relationship as being principal-agent.

c. Acts of the agent are attributed to the agent in this type of relationship.

d. There is minimal effect on UBI when a principal-agent relationship exists.

14. Which of the following organizations will most likely have UBI?

a. The Northern Organization is fully supported by the annual membership dues paid by all of its members.

b. TheSouthernOrganization is aSection 501(c)(6) organization that accepts dues fromassociatememberswho join only to receive certain benefits.

c. The Eastern Organization collects fees from associate members who participate in an activity related toits exempt purpose.

d. TheWestern Organization is a Section 501(c)(5) organization that collects dues from associate membersfor membership convenience, not profit.

15. When is an organization exempt from considering income from running a parking facility as UBI?

a. The parking facility is open to the general public.

b. The parking facility is open every day.

c. The availability of parking is a convenience for organization patrons.

d. The parking facility is run by the organization itself.

16. Which of the following statements best describes the special rules that apply to social and recreational clubs,voluntary employees’ beneficiary associations (VEBAs), and supplemental unemployment benefit trusts(SUBTs)?

a. Once a social club is in liquidation, it is no longer operating exclusively for its tax-exempt purpose;therefore, proceeds from selling its assets will be unrelated business taxable income (UBTI).

b. When calculating taxable investment income, organizations of these types can deduct income receivedfrom dividends in the same way a taxable organization would.

c. If oneof these types of organizations sets aside income for specific purposes under IRCSec. 512(a)(3)(B),it cannot be invested or otherwise used or it will become UBTI again.

d. The primary adjustment that organizations of these types must make to determine their UBTI is to reducetheir gross income by their exempt function income.


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SELF-STUDY ANSWERS


13. Which of the following statements best describes agency rules and their effect on UBI? (Page 67)

a. Control and intent are themost important featuresofanagency relationship. [Thisanswer iscorrect.TheRestatement (Second) of Agency (1958) defines agency as the fiduciary relationship that ariseswhen one person (the principal) agrees with another (the agent) that the agent shall act on theprincipal’s behalf and subject to the principal’s control. Consequently, intent and control are thecentral features of an agency relationship.]

b. Agreements must specifically define a relationship as being principal-agent. [This answer is incorrect.Whether theagreement specificallydefines the relationshipasbeingprincipal-agent is immaterial. The IRSand courts will look at the substance.]

c. Acts of the agent are attributed to the agent in this type of relationship. [This answer is incorrect. If aprincipal-agent relationship exists, the acts of the agent are attributed to the principal.]

d. There is minimal effect on UBI when a principal-agent relationship exists. [This answer is incorrect. Afinding that there is an agency relationship between an exempt organization and another party that is arevenue source for the exempt organization potentially creates UBI problems. Nonprofit organizationsshould carefully review contractual language to ensure that an agency relationship is not beinginadvertently created.]

14. Which of the following organizations will most likely have UBI? (Page 68)

a. The Northern Organization is fully supported by the annual membership dues paid by all of its members.[This answer is incorrect. Tax-exempt membership organizations generally are supported by annualmembership feesordues.When this income ispaidbyallmembers ingeneral support of anorganization’sexempt purpose and activities, it is related to the organization’s exempt purpose and is not from theconduct of an unrelated trade or business. Therefore, the fact that membership income provides theNorthern Organization’s full support will not cause the organization to have UBI.]

b. The Southern Organization is a Section 501(c)(6) organization that accepts dues from associatemembers who join only to receive certain benefits. [This answer is correct. An organizationmay seekadditional income by providing unrelated products or services while at the same time restricting itsmembership to those truly interested in its exempt purposes. Organizations commonly establish anassociate or limited membership category for those primarily interested in obtaining the unrelatedproducts or services, as the Southern Organization did in this scenario. Typically, such associatemembershavenodirect contactwith theexempt functionsof theorganization. According to the rulingin National League of Postmasters of the United States and Ltr. Ruls. 9345004 and 9416002, Section501(c)(5) and (c)(6) organizations can have UBI from the receipt of associate member dues if theassociate member joins primarily to get the benefits offered by the organization. Since that is whathas happened in this scenario, the Southern Organization is likely to have UBI.]

c. The Eastern Organization collects fees from associate members who participate in an activity related toits exempt purpose. [This answer is incorrect. According to Ltr. Rul. 9742001, organizations may havecategories of associate members without generating unrelated business taxable income (UBTI) if thesemembers are active participants in the organizations’ exempt activities. Since that is the case in thisscenario, the Eastern Organization should not have UBI from these membership dues.]

d. TheWestern Organization is a Section 501(c)(5) organization that collects dues from associate membersfor membership convenience, not profit. [This answer is incorrect. According to Rev. Proc. 95-21, the IRSwill not treat dues from associate members of a Section 501(c)(5) organization as UBI unless, for therelevant period, the associate member category was for the principal purpose of producing UBI, which isnot the case for the Western Organization.]


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15. When is an organization exempt from considering income from running a parking facility as UBI? (Page 71)

a. The parking facility is open to the general public. [This answer is incorrect. In Ltr. Rul. 200124022, the IRSruled that operating parking facilities was substantially related to an organization’s exempt purposes andreasoned that without adequate parking, people would be discouraged from going to the area, therebypreventing theorganization fromaccomplishing itspurposes.However,merelyopening theparking facilityto the general public (as opposed to, say, just organization members) is not enough of a reason for theincome to be excluded fromUBI. The organization would need to find a reasonmore in line with whateverits general purpose is to qualify for this exemption.]

b. The parking facility is open every day. [This answer is incorrect. According to Reg. 1.513-1(c)(2)(i), if anexempt organization opens its parking garage or lot to the general public for only a few days annually (forexample, when a major convention or state fair is in town), the resulting income should not be taxable.However, if the parking facility is open to the public one or more days each week throughout the year, theactivity will be considered regularly carried on and, therefore, potentially taxable.]

c. The availability of parking is a convenience for organization patrons. [This answer is correct. Anactivity carried on by a Section 501(c)(3) entity, or by a governmental college or university primarilyfor the convenience of its members, students, patients, officers, or employees, is not an unrelatedtrade or business. Thus, the income from a parking facility operated by an exempt hospital for theconvenience of its patients and their visitors or by an exempt school for its students, faculty, andother employees is not taxable. Similarly, the income from a parking facility operated by an exemptmuseum, zoo, or aquarium primarily for its visitors should not be taxable.]

d. Theparking facility is runby theorganization itself. [This answer is incorrect. Insteadof operating aparkingfacility directly, an organization can lease the facility to a third-party operator. The IRS has ruled that leaseincome was exempt from rent from real property even though the exempt organization lessor providedmaintenance, repairs, cleaning, and lighting to the lessee.]

16. Which of the following statements best describes the special rules that apply to social and recreational clubs,voluntary employees’ beneficiary associations (VEBAs), and supplemental unemployment benefit trusts(SUBTs)? (Page 72)

a. Once a social club is in liquidation, it is no longer operating exclusively for its tax-exempt purpose;therefore, proceeds from selling its assets will be unrelated business taxable income (UBTI). [This answeris incorrect. When it becomes impractical for a club to continue its exempt activities, the sale of its assetsto facilitate liquidation is considered incidental to its exempt purposes, per Rev. Rul. 58-501. Therefore, aclub is still considered operated exclusively for exempt purposes through the date of the sale and thedistribution of the sales proceeds to its members.]

b. When calculating taxable investment income, organizations of these types can deduct income receivedfrom dividends in the same way a taxable organization would. [This answer is incorrect. In calculatingtaxable investment income, a deduction is allowed for all expenses directly connectedwith the productionof that income and for the income set aside in accordance with the procedures under IRC. Sec.512(a)(3)(B). However, evenwhen part of this income is fromdividends, the dividends received deductionavailable to taxable entities is not allowed because it is not considered a directly connected expense, perIRC Sec. 512(a)(3)(A).]

c. If oneof these types of organizations sets aside income for specific purposes under IRCSec. 512(a)(3)(B),it cannot be invested or otherwise used or it will become UBTI again. [This answer is incorrect. Set-asideincome may be temporarily invested or accumulated without losing its exempt function incomeclassification if the amount and duration are not unreasonable.]

d. The primary adjustment that organizations of these types must make to determine their UBTI is toreduce their gross income by their exempt function income. [This answer is correct. According toIRC Sec. 512(a)(3), UBTI is computed differently for these types of organizations. The primaryadjustment that social clubs, VEBAs, and SUBTsmake in determining their UBTI is to reduce grossincome by exempt function income. Exempt function incomemeans gross income from dues, fees,charges, or similar amounts paid by members for goods, facilities, or services (for themselves,dependents, or guests) that further the exempt function of the entity.]


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Lesson 3: Deductions Allowed in DeterminingUnrelated Business Taxable IncomeIntroduction

An organization’s unrelated business taxable income (UBTI) is the excess, if any, of its gross unrelated businessincome (UBI) over allowable deductions. This lesson discusses the expenses that are deductible from UBI indetermining UBTI (and reported in Part II of Form 990-T). Expenses or deductions reported in Part I of the return(e.g., direct advertising expenses), should not be listed again in Part II.

Exempt organizations normally are allowed to deduct expenses directly connected to the production of UBI in thesamemanner as for-profit entities. They are also subject to the same expense limitations that apply to such entities.A complete discussion of all the possible deductions available to an organization in determining UBTI is beyond thescope of this publication. However, if more detailed guidance is needed, see PPC’s 1120 Deskbook.


Completion of this lesson will enable you to:¯ Recognize the general rules for deducting expenses when determining unrelated business taxable income(UBTI) and how to deal with interest expense and charitable contributions.

¯ Determine the effects of depreciation, the Section 179 deduction, and the net operating loss deduction; howto amortize organizational and start-up expenses; and how to deal with qualified disaster expenses and lossesor credits from tax shelters.

General Rules about the Deductibility of Expenses When Determining UBTI

Directly Connected Expenses

The deductions allowed in determining unrelated business taxable income (UBTI) include the ordinary and neces-sary expenses that are directly connected with the unrelated business income (UBI). To be directly connected, anexpense must bear a primary relationship to the conduct of the activity. For example, individuals who work full-timein the activity or an entire building used in the conduct of the activity would be directly connected. The expensesdeductible in computing UBTI would be the salaries and fringe benefits paid to the individuals, as well as all costsattributable to the building (including depreciation). (Guidance on computing depreciation expense appears laterin this lesson.)

Tax-exempt organizations have the same burden as other taxpayers to substantiate the amount and purpose of anydeduction claimed in computing UBTI. When an organization cannot produce original documents to support theexpenses claimed on its tax return, the Tax Court held that the annual report and the audited financial statementsare insufficient evidence.

Limitations on Certain Deductions

In computing its UBTI, an organization’s directly connected expenses are subject to the deduction limitations thatapply to for-profit entities.

Related Party Rules. The related party rules normally prevent an organization from immediately recognizing a losson the disposition of property to a related entity, generally defined as members of the same controlled group (e.g.,a loss on the sale of property to an organization’s taxable subsidiary).

If an otherwise deductible expense is owed to a related party using the cash method of accounting, the relatedparty rules delay the deduction of such expense until the tax year in which it is paid. For example, if a portion of theyear-end accrual of a foundation manager’s bonus (assuming the manager directly or indirectly controls thefoundation) is directly connected to an unrelated business activity, the accrued bonus cannot be included indetermining UBTI until the year the manager includes it in income.


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Uniform Capitalization (UNICAP) Rules. The UNICAP rules require organizations to capitalize or include ininventory certain costs that would otherwise be immediately deductible. The rules apply to the production of realand personal tangible property (e.g., a building or piece of machinery) held for sale or used in an unrelated tradeor business. Depending on the level of an organization’s gross receipts, the rules can also apply to personalproperty acquired for resale in an unrelated business activity. For example, interest expense allocated to theproperty’s production period may have to be capitalized. Capitalization of interest is required if either of thefollowing conditions apply to the property:

1. It is real property.

2. It is tangible personal property that either:

a. is produced for use by the taxpayer or a related party and has a useful life of 20 years or more underIRC Sec. 168 (interest capitalization is not required on property with a production period of 90 daysor less and a total cost not exceeding $1 million divided by the number of days in the productionperiod;

b. has an estimated production period exceeding two years; or

c. has an estimated production period exceeding one year and a cost exceeding $1 million.

For this purpose, a property’s production period begins on the date production of the property starts and ends onthe date the property is ready to use or to be held for sale.

Example 3A-1 Allocating interest expense related to property built for self-use.

Charities, Inc. (Charities), borrowed $100,000 to construct a small office building to be used exclusively in anunrelated business activity. During the current year, interest on the loan is $4,500. (The building is still fourmonths away from completion at year-end.) None of the interest expense can be deducted in the current year.The debt is allocated entirely to the construction of real property. Thus, the interest expense must becapitalized into the basis of the building. Such capitalized interest expense is then recovered throughdepreciation once the building is placed in service.

See PPC’s 1120 Deskbook for more guidance on the application of the UNICAP rules.

Meals and Entertainment Expenses. For expense paid or incurred before January 1, 2018, the deduction formeals and entertainment expenses directly connected to an unrelated business activity normally is reduced by50% of the expenditure. However, meals provided on an employer’s premises for the employer’s convenience areconsidered a 100% deductible de minimis fringe benefit. Although not every meal provided on the employer’sbusiness premises is for the employer’s convenience, IRC Sec. 119(b)(4) treats allmeals as being provided for theemployer’s convenience if more than 50% of the employees who receive meals on the employer’s businesspremises are furnished the meals for the employer’s convenience. Thus, if this 50% safe harbor test is satisfied, theemployer can deduct 100% of the cost of providing all the meals.

Law Change: Effective for amounts paid or incurred after December 31, 2017, the 2017 Tax Cuts and Jobs Act(TCJA) repealed the deduction for entertainment expenses. In addition the TCJA expands the 50% limit on thedeductibility of business meals to include those provided on the employer’s premises (i.e., there is no longer a100% deduction).

For any portion of meal and entertainment expenses to be deductible, a bona fide business discussion normallymust occur immediately before, during, or immediately after the meal or entertainment. However, no deduction isallowed for the portion of a business meal that is lavish or extravagant under the circumstances; neither is adeduction normally allowed for a business meal unless an employee of the organization (or an independentcontractor such as a CPA or attorney who is providing services to the organization) is present at the meal.

In addition, an organization cannot deduct expenses for use of a facility (such as a yacht or hunting lodge) for anactivity usually considered entertainment, amusement, or recreation.


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Travel for Companions. Travel expenses of any individual accompanying an organization’s officer or employee,including a spouse or other companion, cannot be deducted unless the individual is an employee and his or hertravel is for a bona fide business purpose and would otherwise be deductible by that individual. If the value of thecompanion travel is reported as taxable compensation to the employee, the expenses may be deducted asemployee wage expense.

Property Leased to Exempt Entities. The deductions related to property leased to a governmental or othertax-exempt entity cannot exceed the amount of income from the lease payments. (This limitation also applies tocertain property that is treated as tax-exempt use property other than by reason of the lease.) Any amount that isdisallowed in the current year is treated as a deduction with respect to the property in the next tax year.

Fines and Penalties. No portion of a fine or penalty paid in connection with an unrelated business activity isdeductible in determining an organization’s UBTI. However, some payments labeled “penalties” may neverthelessbe deductible under IRC Sec. 162(a). If the purpose of imposing a payment liability is remedial (e.g., it is intendedto encourage prompt compliance with the law or is to compensate another party) rather than punitive, the paymentgenerally will be deductible.

Other Allowable Deductions

In addition to directly connected expenses, an organization may be allowed to claim a charitable contributiondeduction, a net operating loss deduction, and the $1,000 specific deduction when calculating its UBTI.

Dual Use of Facilities or Personnel

Allocate the expenses of facilities and personnel used to conduct both exempt function and unrelated businessactivities between the two uses on a reasonable basis. Keep adequate records to support the allocation methodused.

There are two basic methods for allocating fixed overhead expenses of facilities used for both unrelated businessactivities and exempt function activities between such uses:

1. The method approved in Rensselaer Polytechnic Institute is to allocate expenses using the ratio of daysa facility is used for unrelated business activities during the tax year (numerator) versus the total days thefacility is used for all purposes during the year (denominator). This approach treats the fixed expensesincurred during the period the facility is not in use as being allocable to both exempt and nonexempt uses.Consequently, it maximizes the fixed expenses allocable to the unrelated business activities.

2. The IRS agrees that the numerator of the allocation ratio should be the number of days the facility is usedfor unrelatedbusiness activities. However, the IRSasserts that the denominator should be the total numberof days the facility is available for use during the year, not actual usage. This method treats the fixedexpenses related to theportionof theyear the facility isnot inuseasbeingsolelyexempt functionexpenses.

Example 3A-2 Allocating expenses for the dual use of facilities and personnel.

The Law Enforcement Center (LEC), a tax-exempt organization, conducts exhibits and shows throughout theyear in its multipurpose auditorium. All of these activities are exempt function activities. When the auditoriumis not needed for exempt function activities, LEC regularly stages special events (e.g., concerts, movies, andplays) in it that produce unrelated business income (UBI).


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In the current year, LEC conducted exempt function activities in the facility for 150 days and unrelatedbusiness activities for 75 days for a total of 225 days of use. The gross UBI totaled $355,000, while theexpenses attributable solely to this revenue were as follows:

Fees paid to performers $ 143,300Movie rental fees 39,700Legal fees related to preparing or reviewing performers’ contracts 3,750Salary of special events manager 28,000Allocable portion of the $50,000 salary of LEC’s president, Sheila Roberts (shespent 10% of her time on matters related to the special events) 5,000Fringe benefit costs associated with the manager and the portion of the presi-dent’s time devoted to matters dealing with the facility:Health insurance costs 3,200Payroll taxes 2,200Pension contribution 1,300

Total direct expenses $ 226,450

In addition, LEC incurred the following expenses for operating the auditorium for the entire year (including the140 days when the facility was not in use):

Salaries of facility manager and security personnel $ 67,000Fringe benefit costs for these employees:Health insurance costs 9,800Payroll taxes 6,100Pension contribution 4,300

Repairs and maintenance 17,900Depreciation 26,500Utilities and other operating expenses 38,450

Total indirect (fixed) expenses $ 170,050

The $226,450 of direct expenses are deductible because such expenses are directly connected with theactivities that produced that income. In addition, a portion of the indirect (fixed) expenses of operating thefacility are allocated to UBI, based on a reasonable allocation method.

Using the Rensselaer method, LEC could allocate $56,683 of the facility’s indirect expenses to its unrelatedbusiness activities, calculated as follows:

75 (days used in unrelated business activity)225 (total number of days facility was used)

× $170, 050 = $56, 683

Using the IRS method, LEC could allocate only $34,942 of the facility’s indirect expenses to its unrelatedbusiness activities, calculated as follows:

75 (days used in unrelated business activity)365 (total number of days in the tax year)

× $170, 050 = $34, 942

The $21,741 ($56,683− $34,942) difference between the two methods involves the fixed expenses related tothe portion of the year when the facility is not used for any purpose. The IRS method treats these expensessolely as exempt function expenses (i.e., totally nondeductible in calculating UBTI). In contrast, the Rensse-laer method allocates the fixed expenses during the facility’s down time between the various uses of thefacility, both exempt and nonexempt. Thus, the Rensselaermethod allows more to be deducted in determin-ing UBTI.

LEC reports the deductible expenses related to its unrelated business activities in Part II of Form 990-T. Theportion of Sheila’s compensation ($5,000) allocable to unrelated gross business income must be reported incolumn 4 of Schedule K of Form 990-T, as well as on line 14 of Part II. The remainder of her salary is notreported on Form 990-T.


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Expense Allocation in Exploited Exempt Activity

An organization’s exempt function activities may generate goodwill that can be exploited commercially. If so, theresulting income may be UBI unless the activity significantly contributes to the accomplishment of the organization’sexempt purpose. If it does, expenses (including Section 179 expense) and depreciation attributable to the conduct ofthe exempt activity are generally not deductible in computing UBTI.

However, an organization can offset its expenses and depreciation from the conduct of its exempt activity againstincome from the commercial exploitation if the organization can establish that (1) the commercial activity is a kindcarried on for profit by taxable organizations, and (2) its exempt activity exploited commercially is a type of activitynormally conducted by taxable organizations in pursuit of such business.

Even if an organization can establish these two points, it can deduct depreciation and expenses attributable to theexempt activity against the UBI only to the extent that:

1. the aggregate of such depreciation and expenses exceeds the income derived from or attributable to theexempt activity, and

2. the allocation of the amounts in excess of the income derived from the exempt activity does not result ina loss from the unrelated trade or business activity.

Example 3A-3 Advertising on the website.

Concerned Citizens of America (CCA) is a nonprofit organization that promotes its educational mission on itswebsite. The website also earns $50,000 of taxable advertising revenue unconnected with any periodical. Thewebsite generates no other revenue. Expenses directly connected to the conduct of the advertising activityare $2,000. Other website expenses unrelated to the advertising are $250,000.

Visitors to CCA’s website are interested in the educational material. CCA is exploiting the web traffic byposting advertisements next to the educational material. Advertising is a commercial activity typically carriedon for profit by taxable organizations, and the educational material is an exempt activity typically conductedby taxable organizations in pursuit of advertising revenue.

CCA has $48,000 of net income from an unrelated trade or business. However, since the advertising incomearises from the exploitation of an exempt activity, CCA should complete Form 990-T Schedule I (althoughSchedule I is called “Exploited Exempt Activity Income, Other Than Advertising Income,” the form instructionsindicate that advertising income other than from periodicals should be reported here). CCA may deduct itsexempt activity website expenses to the extent that they exceed its exempt activity website revenue, butlimited to the net income from the unrelated activity. CCA would deduct $48,000 of excess exempt expenses,and net UBI from the activity would be $0.

Allocating and Deducting Interest Expense

An organization may incur interest expense for a variety of reasons. However, interest expense is generallydeductible in calculating unrelated business taxable income (UBTI) only if it is directly connected with the produc-tion of the unrelated business income (UBI). In addition, specific rules may bar or defer the deduction of interestexpense even when it arises in an unrelated trade or business.

Deductible interest is reported on line 18, Part II of Form 990-T, and the deduction must be substantiated in asupporting statement.

Allocable Interest Expense

Since borrowed funds may be used for multiple purposes, the related interest expense must be allocated to therespective uses in order to determine deductibility. If, for example, loan proceeds are used in part to acquireinvestment assets and in part to acquire an interest in a passive activity, interest must be allocated to each use. The


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portion allocable to the acquisition of investment assets is deductible in accordance with the debt-financed incomerules. This interest expense is claimed in column 3(b) of Schedule E, Form 990-T. The deductibility of the interestallocable to the passive activity may be limited by the “at risk” rules of IRC Sec. 465 [see Form 6198 (At-RiskLimitations)] or the passive activity loss rules of IRC Sec. 469 [see Form 8582 (Passive Activity Loss Limitations) fortrusts and Form 8810 (Corporate Passive Activity Loss and Credit Limitations) for corporations].

Interest expense on a debt is allocated in the same manner as the debt to which such interest relates is allocated.Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures. See Temp. Reg.1.163-8T(a)(3) for the tracing rules.

Interest attributable to the portion of a loan used to carry out exempt purpose activities is not deductible for UBTIpurposes.

Nondeductible or Deferred Interest Expense

Municipal Bond Interest. Interest income from state and local bonds is exempt from UBI. Therefore, interest onindebtedness incurred or continued to purchase or carry such bonds is not deductible.

Prepaid Interest. Generally an organization that uses the cash method of accounting cannot currently deductinterest attributable to years following the current year. For example, a cash basis, calendar year organization thatprepays interest in 2017 for 2018 in connection with an unrelated trade or business can only deduct that part of theprepayment allocable to 2017. The prepayment for 2018 will be deductible in 2018.

Interest on Straddle Investments. An organization may use straddles as part of its investment portfolio strategies(a straddle is basically the holding of offsetting positions in personal property that are designed to reduce owner-ship risks. Interest expense (and other carrying charges) attributable to straddles is not currently deductible. It iscapitalized as part of the straddle cost.

Original Issue Discount. A corporation may issue a debt obligation (e.g., a bond) at a discount. Original issuediscount (OID) is the excess of the bond’s stated redemption price at maturity over its issue price if the OID exceedsa de minimis amount. This discount is normally deductible as interest expense over the life of the bond if the debtis incurred in connection with an unrelated trade or business. However, special rules apply to the deduction of OIDon an “applicable high yield discount” obligation:

1. No interest deduction is allowed until paid.

2. In some cases, a deduction may be barred for all or part of the OID, depending on the obligation’s yield,maturity date, and amount of OID.

A high-yield OID obligation is one with interest that is at least five percentage points over the applicable federal ratefor the month of issue and has a maturity date more than five years from the date of issue.

Interest on Tax Underpayments. No deduction is allowed for interest on any portion of an underpayment of taxthat arises because of:

1. an undisclosed listed transaction, or

2. an undisclosed reportable avoidance transaction.

A reportable transaction is any transaction for which information must be included with a return or statementbecause it is of a type that the IRS has determined as having potential for tax avoidance or evasion. A listedtransaction is a reportable transaction that is the same as, or substantially similar to, a transaction specificallyidentified by the IRS as a tax avoidance transaction for Section 6011 purposes.

Interest for Production of Designated Property. Interest that is allocable to the production by the organization ofcertain types of property held for sale or used in an unrelated business must be capitalized under the UniformCapitalization Rules.


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Related Party Interest. An organization that uses the accrual method of accounting for an unrelated trade orbusiness generally cannot deduct interest (and other expenses) owed to a related cash basis taxpayer until theyear in which payment is made and the interest is includible in the gross income of the lender. Consequently, anaccrual basis organization is treated as being on the cash method for purposes of deducting interest owed to arelated cash basis taxpayer.

Example 3B-1 Related party interest.

Forney First, Inc. (FFI), an accrual basis organization exempt under IRC Sec. 501(c)(3), provides food andshelter to needy families in Forney. FFI augments its charitable contributions by selling importedmerchandise(an unrelated business activity) in its thrift store. To expand these activities, FFI borrows $500,000 for one yearat 6% interest from ABC Pawnshop, Inc. (ABC), a wholly owned taxable subsidiary. ABC uses the cashmethod of accounting. On December 31, there is accrued interest of $22,500 on the loan. FFI cannot deductany of this interest until it repays the loan in the following year and the interest income is reported by ABC.

Interest Paid to a Partnership. A corporate organization that pays interest to a partnership in which it is a partner,directly or indirectly, may not be able to deduct such interest under certain circumstances.

Other Rules

An organization can deduct foregone interest on a below-market loan that it is deemed to have paid to the lender.A below-market loan is:

1. a demand loan where interest is payable on the loan at a rate less than the applicable federal rate, or

2. a term loan where the amount loaned exceeds the present value of all payments due under the loan.

These rules are inapplicable to loans of $10,000 or less, to amounts treated as unstated interest, and to certainother loans to qualified continuing care facilities.

Deducting Charitable Contributions

General Rules

When calculating unrelated business taxable income (UBTI), organizations are allowed to deduct charitablecontributions, regardless of whether the contributions are directly connected with carrying on an unrelated trade orbusiness. The term charitable contribution has the samemeaning here as it does in the case of for-profit entities. Forexample, a Section 501(c)(3) organization may claim a deduction for a contribution to another charitable organiza-tion, but not for payments made in conducting its own charitable programs or for scholarships and similar awardsmade to individuals. Although an interfund transfer on an organization’s booksmay qualify as a charitable contribu-tion under state law, such transfer is not equivalent to payment to an outside charity under federal law.

Deduction Limit

A corporate organization’s deduction for otherwise allowable charitable contributions is generally limited to 10% ofits UBTI, computed without regard to the charitable contribution itself, any domestic production activities deductionunder IRC Sec. 199, any net operating loss carryback under IRC Sec. 172 to the tax year, or any capital losscarryback under IRC Sec. 1212(a)(1) to the tax year. Charitable contributions that exceed the 10% limit may becarried over and deducted against UBTI in the succeeding five tax years (to the extent contributions made in thoseyears, plus carryover contributions from earlier years, do not already exceed the 10% limit for that year).

Tax-exempt trusts are allowed a higher deduction limit (either 30% or 50% of UBTI, calculated without the charitablecontribution deduction). In addition, a tax-exempt trust may claim a charitable contribution deduction not only forcontributions made to unrelated charitable entities but also for distributions made to charitable beneficiaries of thetrust.


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Example 3C-1 Contributions deductible in determining UBTI.

Peace for All, Inc. (PFA), a Section 501(c)(3) organization, operates a soup kitchen for homeless individuals.Substantially all of the food served is donated to PFA by local restaurants and grocery stores. During the year,PFA also spent $100,000 of its own funds in operating the facility. PFA occasionally receives more perishablefood than it can use. To avoid wasting this excess food, PFA donates it to TSP (another public charity thatoperates a similar type of soup kitchen). PFA donated $6,000 of food to TSP during the year (based on the fairmarket value of the food at the time PFA made the donations, which in all cases was less than PFA’s basis inthe donated items). PFA also operates an unrelated business. Prior to any deduction for charitable contribu-tions, PFA’s UBTI from this activity is $20,000.

PFA has a total of $6,000 in charitable contributions for the year. None of the $100,000 PFA spent on its owncharitable activities is deductible. In determining its UBTI, PFA can deduct the lesser of its charitable contribu-tions ($6,000) or 10% of its UBTI before any contributions deduction. Thus, its deduction for charitablecontributions is $2,000 ($20,000 × 10%). PFA has $4,000 ($6,000 − $2,000) of contributions that carry overto the next five tax years, subject to the normal 10% limitation in each of those years.

Accrual-basis Corporations

Tax-exempt corporate organizations using the accrual basis of accounting can make retroactive charitable contri-butions. In determining its UBTI, such an organization may deduct a charitable contribution made after year-end ifthe following conditions are satisfied:

1. The entity’s board of directors authorized the contribution prior to the end of the taxable year that thededuction is taken.

2. The contribution is actually made on or before the 15th day of the third month following the end of the taxyear for which the deduction is claimed.

3. The organization elects to treat the contribution as paid during the year for which Form 990-T is filed (i.e.,the election can be made on the 2017 return for contributions paid in 2018).

Reg. 1.170A-11(b)(2) indicates the election is made by complying with the following requirements:

1. Report the contribution on Form 990-T, Part II, line 20.

2. Attach a written declaration to the return. The declarationmust indicate the contribution was authorized ina resolution adopted by the board of directors during the tax year and the date of the resolution. Thedeclaration is verified by signing the return.

3. Retainacopyof the resolutionof theboardauthorizing thecontributionandmake it available for inspection.

Example 3C-2 Electing to deduct contributions made after year-end.

PFA (see Example 3C-1) makes a $20,000 contribution to a qualifying organization on March 1, 2018. Thecontribution was approved by its Board of Directors in 2017. PFA may elect to include the $20,000 as acharitable contribution on its 2017 Form 990-T. The contribution is reported on line 20 of Part II (subject tolimitations previously discussed). PFA must attach a written declaration to the return indicating the contribu-tion was authorized in a resolution adopted by the board of directors during the tax year (2017). A copy of thisresolution must also be retained by PFA and made available for inspection.

Contributions of Property

If an organization contributes more than $500 in property other than cash during a tax year, it is required to attacha schedule to Form 990-T describing the property contributed and the method used to determine its fair marketvalue (FMV) (e.g., thrift shop prices or newspaper advertisements). If the organization contributes more than$5,000 in property during a year, Form 8283 (Noncash Charitable Contributions) must be attached to Form 990-Twhen it is filed.


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Example 3C-3 Property contributions in excess of $500.

PFA (see Example 3C-1) contributed a painting valued at $2,000 to Hope Museum. This was PFA’s onlyproperty donation during the year. Since PFA donatedmore than $500 but less than $5,000 in property duringthe year, it attaches a schedule to its Form 990-T describing the property contributed and the method used todetermine the FMV. A deduction for the contribution is claimed on line 20, Part II, of PFA’s Form 990-T (subjectto the deduction limit discussed earlier in this lesson).

Example 3C-4 Property contributions in excess of $5,000.

Assume the same facts as in Example 3C-3, except that the painting has an appraised value of $25,000. Form8283 (including a copy of the appraisal) must be attached to Form 990-T.

The deduction for certain types of property can be an amount other than its FMV, including—

1. vehicles (automobiles, boats, and airplanes), and

2. intellectual property (such as patents, copyrights, trademarks, and software).

Businesses that donate certain types of property, such as inventory and other ordinary or short-term capital gainproperty, normally are limited to a charitable deduction equal to the property’s basis, even if FMV is greater.However, certain qualifying contributions of such property entitle the donor to an enhanced charitable deduction forUBI purposes equal to the lesser of:

¯ basis plus half of the appreciation (fair market value in excess of basis); or

¯ two times basis.

The enhanced contribution deduction includes the following:

1. A corporation’s inventory or property held for sale to customers gifted to a qualified public charity or privateoperating foundation,where thedonee’suseof theproperty is for thecareof infants, or ill or needypersons.

2. Anyentity’s donationsof food from inventory, if the charitable doneeaffirms inwriting that it will use the foodsolely for the care of the ill, the needy, or infants. The foodmust be “apparently wholesome food” (i.e., foodintended for human consumption that meets all governmental quality and labeling standards andregulations even though it may not have been readily marketable due to appearance, age, freshness,grade, or other conditions).

Thegeneral 10% limit oncharitable contributions (discussedpreviously) increases to15% for contributionsof food inventory. The FMV of wholesome foods shall not be determined based solely on the donor’sinternal standards or lack ofmarket, but is instead based on the price at which similar food itemswere soldin the recent past.

3. A corporation’s scientific property used for research gifted for research purposes to an institution of highereducation or to an exempt scientific research organization, provided certain requirements are satisfied.

Substantiation for Contributions

For cash or property contributions of $250 or more, an organization is not allowed a deduction for the donationunless it receives a contemporaneous written acknowledgment of the donation from the donee organization. Thisacknowledgment is not attached to Form 990-T but should be kept with the organization’s records. For monetarygifts (e.g., cash or check), regardless of amount, a bank record, receipt, letter, or other written communication fromthe donee organization should be maintained that reflects the donee’s name, contribution date, and amount.

For contributions of property [other than intellectual property, vehicles (if the donor’s deduction is limited to thegross proceeds from its sale), inventory, or publicly traded securities], an organization must obtain a qualified


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appraisal if claiming a deduction of more than $5,000. [A qualified appraisal is an appraisal that satisfies therequirements of Reg. 1.170A-13(c)(3).] This appraisal must be attached to Form 990-T (with Form 8283) if (1) thecontribution is art and the deduction claimed is $20,000 or more, or (2) the deduction claimed is more than$500,000, regardless of the type of property contributed.

An organization must satisfy additional substantiation requirements if the contributed property is an automobile,boat, or airplane, or certain real property interests located in a registered historic district.


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SELF-STUDY QUIZ


17. Which of the following organizations has correctly made a deduction when calculating its 2017 UBTI?

a. Education First, a cash basis organization, sells an asset to a related property at a loss and recognizes theloss right away.

b. CharityManufacturing immediatelydeducts theproductioncostsof personal tangibleproperty that it sells.

c. TheSalvationSociety deducts 100%ofmeals that it providesonsite to feed its employeesduring its annualfundraising push.

d. Clean Our Air deducts travel expenses for its president and his wife, who is not affiliated with theorganization, on a business-related trip.

18. Assuming all other conditions are met, when can a tax-exempt corporate organization deduct a charitablecontribution made after year-end from its UBTI?

a. The contribution is authorized by the organization’s management.

b. The contribution must be made before June 30 of the next tax year.

c. The organization must elect this treatment on the tax year’s Form 990-T.

d. The contribution is made of cash, not property.


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SELF-STUDY ANSWERS


17. Which of the following organizations has correctly made a deduction when calculating its 2017 UBTI?(Page 83)

a. Education First, a cash basis organization, sells an asset to a related property at a loss and recognizes theloss rightaway. [Thisanswer is incorrect. IRCSecs.267(a)(1) and (f)(2) and1563(b)(2)(B)normallypreventan organization from immediately recognizing a loss on the disposition of property to a related entity. If anotherwise deductible expense is owed to a related party using the cashmethod of accounting, the relatedparty rules delay the deduction of such expense until the tax year inwhich it is paid. Therefore, if EducationFirst does not receive the funds for the sale this year, it will have to wait to claim the deduction.]

b. CharityManufacturing immediatelydeducts theproductioncostsof personal tangibleproperty that it sells.[This answer is incorrect. The UNICAP rules require organizations to capitalize or include in inventorycertain costs thatwouldotherwisebe immediately deductible. The rulesapply to theproductionof real andpersonal tangible property (such as that produced by Charity Manufacturing) held for sale or used in anunrelated trade or business.]

c. The Salvation Society deducts 100% of meals that it provides onsite to feed its employees duringits annual fundraising push. [This answer is correct. The deduction for meals and entertainmentexpenses directly connected to an unrelated business activity normally is reduced by 50% of theexpenditure. However, meals provided on an employer’s premises for the employer’s convenienceare considered a 100% deductible de minimis fringe benefit under IRC Sec. 132(e)(2). Therefore,since providing the meal benefits the Salvation Society by keeping its employees on premises forthe fundraisingpush, it qualifies for thisdeduction.Note:Effective foramountspaidor incurredafterDecember 31, 2017, the 2017 Tax Cuts and Jobs Act (TCJA) expands the 50% limit on thedeductibility of business meals to include those provided on the employer’s premises (i.e., there isno longer a 100% deduction).]

d. Clean Our Air deducts travel expenses for its president and his wife, who is not affiliated with theorganization, on a business-related trip. [This answer is incorrect. Travel expenses of any individualaccompanying an organization’s officer or employee, including a spouse or other companion, cannot bededucted as a travel expense unless the individual is an employee and his or her travel is for a bona fidebusiness purpose and would otherwise be deductible by that individual. However, the expenses may bededucted as employee wage expense if the value of the companion travel is reported as taxablecompensation to the employee. ]

18. Assuming all other conditions are met, when can a tax-exempt corporate organization deduct a charitablecontribution made after year-end from its UBTI? (Page 89)

a. The contribution is authorized by the organization’smanagement. [This answer is incorrect. According toIRC Sec. 170(a)(2) and Reg. 1.170A-11(b)(2), the entity’s board of directors (not just management) musthave authorized the contribution prior to the end of the taxable year that the deduction is taken.]

b. The contributionmust bemade before June 30 of the next tax year. [This answer is incorrect. Per IRCSec.170(a)(2) and Reg. 1.170A-11(b)(2), the contribution must actually be made on or before the 15th day ofthe third month following the end of the tax year for which the deduction is claimed.]


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c. Theorganizationmust elect this treatment on the tax year’s Form990-T. [This answer is correct.Oneof the conditions for this treatment discussed in IRCSec. 170(a)(2) andReg. 1.170A-11(b)(2) is thatthe organization must elect to treat the contribution as paid during the year for which Form 990-Tis filed (i.e., the election can be made on the 2017 return for contribution paid in 2018).]

d. The contribution ismade of cash, not property. [This answer is incorrect. The conditions listed in IRC Sec.170(a)(2) and Reg. 1.170A-11(b)(2) do not include a limitation on the form of the contribution; therefore,this condition would not need to be met. However, if the organization did contribute property, there areother rules it must follow.]


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Managing Depreciation and Section 179 Deduction

Background

When calculating unrelated business taxable income (UBTI), an organization is allowed a depreciation deductionto the extent the use of depreciable property is directly connected with the organization’s unrelated businessactivity. If property is only partially used for an unrelated business activity (and the remainder of the time for anexempt function), a depreciation deduction is allowed in computing UBTI to the extent the property is used in theunrelated business activity.

Calculating Deductible Depreciation

For simplicity, many tax-exempt organizations use straight-line (SL) depreciation for keeping their books andreporting on their annual Form 990. (An organization has several options for calculating depreciation, as explainedin PPC’s 1120 Deskbook.) However, to calculate UBTI, deductible depreciation is normally determined based onthe same rules applicable to for-profit enterprises (except that unrelated debt-financed property must be depreci-ated using the SL method of depreciation). Form 4562 (Depreciation and Amortization) is used to claim theorganization’s allowable depreciation deductions and should be attached to Form 990-T before the return is filed.

Reporting Depreciation Expense

The total depreciation reported on Form 4562 is listed on line 21 of Form 990-T. Any depreciation reported onForm 4562, but claimed in other parts of the return (e.g., Schedules A, C, E, I, or J) should be reported on line 22a.The net depreciation deductible in Part II is listed on line 22b.

The Section 179 Deduction

Organizations can elect to expense (rather than capitalize and depreciate) under Section 179 qualified propertyused in an unrelated trade or business activity.

Deduction Limit. Themaximum amount that can be expensed under Section 179 is $500,000, indexed for inflation.For 2017, the overall limit is $510,000.

Phase-out of Deduction. Themaximum deduction that can be claimed is reduced dollar for dollar to the extent theamount of qualified property placed in service during the year exceeds $2,030,000 of qualifying property in 2017.Thus, if the organization places at least $2,540,000 of qualified property into service in 2017, no Section 179deduction is allowed.

Taxable Income Limitation. The maximum Section 179 deduction is also reduced to the extent it exceeds theorganization’s UBTI for the year (calculated before any net operating loss deduction or Section 179 deduction). Anyportion of the Section 179 deduction attributable to personal property disallowed by the taxable income limit maybe carried over indefinitely to future tax years.

Example 3D-1 Claiming the Section 179 deduction.

United Charities, Inc. (United), a Section 501(c)(3) tax-exempt organization, has $8,000 of UBTI. Included inthe calculation of UBTI is a deduction of $715 in depreciation related to a $5,000 piece of equipment thatUnited acquired during the year for use in its unrelated business activity.

To reduce its UBTI for the current year, United can elect to claim a Section 179 deduction for the newequipment and lower its UBTI to $3,715 ($8,000 + $715− $5,000). This election is made by completing PartI of Form 4562 and attaching it to United’s Form 990-T. The Section 179 deduction, along with United’s otherdepreciation expense calculated on Form 4562, is shown on Part II, line 21, of Form 990-T.

Qualified Tangible Property. Property eligible for the expense election includes tangible property (that is deprecia-ble under IRC Sec. 1245) purchased for use in an unrelated trade or business, and off-the-shelf computer software.


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However, it does not include property used outside the U.S. and property used for lodging. In addition, the propertycannot have been purchased from certain related parties [within the meaning of IRC Secs. 267 and 707(b)] or fromanother member of the same controlled group.

Qualified Real Property. Real property eligible for the Section 179 expense election includes the following:

1. Qualified leasehold improvement property costs, as defined by IRC Sec. 168(e)(6). The definition coversonly nonresidential building interior costs, and certain interior costs are excluded (such as the cost ofelevators and any interior structural framework of the building). The improvements must be placed inservice more than three years after the date the building was first placed in service.

2. Qualified restaurant property costs, as defined by IRC Sec. 168(e)(7). The definition covers both buildingand improvement costs. To qualify, however, more than 50% of the building’s square footage must bedevoted to the preparation of meals and seating for on-premises consumption of those meals.

3. Qualified retail improvement costs, as defined by IRC Sec. 168(e)(8). The definition covers onlynonresidential building interior costs for a building that is open to the general public and used in a retailbusiness of selling tangible personal property to the general public. Certain interior costs are excluded(suchas thecostofelevatorsandany interior structural frameworkof thebuilding). The improvementsmustbe placed in service more than three years after the date the building was first placed in service.

Qualified real property costs that are expensed under this provision reduce the overall maximum Section 179deduction allowance ($510,000 for 2017). If the limitation is exceeded, there is no prescribed order for which typeof cost must be expensed first.

Example 3D-2 Coordination with overall allowance.

In 2017, Good Deeds, Inc., (GDI), a Section 501(c)(3) organization with $600,000 of UBTI for the year, placesin service $110,000 of eligible personal property and $400,000 of qualified real property. GDI does notpurchase any other assets in 2017. GDI’s maximumSection 179 deduction for the year is $510,000 ($110,000for personal property + $400,000 for real property).

In 2017, GDI places in service $300,000 of eligible personal property and $600,000 of qualified real property.GDI does not purchase any other assets in 2017. GDI’s maximum Section 179 deduction for the year is$510,000. The $510,000 can come from any combination of personal and real property costs, as long as thelimitation on real property costs is not exceeded.

Bonus Depreciation

Law Change: The Tax Cuts and Jobs Act of 2017 (TCJA) made the following changes to IRC Sec. 168(k) that dealswith bonus depreciation:

¯ 50%bonus depreciation is available for qualifying new assets that are acquired and placed in service priorto September 28, 2017.

¯ Bonusdepreciationwas increased to100%withaphasedown forqualifyingnewandusedpropertyplacedin service after September 27, 2017, and before 2023 (2024 for certain property with longer productionperiods and certain aircraft).

¯ Bonus depreciation will phase down to 80% in 2023, 60% in 2024, 40% in 2025 and 20% in 2026. Forpropertywith a longer production period and certain aircraft, the phase down is: 80% in 2024, 60% in 2025,40% in 2026 and 20% in 2027.

¯ ForqualifiedpropertyacquiredbeforeSeptember28,2017,butplaced inserviceafterSeptember27,2017,bonus depreciation is available at 50% for property placed in service before 2018; 40% for property placedin service in 2018; and 30% for property placed in service in 2019. The phaseout for property having longerproduction periods and certain aircraft that are acquired before September 28, 2017, but placed in service


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after September 27, 2017, is: 50% for property placed in service in 2018, 40% for property placed in servicein 2019, 30% for property placed in service in 2020.

¯ For qualified property placed in service during the first tax year ending after September 27, 2017, thetaxpayer can elect to have bonus depreciation applied at 50% instead of the 100% that would generally beavailable for such property. The Secretary shall provide guidance on how this election is made.

Qualified Property. To be eligible for first-year bonus depreciation, the asset must fit into one of the followingdefinitions: (1) eligible Section 168 recovery property that has a recovery period of 20 years or less; (2) depreciablecomputer software with the exception for software that is amortizable over 15 years under IRC Sec. 197; (3) waterutility property, as defined in IRC Sec. 168(e)(5); or (4) qualified improvement property. Certain property havinglonger production periods can also qualify for bonus depreciation.

Law Change: The 2017 TCJA made the following changes to the definition of property that qualifies for bonusdepreciation:

¯ Added film or television production and qualified live production property to the list of assets eligible forbonus depreciation.

¯ Property acquired and placed in service prior to September 28, 2017, has to be new to qualify for bonusdepreciation. However, property acquired and placed in service after September 27, 2017, can be new orused.

¯ Qualified property will no longer include the following:

¯¯ Public utility property primarily used in a trade or business described in IRC Sec. 163(j)(7)(A)(iv).

¯¯ Certain vehicle dealer property used in a trade or business that has floor plan financing indebtedness.

Certain Leasehold Improvement Costs Qualify. The bonus depreciation break is available for the cost ofqualified leasehold improvement property. To meet this definition, the following tests must be met:

1. The improvement must be to the interior portion of a building.

2. The building must be nonresidential real property.

3. The improvement must be placed in service after the date the building was first placed in service. Theimprovements must not be for the enlargement of the building, an elevator or escalator, or the internalstructural framework of the building.

Additionally, bonus depreciation is allowed for certain trees, vines, and plants bearing fruit or nuts when planted orgrafted after December 31, 2015, rather than when placed in service.

Depreciation Expense on Property Converted to a Taxable Use

Special rules apply if an asset previously used in an exempt activity is converted for use in an unrelated businessactivity. The property’s depreciation expense for determining UBTI is calculated as if the organization first acquiredthe property at the time it is converted to a taxable use. The property’s unadjusted basis for calculating depreciationbecomes the lesser of the property’s fair market value (FMV) or its adjusted basis at the time of conversion(generally, original cost less depreciation taken to the date of conversion).

Example 3D-3 Depreciating an asset previously used in an exempt function activity.

Several years ago, United Charities, Inc. (United), purchased a soft drink machine for $1,800 that it originallyused in an exempt function activity. During this use, $540 of depreciation was claimed on the machine (usingSL depreciation, zero salvage value, and a 10-year life). In 2017, United began using the machine in anunrelated business activity when the machine’s adjusted basis was $1,260 ($1,800− $540), but its FMV wasonly $1,100.


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Themachine’s basis for calculating depreciation for the unrelated business activity is the lesser of its adjustedbook basis under Reg. 1.1016-4 ($1,260) or FMV ($1,100) at the time of conversion; thus, its depreciablebasis is $1,100.

Although 10-year SL depreciation was used when the asset was used in an exempt function activity, United istreated as if it acquired the asset when it was converted to a taxable use. Thus, United should use one of thedepreciation methods allowed in calculating UBTI. Because IRC Sec. 179(d)(1) defines Section 179 propertyas that “acquired by purchase for use in the active conduct of a trade or business,” United cannot claim theSection 179 deduction. United acquired the asset by purchase for use in an exempt activity. The machineentered an active trade or business by conversion, not by purchase.

Automobile Depreciation

Annual depreciation on passenger automobiles (including trucks, vans, and electric automobiles) is limited tospecified dollar amounts. These limits are normally specified in a revenue procedure issued early in each calendaryear. The first-year limits for 2017 depend on whether the vehicle qualifies for the additional first-year depreciationdeduction under IRC Sec. 168(k) for vehicles acquired during 2017. [A vehicle does not qualify if it must bedepreciated under the alternative depreciation system of IRC Sec. 168(g) or if the taxpayer elects out of theadditional first-year depreciation deduction.]

Law Change: The 2017 Tax Cuts and Jobs Act (TCJA) extended the placed-in-service deadline for the $8,000increase in bonus depreciation available for vehicles that fall under the luxury auto depreciation rules fromDecember 31, 2019, to December 31, 2026.

¯ For new autos, the maximum first-year depreciation deduction for 2017 is $11,160 ($8,000 + $3,160).

¯ For new light trucks and vans, the maximum first-year deduction for 2017 is $11,560 ($8,000 + $3,560).

The following table shows the limits (including Section 179 depreciation) for vehicles in 2017 for which the Section168(k) additional depreciation applies and for which it does not apply:

Auto Truck/Van

Year 168(k) Non-168(k) 168(k) Non-168(k)

First year $ 11,160 $ 3,160 $ 11,560 $ 3,560Second year 5,100 5,100 5,700 5,700Third year 3,050 3,050 3,450 3,450Each succeeding year (until cost is fully recovered) 1,875 1,875 2,075 2,075

For these purposes, trucks and vans include passenger autos built on a truck chassis, and minivans and sportutility vehicles (SUVs) built on a truck chassis. The annual depreciation limits only apply to a passenger automobile,which is generally defined as any four-wheel vehicle manufactured primarily for street use that has an unloadedgross vehicle weight (GVW) of 6,000 pounds or less. In the case of a truck or van (including minivans and SUVs),the 6,000 pound limit still applies. However, the “passenger automobile” definition is modified by deleting the word“unloaded” and instead referring only to theGVW. Thismodification is critical because while few automobiles weighmore than 6,000 pounds unloaded, the GVW of several full-sized pickup trucks and vans exceeds 6,000 pounds.GVW is not defined in IRC Sec. 280F or the related regulations. However, according to a proposed regulation for theluxury auto tax (which uses the same term in a similar context), GVW means the manufacturer’s maximum weightrating for a loaded vehicle. This same proposed regulation also defines the term “truck or van” to include minivansand SUVs.

In addition, most trucks or vans that exceed the 6,000 pound limit are eligible for the regular Section 179 deduction(as discussed earlier in this lesson). However, the Section 179 deduction for a vehicle defined in IRC Sec. 179(b)(5)(primarily SUVs) that is not subject to the Section 280F limits and is rated at no more than 14,000 pounds GVW is$25,000.


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Deducting Net Operating Losses

General Rules

An organization whose total deductions (Part II, line 29 of Form 990-T) exceed its unrelated business income (UBI)(Part I, line 13) has a net operating loss (NOL) equal to the amount of such excess. Generally, an NOL may becarried back two tax years (three years in certain limited situations) and forward for up to 20 years from the year ofthe loss (Part II, line 31, of Form 990-T). However, the organization may elect to forgo the carryback and only carrythe NOL forward. Different carryback periodsmay exist for portions of an NOL (i.e., the general two-year period, thethree-year period for eligible losses, and the five-year period for farming). A separate election to forgo only theportion attributable to a farming loss five-year carryback and instead have the two- or three-year carryback apply tothe farming loss portion is available. The NOL is allowed as a deduction in computing unrelated business taxableincome in the year (or years) to which it is carried, up to the amount of the organization’s taxable income in thoseyears.

An NOL deduction may be claimed only in years the organization is subject to the unrelated business income tax.However, in determining the span of years for which an NOLmay be carried back or forward, tax years for which theorganization is not subject to the tax on UBI are counted.

Example 3E-1 Carryback and carryover of a net operating loss.

Apple Eaters Anonymous (AEA), a tax-exempt organization, had an $8,500 loss from its unrelated businessactivities for 2017. AEA had taxable income from unrelated activities of $3,000 in 2015 and $7,500 in 2014(prior to claiming the $1,000 specific deduction). However, in 2016, it had no unrelated activities.

AEA may carry back $3,000 of the 2017 loss to 2015. None of the loss may be carried back to 2014 as that ismore than two years prior to the 2017 loss (i.e., 2016 counts as part of the two-year carryback period eventhough none of the loss may be carried to such year). AEA also has a $5,500 ($8,500 − $3,000) NOLcarryforward that will expire if not used before the end of 2037 (20 years after 2017).

The $1,000 specific deduction (Part II, line 33, of Form 990-T) is not allowed for computing the NOL.

The Amortization of Organizational and Start-up Expenses

Corporate Organizational Expenditures

Organizational costs are costs incurred for the creation of the corporation, chargeable to the capital account of thecorporation, and of a character that if expended incident to the creation of a corporation having a limited life wouldbe amortizable over such life. Examples include fees paid to the state of incorporation, the cost of organizationalmeetings of directors or shareholders, and legal fees incurred in drafting corporate documents such as the bylawsand articles of incorporation.

Taxpayers can elect to deduct the lesser of (1) the amount of organizational expenses incurred, or (2) $5,000,reduced (but not below zero) by the amount by which the organizational expenses exceed $50,000. This deductionis taken on line 28, Part II, of Form 990-T. If the total costs are $55,000 ormore, the deduction is reduced to zero. Anyremaining organizational expenses will be amortized ratably over a 180-month period beginning with the month inwhich the taxpayer begins business.

The election applies only to expenditures incurred before the end of the tax year in which the corporation beginsbusiness (regardless of whether the corporation uses the cash or the accrual method of accounting or whether theexpenditures are paid in the tax year in which they are incurred).

Start-up Expenditures

Taxpayers can elect to deduct (in the tax year an active trade or business begins) the lesser of (1) the start-upexpenditures for the active trade or business; or (2) $5,000, reduced (but not below zero) by the amount by which


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the start-up expenditures exceed $50,000. Like corporate organizational expenditures, this deduction is also takenon line 28, Part II, of Form 990-T. Any remaining start-up expenditures are deductible ratably over 180 monthsbeginning with the month in which the active trade or business begins.

Eligible expenses include those incurred to investigate the creation or acquisition of an active business, to createa new business, and other costs incurred before the business begins (such as pre-opening costs). Start-up costsfor which an election is not made must be capitalized. However, expenses incurred in a failed attempt to acquire aspecific business are not start-up costs and can be expensed.

The election can be made with a return for a year before the year the business begins. However, the election mustbe made no later than the due date of the return (including extensions) for the year when the active trade orbusiness begins. This may not be the same year expenses are incurred or paid or that income is first recognized.The election can be revised to include start-up costs incurred in the subsequent year. A “protective” election toamortize start-up costs, made with a return on which the costs were currently deducted in full, has been held invalidby the IRS in FSA 1999-1189.

Example 3F-1 Start up costs for a new periodical.

The Global Cooling Foundation (GCF) is a nonprofit organization that publishes two periodicals with taxableadvertising. It incurs $20,000 of start-up costs related to establishing a weekly newsletter that will also earntaxable advertising revenue, although the newsletter was not published in the current year.

Direct advertising expenses must correspond to specific advertising revenue. GCF is not permitted to deductthe $20,000 of newsletter expenses against the advertising revenue of its other two periodicals in the currentyear.

If the newsletter generates taxable advertising revenue in the subsequent year, the conservative approach willbe to deduct $5,000 of start-up costs and amortize the remaining $15,000 over the next 15 years. Using amore aggressive approach, the taxpayer might reason that the newsletter is not a new advertising activity butrather a new manifestation of an existing advertising activity, and deduct all $20,000.

Deducting Disaster Expenses

Several natural disasters occurred in the U.S. during 2017 and an organizationmay have incurred expenses relatedto these disasters. Disaster expenses directly connected with an unrelated trade or business are deductible if theincome is reported on Form 990-T, Part I. Taxpayers in federally declared disaster areas may elect to deduct lossesin the tax year preceding the tax year in which the loss occurred.

Losses and Credits Derived from Tax Shelters

The IRS will deny the deduction of any loss or credit taken against unrelated business income that is derived froma prohibited tax shelter transaction. In addition, there are substantial penalties for the failure to disclose direct orindirect participation in such transactions.


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103

SELF-STUDY QUIZ


19. If Section 168(k) does not apply, how much will a passenger automobile be depreciated in the first year?

a. $3,160.

b. $3,560.

c. $5,100.

d. $11,160.

20. Crops for the Hungry (CH), a tax-exempt organization, has a net operating loss (NOL) related to farming.Whatis the maximum number of years CH can carry this NOL back?

a. Two years.

b. Three years.

c. Five years.

d. Twenty years.


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SELF-STUDY ANSWERS


19. If Section 168(k) does not apply, how much will a passenger automobile be depreciated in the first year?(Page 96)

a. $3,160. [This answer is correct. According to IRC Sec. 280F(a)(1), first-year depreciation for apassenger automobile when Section 168(k) does not apply is $3,160.]

b. $3,560. [This answer is incorrect. This is the first-year depreciation amount for a truck or vanwhenSection168(k) does not apply, which is different from a passenger automobile.]

c. $5,100. [This answer is incorrect. This would be the second-year depreciation amount for the automobiledescribed above, not the first-year amount.]

d. $11,160. [This answer is incorrect. This would be the amount of first-year depreciation for a passengerautomobile if Section 168(k) applied.]

20. Crops for the Hungry (CH), a tax-exempt organization, has a net operating loss (NOL) related to farming.Whatis the maximum number of years CH can carry this NOL back? (Page 100)

a. Two years. [This answer is incorrect. Two years is the general carryback period for anNOL under IRCSec.172(b)(1)(A) and (F). Because CH’s NOL is specific to farming activities, a special carryback periodapplies.]

b. Three years. [This answer is incorrect. The three-year carryback period is specific to eligible losses, butthis is separate from farming, which has another NOL carryback time period.]

c. Fiveyears. [Thisanswer is correct.Different carrybackperiodsmayexist forportionsof anNOL(i.e.,the general two-year period, the three-year period for eligible losses, and the five-year period forfarming). Therefore, CH’s NOL would fall under the five-year period for carryback. However, aseparate election to forgo only the portion attributable to a farming loss five-year carryback andinstead have the two- or three-year carryback apply to the farming loss portion is available.]

d. Twenty years. [This answer is incorrect. Under IRC Sec. 172(b)(1)(A) and (F), an NOL can be carriedforward (not back) for up to 20 years from the year of the loss.]


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Lesson 4: Form 990-T Tax CalculationIntroduction

Organizations are taxed on their unrelated business taxable income (UBTI) at the same rates that apply to for-profitentities. They are also allowed to claim most of the same tax credits. The tax rates that apply to an entity’s UBTIdepend on whether it is a trust or a corporation. However, both entities make estimated tax payments using thecorporate estimated tax payment rules. In addition to tax on UBTI, certain organizationsmay be subject to proxy taxon lobbying expenditures, income tax for noncompliant hospital facility income, and alternative minimum tax.


Completion of this lesson will enable you to:¯ Identify the proper rate schedule, how topay any taxdue, the tax credits available to reduceunrelatedbusinessincome tax.

¯ Identify how to address the proxy tax on lobbying expenditures, alternative minimum tax, and estimated taxpayments, as well as the requirements for mandatory electronic tax payments.

Determining the Proper Rate Schedule and Paying Any Tax Due

Applicable Tax Rate Schedule

Exempt trusts are taxed on their unrelated business taxable income (UBTI) using the Section 1(e) tax ratesapplicable to taxable trusts. All other exempt organizations with UBTI compute the tax due using the Section 11corporate tax rates.

Members of a Controlled Group

Corporate members of a controlled group are allowed only one $50,000, one $25,000, and one $9,925,000 taxableincome bracket on line 35a of Form 990-T. The controlled groupmay apportion the taxable income brackets amongthe group members. Each member must attach a copy of Schedule O (Form 1120)—Consent Plan and Apportion-ment Schedule for a Controlled Group to its tax return. If no apportionment is adopted, the taxable income bracketsare divided equally among the controlled group members. The IRS instructions for line 35c of Form 990-T providea worksheet for computing the tax for members of a controlled group.

The IRS instructions for lines 35a and 35b define the members of a controlled group in terms of stock ownership.They do not specifically address the relationship between two tax-exempt nonstock organizations. Control foridentifying UBI from a controlled organization means that one organization has the power to remove and replace atleast 80% of the board of directors. In other contexts, control is defined as ownership of more than 50% of thebeneficial interests in an entity. This course suggests that if one nonprofit organization has the power to remove,replace, elect, approve, or veto a majority of the board of directors of another nonprofit organization, then the twoorganizations have a parent/subsidiary relationship. If the two organizations have overlapping boards, such that amajority of the board members of either nonprofit organization are also board members of the other nonprofitorganization, then the two organizations have a brother/sister relationship.

Deferred Tax Liability

An organization may owe deferred tax pursuant to IRC Sec. 1291(c)(1) because of an excess distribution from apassive foreign investment company that is taxable as unrelated business income. The portion of the deferred taxamount that is the aggregate increase in taxes [calculated in accordance with IRC Sec. 1291(c)(2)] must beincluded in the amount entered on line 35c of Form 990-T (for corporations) or on line 36 (for trusts). Write “Sec.1291” and the amount of such tax to the left of the applicable line.

Paying Tax Due

Normally, an organization will pay most or all of its tax liability for a year by estimated tax payments throughout thatyear. However, any balance due shown on line 48 of Form 990-T when the return is prepared must be paid in full by


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the date the return is filed, but no later than the 15th day of the fifthmonth after the end of the tax year. Organizationsmust use electronic funds transfer to make all federal deposits (such as deposits of estimated tax, employment tax,and excise tax). Generally, electronic fund transfers are made using the Electronic Federal Tax Payment System(EFTPS). Note that EFTPS payments must be scheduled by 8 pm Eastern Time on the day before the due date tobe timely.

Law Change: The Internal Revenue Service announced that Hurricane Harvey, Irma, and Maria victims in federallydeclared disaster areas have until January 31, 2018, to file certain tax returns and make certain tax payments. Therelief was available for taxpayers in any area designated by the Federal Emergency Management Agency (FEMA )as qualifying for individual assistance. The tax relief postponed various tax filing and payment deadlines thatoccurred related to the following hurricanes:

¯ Harvey, starting on August 23, 2017.

¯ Irma, starting on September 4, 2017 (Florida), September 5, 2017 (Puerto Rico and Virgin Islands), andSeptember 7, 2017 (Georgia).

¯ Maria, starting on September 17, 2017 (Puerto Rico), and September 16, 2017 (Virgin Islands).

As a result, affected businesses had until January 31, 2018, to file returns and pay any taxes that were originally dueduring this period. Therefore, an organization that was required to pay tax during this period may qualify for thepenalty relief.

The IRS automatically provides filing and penalty relief to any taxpayer with an IRS address of record located in thedisaster area. Therefore, taxpayers need not contact the IRS to get this relief. However, if an affected taxpayerreceives a late payment penalty notice from the IRS that had a payment or deposit due date falling within thepostponement period, the taxpayer should call the number on the notice to have the penalty abated.

If EFTPS is not used, arrange for a tax professional, financial institution, payroll service, or other trusted third partyto make deposits on the organization’s behalf. In addition, a financial institution may initiate same-day wirepayment on behalf of the organization. International taxpayers who do not have a U.S. bank account may completean international wire transfer through a foreign bank using the Same-Day Taxpayer Payment Worksheet found atwww.irs.gov/Individuals/International-Taxpayers/Foreign-Electronic-Payments.

The Tax Credits That Are Available to Reduce Unrelated Business IncomeTax

Background

Most tax credits available to for-profit enterprises can reduce the unrelated business income tax (UBIT) liability of anonprofit organization.

General Business Credit (GBC)

Most of the allowable tax credits are combined into the Section 38 general business credit (GBC). The creditscomprising the GBC generally are calculated on their own specific forms and then carried to Form 3800 (GeneralBusiness Credit). A list of the various credits, applicable Code sections, and forms is beyond the scope of thiscourse but can be found in PPC’s 990 Deskbook.

Example 4B-1 Claiming the disabled access credit.

Charities, Inc. (Charities), a Section 501(c)(3) tax-exempt organization, uses the calendar year for its account-ing period. It operates an unrelated business activity in a building acquired in 2002. During 2017, Charitiesspent $9,000 to remove certain architectural barriers from the building to comply with the Americans WithDisabilities Act of 1990.


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The gross receipts from Charities’s unrelated business activities in the prior year were $800,000. In 2017,Charities owes tax of $22,250 on its UBTI (before deducting any tax credits), and its tentative minimum tax(TMT) is $16,000.

Charities is an eligible small business [defined in IRC Sec. 44(b)] and made eligible access expendituresduring the year. Thus, it is entitled to a disabled access credit of $4,375 for the year, calculated on Form 8826(Disabled Access Credit). The credit is claimed on line 41c, Part IV, of Form 990-T.

See PPC’s 1040 Deskbook for requirements for claiming the DAC and the rehabilitation credit (RIC).

Carryback and Carryforward Rules for the GBC

GBCs have a one-year carryback and a 20-year carryforward. Any unused credits for a year must be carried backto the preceding tax year before being carried forward. There is no election to forgo the carryback period. However,GBCs that arose in tax years beginning before 1998 have a 15-year carryforward period. Unused credits at the endof the 20-year carryforward or at the time the organization terminates its existence may be deducted (not credited)from taxable income.

Minimum Tax Credit

The alternative minimum tax (AMT) paid by a corporate organization (and part or all of the AMT paid by an exempttrust) in one year is allowed as a minimum tax credit (MTC) against the entity’s regular tax liability from unrelatedbusiness activities in subsequent years. The rationale for allowing the AMT paid in one year to reduce the regulartax liability in subsequent years is that, because of the independent nature of the AMT and regular tax systems,double taxation of income or the disallowance of deductions might otherwise result. The MTC that may be used inany year is limited to the excess of the regular tax (after reduction by most credits) over the tentative minimum tax(TMT) for the year.

Example 4B-2 Benefit of minimum tax credit.

United Charities, Inc. (United) operates an unrelated business activity that generates substantial amounts oftaxable income. In 2007, United acquired several expensive pieces of machinery it uses in this activity.Because of the accelerated depreciation taken on these assets, United paid AMT in each of the four yearsprior to 2011 and has an MTC carryforward into 2017 of $18,500.

For 2017, United has a $29,000 regular tax liability (unrelated business income tax). United currently qualifiesas a “small” corporation and is exempt from AMT for 2017. (See discussion later in this lesson.) regardingexemption from AMT for small corporations.)

United can offset its regular tax liability with its MTC carryforward of $18,500. IRC Sec. 55(e)(5) limits theamount of MTC that can be used by a “small” corporation to $25,000 plus the amount by which thecorporation’s regular tax liability exceeds 25%of the excess of the regular tax over $25,000. For example, if theregular tax liability is $29,000, the limit for the MTC is $28,000 {$25,000+ [.75× ($29,000− $25,000)]}. Thus,United can use its entire MTC carryforward of $18,500 to reduce its tax liability to $10,500. Without the MTC,United would not have benefited from the higher AMT depreciation in the current year. The MTC is claimed onForm 8827 (Credit for Prior Year Minimum Tax—Corporations). The amount from line 8b of Form 8827 shouldbe entered on page 2, line 41d, of United’s Form 990-T.

Using Tax Credits

GBCs are used on a first-in, first-out basis. Therefore, an organization needs to identify the earliest generatedcredits carried forward to the current year, then any GBCs generated in the current year, then any GBCs carriedback to the year (in the case of an amended return). If the organization’s credits exceed its tax liability, the creditsmust be used in the order specified in the instructions to Form 3800 (General Business Credit).


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Certain credits are determined based on expenses that would otherwise be allowable as deductions from UBI. Forthe following credits, the otherwise allowable expense deduction must be reduced by the amount of the credit:

¯ Disabled access.

¯ Employer credit for social security and Medicare taxes paid on certain employee tips.

¯ Employer-provided childcare facilities and services.

¯ Orphan drug.

¯ Small employer pension plan start-up costs.

¯ Mine rescue team training.

¯ Agricultural chemicals security.

¯ Employer differential wage payments.

Filing Form 990-T Only to Claim the Health Insurance Tax Credit

Tax-exempt organizations that are qualified small business employers and are filing Form 990-T only to claim thehealth insurance tax credit may follow these specific instructions for completing Form 990-T:

1. Complete the heading of Form 990-T except for items E, H, and I.

2. Enter “-0-” on line 13, column (A), line 34, and line 44.

3. Enter the credit from line 20 of Form 8941 on line 45f.

4. Complete lines 46, 49, 50 and the signature area.

5. Write “Request for 45R Credit Only” on the top of Form 990-T.

6. Attach a completed Form 8941 to the return.


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SELF-STUDY QUIZ


21. Catch and Release (C&R) is a tax-exempt organization with UBTI. How will it be taxed?

a. It will be taxed at a lesser amount than for-profit entities.

b. It will be taxed using the Section 1(e) tax rates.

c. It will be taxed using the Section 11 corporate tax rates.

d. It is prohibited from claiming tax credits.

22. Which of the following statements best describes an aspect of how a tax-exempt organization deals with thetax credits available to reduce its unrelated business income tax (UBIT)?

a. The general business credit (GBC) is calculated on a single form.

b. If GBCs are unused, they must be carried forward to the next tax year.

c. The minimum tax credit (MTC) can only be taken in the same year the alternative minimum tax (AMT) ispaid.

d. Disabled access and other credits may affect other deductions available to the organization.


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SELF-STUDY ANSWERS


21. Catch and Release (C&R) is a tax-exempt organization with UBTI. How will it be taxed? (Page 105)

a. It will be taxed at a lesser amount than for-profit entities. [This answer is incorrect. Organizations are taxedon their UBTI at the same rates that apply to for-profit entities. Therefore,C&Rwill not pay (dollar-for-dollar)less tax on its UBTI simply because it is an exempt organization.]

b. It will be taxed using the Section 1(e) tax rates. [This answer is incorrect. Per IRC Sec. 511(b)(1), exempttrusts are taxed on their UBTI using the Section 1(e) tax rates applicable to taxable trusts. However, sinceC&R is not a trust, these rates do not apply.]

c. It will be taxed using the Section 11 corporate tax rates. [This answer is correct. All exemptorganizations other than exempt trusts with UBTI compute the tax due using the Section 11corporate tax rates. Therefore, that is what C&R would use in this scenario.]

d. It is prohibited from claiming tax credits. [This answer is incorrect. Just because C&R is a tax-exemptorganization, that does not mean it is prohibited from claiming tax credits if it has UBTI. In fact, exemptorganizations with UBTI are allowed to claim most of the same tax credits as for-profit organizations.]

22. Which of the following statements best describes an aspect of how a tax-exempt organization deals with thetax credits available to reduce its unrelated business income tax (UBIT)? (Page 106)

a. The general business credit (GBC) is calculated on a single form. [This answer is incorrect. Most of theallowable tax credits are combined into the Section 38 GBC. The credits comprising the GBC generallyare calculated on their own specific forms and then carried to Form 3800 (General Business Credit).]

b. If GBCsare unused, theymust be carried forward to thenext tax year. [This answer is incorrect.GBCshaveaone-year carrybackandhavea20-year carryforwardunder IRCSec. 39(a)(1) and (2).Anyunusedcreditsfor a yearmust be carried back to the preceding tax year before being carried forward. There is no electionto forgo the carryback period.]

c. The minimum tax credit (MTC) can only be taken in the same year the alternative minimum tax (AMT) ispaid. [This answer is incorrect. The AMT paid by a corporate organization (and part or all of the AMT paidby an exempt trust) in one year is allowed as a MTC against the entity’s regular tax liability from unrelatedbusiness activities in subsequent years (not the same year). The rationale for allowing the AMTpaid in oneyear to reduce the regular tax liability in subsequent years is that, because of the independent nature ofthe AMT and regular tax systems, double taxation of income or the disallowance of deductions mightotherwise result.]

d. Disabled access and other credits may affect other deductions available to the organization. [Thisanswer is correct. Certain credits (disabled access, employer-provided childcare facilities andservices, orphan drug, etc.) are determined based on expenses that would otherwise be allowableas deductions from UBI. For these credits, the otherwise allowable expense deduction must bereduced by the amount of the credit.]


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The Proxy Tax on Lobbying Expenditures

Section 501(c)(4), (c)(5), and (c)(6) organizations engaging in lobbying activities generally either must:

1. tell their members how much of the dues and other payments made by the members are allocable tolobbying activities (and therefore nondeductible) or

2. compute a proxy tax on Form 990-T.

The circumstances under which an organization is excepted from the lobbying expenditures reporting requirementof IRC Sec. 6033(e) are explained in Rev. Proc. 98-19.

The proxy tax equals the organization’s lobbying expenses that are not reported to its members multiplied by 35%.The tax is included on line 37 of Form 990-T. A schedule showing the calculation of the tax should also be attachedto the return.

Example 4C-1 Paying the proxy tax instead of reporting lobbying expenditures.

The Crowley Chamber of Commerce (CCC), a Section 501(c)(6) organization, makes annual lobbying expen-ditures of approximately 10% of its membership dues. During its current tax year, CCC’s actual lobbyingexpenses total $40,000. Crowley elects not to notify its members of the amount of dues allocable to nonde-ductible lobbying activities.

Because CCC does not notify its members of the portion of their dues that are not deductible as a result ofCCC’s lobbying activities, CCC must pay the proxy tax. The tax is $14,000 ($40,000 × 35%) and is reportedon Form 990-T, Part III, line 37.

Income Tax for Noncompliant Hospital Facility IncomeTo qualify as a tax-exempt charitable hospital, a hospital organization that operates one or more hospital facilitiesmust meet the requirements of IRC Sec. 501(r). Unless the failures were caused by minor omissions or errors thathave been corrected or the failures were corrected and disclosed, a hospital facility failing to meet one or more ofthe Section 501(r) requirements during a tax year is treated as being noncompliant. If a hospital organizationoperates more than one hospital facility, the noncompliant hospital facility will be subject to an income tax on itsnoncompliant facility income.

Noncompliant facility income is the gross income earned by the noncompliant hospital facility (i.e., one that fails tomeet one or more of the Section 501(r) requirements) during the tax year, less income tax deductions directlyconnected to the operation of that hospital facility during the tax year, excluding any gross income and deductionstaken into account in determining unrelated business taxable income from the facility during the tax year.Noncompliant facility income is subject to tax using the corporate tax rates in IRC Sec. 11 or the trust rates in IRCSec. 1(e) [if the hospital organization is a trust under IRC Sec. 511(b)(2)]. This tax is reported on line 39 of Form990-T.

When calculating a hospital facility’s noncompliant facility income, the gross income and allowable deductions forthe hospital facility may not be combined with the gross income and allowable deductions for the hospitalorganization’s other noncompliant hospital facilities or its unrelated trade or business activities under IRC Sec. 513.

Alternative Minimum Tax (AMT)

General Rules

Organizations with unrelated business income are subject to two parallel tax systems: the “regular” income taxand the alternative minimum tax (AMT). An organization’s unrelated business tax liability is the larger of the twotaxes. The primary purpose for the AMT system (as it applies to exempt organizations) is to ensure entities witheconomic income from an unrelated business activity, but little or no unrelated business taxable income (UBTI), paysome current income tax.


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Small Corporations

An exempt corporate organization is exempt from AMT if it qualifies as a “small” corporation. A small corporation isone that has average gross receipts of no more than $5 million in its prior tax year if it had only one prior tax year,and average gross receipts of no more than $7.5 million for the three-year period (or portion thereof) ending beforeits current year if it had more than one prior year. A corporation that has been exempt from the AMT as a smallcorporation and then becomes subject to the AMT when it exceeds the gross receipts threshold will remain liablefor the AMT in all future years.

Example 4E-1 Calculating average gross receipts.

The Everybody Loves Everybody Foundation is incorporated in Year 1. The Foundation will qualify as a smallcorporation in its first year of existence regardless of its gross receipts.

In its second year, the Foundation is in its first three-taxable-year period (or portion thereof). If gross receiptsdid not exceed $5 million in its first year, then the Foundation is a small corporation for its second year. In itsthird year, the Foundation is a small corporation if the average gross receipts in its first and second years didnot exceed $7.5 million. In its fourth and all subsequent years, the Foundation is a small corporation if theaverage gross receipts in its previous three years did not exceed $7.5 million.

Gross receipts include total sales net of returns and allowances, not reduced by cost of goods sold or the basis ofproperty sold except for property used in the organization’s trade or business, property held for the production ofincome, or real property used in the trade or business.

Calculating AMT

A corporate organization’s AMT liability is calculated on Form 4626 (Alternative Minimum Tax—Corporations). Atrust determines its liability on Schedule I (Alternative Minimum Tax) of Form 1041 (U.S. Income Tax Return forEstates and Trusts). If the organization owes AMT, Form 4626 or Schedule I, as appropriate, should be attached toForm 990-T and the AMT entered on line 38 of Part III, Form 990-T.

For 2017, corporations are allowed an exemption of $40,000 ($24,100 for trusts) in calculating AMT. The exemptionis phased out to the extent of 25% of the organization’s AMTI over $150,000 ($80,450 for trusts) and is fully phasedout when AMTI reaches $310,000 ($176,850 for trusts). The exemption must be allocated among controlled groupmembers of corporate organizations.

Making Estimated Tax Payments

Requirement to Make Estimated Tax Payments

A tax-exempt entity must make estimated tax payments if the total unrelated business income tax it expects to owefor the tax year is at least $500. Corporate estimated payment rules apply whether the entity is a trust or corporation.

Organizations may use Form 990-W (Estimated Tax on Unrelated Business Taxable Income for Tax-Exempt Organi-zations) to determine their estimated tax payments.

Definition of Tax

For the estimated tax payment rules, the term tax means—

1. the unrelated business tax (i.e., line 35c or 36 of Form 990-T, Part III);

2. plus the alternative minimum tax (i.e., line 38 of Form 909-T, Part III) (IRC Sec. 55);

3. less available tax credits, if any (i.e., line 41e of Form 990-T, Part IV).

According to IRC Sec. 6033(e)(2)(C), the proxy tax is treated in the same manner as income taxes. However, IRCSec. 6655(g)(1) does not include the proxy tax in the definition of taxes requiring estimated payments. The IRS


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instructions for Form 990-T and Form 990-W (Estimated Tax on Unrelated Business Taxable Income for Tax-ExemptOrganizations) indicate the proxy tax should be ignored for estimated tax payment purposes.

Procedures for Making Estimated Payments

Estimated tax payments generally are made in four installments on the 15th day of the 4th, 6th, 9th, and 12thmonths of the tax year. For calendar-year organizations, those dates are April 15, June 15, September 15, andDecember 15. If the due date for a payment falls on a Saturday, Sunday, or legal holiday (in either the District ofColumbia or statewide in the state where the payment will be sent), the payment is not due until the next day thatis not a Saturday, Sunday, or legal holiday.

Law Change: The Internal Revenue Service announced that Hurricane Harvey, Irma, and Maria victims in federallydeclared disaster areas had until January 31, 2018, to file certain tax returns and make certain tax payments. Therelief was available for taxpayers in any area designated by the Federal Emergency Management Agency (FEMA)as qualifying for individual assistance. The tax relief postponed various tax filing and payment deadlines thatoccurred related to the following hurricanes:

¯ Harvey, starting on August 23, 2017.

¯ Irma, starting on September 4, 2017 (Florida), September 5, 2017 (Puerto Rico and Virgin Islands), andSeptember 7, 2017 (Georgia).

¯ Maria, starting on September 17, 2017 (Puerto Rico), and September 16, 2017 (Virgin Islands).

Estimated tax payments that were due during these periods could have been extended until January 31, 2018.

An organization can elect to apply all or any portion of an overpayment of tax shown on its Form 990-T as a paymentof estimated tax for its next tax year in lieu of a refund. The election is made on Part IV of Form 990-T, line 50 (in thefirst of two blanks). An overpayment applied to a succeeding year’s estimated taxes is applied to unpaid install-ments in the order in which they must be paid to avoid liability for the penalty for failure to pay estimated tax.

Amount of Estimated Payment Due

General Rule. Each of an organization’s four estimated tax payments is normally required to be 25% of therequired annual payment. The term required annual payment means the lesser of the following two amounts.

1. 100% of the tax for the current year.

2. 100% of the tax shown on the organization’s Form 990-T for the preceding year (i.e., the safe harborprovision).

The required annual payment cannot be based on 100% of the preceding year’s tax if the preceding year was lessthan 12 months or if the organization did not file a return for such preceding tax year showing a liability for tax. TheIRS has ruled that a preceding year return that shows zero tax liability will not be considered a return showingliability for tax under IRC Sec. 6655(d)(1) and therefore cannot use the 100% safe harbor.

Special rules also apply to large organizations.

Exceptions to the General Rule. If an organization’s annualized income installment or adjusted seasonal install-ment is less than the estimated payment required under the general rule, it can use the lesser of these twoinstallments as its required installment for a particular quarter. However, any reduction in a quarterly paymentresulting from use of the annualized income or the adjusted seasonal installment is added to the next requiredinstallment that is not an annualized income or adjusted seasonal installment (i.e., it is recaptured). An organiza-tion’s annualized income and adjusted seasonal installments may be calculated in Schedule A of Form 990-W.

Additional guidance on using the annualized income installment method and the ability to use different annualiza-tion periods is included in the discussion of the estimated payment rules for private foundations in PPC’s 990


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Deskbook. (The rules that apply for making estimated payments related to a private foundation’s net investmentexcise tax also apply for estimated payments related to the unrelated business income tax.)

Example 4F-1 Calculating estimated tax payments using Form 990-W.

Charities, Inc. (Charities) had $100,000 of unrelated business taxable income (UBTI) in 2017. Its net tax on thisincome was $17,875 ($22,250 of income tax less a $4,375 disabled access credit—see Example 4B-1).Charities expects approximately the same UBTI in 2018, but it will not have any tax credits for the year.Assuming the adjusted seasonal and annualized income installment methods do not apply, Charities shouldcalculate its estimated tax payments for 2018 using Form 990-W, based on 100% of its 2017 tax liability. Thisliability is lower than its expected 2018 tax liability because of the tax credit used in 2017, and Charities isentitled to pay the lower amount.

Large Organizations

For a large organization, the required annual payment (as defined earlier in this lesson under the subheading“Amount of Estimated Payment Due”) cannot be based on 100% of the preceding year’s tax except for the firstrequired installment. Any deferral on the first installment caused by using 100% of the prior year’s tax must beadded to the next required installment calculated using a percentage of the current-year tax under the general rule.

For this rule, a large organization (or its predecessor) is one that had UBTI of at least $1 million in any of the threetax years immediately preceding the year for which estimated payments are being calculated. For this purpose,UBTI is calculated without deducting any net operating loss or capital loss carrybacks or carryovers that otherwiseapply. Special rules apply for corporations with assets of $1 billion or more.

Example 4F-2 Calculating estimated tax payments.

The Everybody Loves Everybody Foundation is a calendar year Section 501(c)(3) public charity. In 2017, theFoundation filed Form 990-T showing a $1,000 tax liability. In 2018, the Foundation anticipates its tax liabilitywill be $800. The Foundation should make quarterly estimated payments of $200 each (25% of the currentyear expected liability) on April 15, June 16, September 15, and December 15, 2018, using EFTPS.

In 2018, the Foundation anticipates its tax liability will be $2,000. The Foundation should make quarterlyestimated payments of $250 each (25% of the prior year liability).

In 2018, the Foundation anticipates its tax liability will be $400. The Foundation is not required to makequarterly estimated payments in 2018.

In 2017, the Foundation filed Form 990-T showing a net operating loss and a $0 tax liability. In 2018, theFoundation anticipates its tax liability will be $2,000. It may not base its 2018 quarterly estimated payments ona prior year return that showed no tax liability. The Foundation should make quarterly estimated payments of$500 each (25% of the current year expected liability).

In 2017, the Foundation filed Form 990-T showing a net operating loss and a $0 tax liability. In 2018, theFoundation anticipates it will again show a net operating loss, and therefore it makes no quarterly estimatedpayments during the first three quarters of 2018. However, in late September 2018, the Foundation earnsunrelated business income that it anticipates will result in a $2,000 tax liability. The Foundation should makean estimated payment of $2,000 (100% of the current year expected liability) on December 15, 2018. (TheFoundation could also calculate its payment using the annualized income method.)

In 2017, the Foundation filed Form 990-T showing a $1.2 million tax liability. In 2018, the Foundation antici-pates its tax liability will be $1.5 million. The Foundation is a large organization and may only base its firstquarter installment on its preceding year’s tax liability, and then must “catch up” any shortfall with its secondquarter installment. The Foundation should make a first quarter estimated payment of $300,000 (25% of theprior year liability) on April 15, 2018. The Foundation should make a second quarter estimated payment of$450,000 (50% of the current year expected liability less the amount paid in the first quarter) on June 15. TheFoundation should make third and fourth quarter payments of $375,000 each (25% of the current yearexpected liability) on September 15 and December 15, respectively.


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Penalty for Underpayment of Estimated Tax

A penalty is imposed on an organization that underpays any installment of its estimated tax.

Requirements for Making Mandatory Electronic Tax Payments

General

Most organizations must make their income tax payments electronically since the IRS no longer accepts depositswith Form 8109 (Federal Tax Deposit Coupon).

How to Make Electronic Tax Deposits

An organization enrolls in EFTPS by completing Form 9779 (EFTPS—Business Enrollment Form) or enrollingonline at www.eftps.gov. If the organization falls within the mandatory filing requirements, an explanatory letterfrom the IRS should be sent automatically to the taxpayer alongwith Form 9779 preprinted with the taxpayer’s basicinformation, such as the taxpayer identification number, name, address, and contact name from IRS records.

Enrollment information provided online is reviewed for accuracy, and confirmation materials are mailed to thecontact or primary taxpayer listed on the Enrollment Form. Online applications are convenient and much quickerthan paper applications (applicants receive online confirmations in 15 business days, compared to the 10 weekssometimes required for paper applications). A unique Personal Identification Number (PIN) will be mailed sepa-rately to new EFTPS users for added security. More information can be obtained from IRS Pub. 966, “ElectronicFederal Tax Payment System: A Guide to Getting Started,” by visitingwww.eftps.gov, or by calling (800) 555-4477.

Failure-to-Deposit Penalty

Under IRC Sec. 6656(b), the failure-to-deposit penalty is 2% of the underpayment if the failure to deposit is for fivedays or less, 5% if the failure is for more than five days, and 10% if the failure is for more than 15 days unless it isshown that the failure is due to reasonable cause and not willful neglect. The penalty increases to 15% of theunderpayment if the tax is not deposited on or before the earlier of (1) the 10th day after the date of the firstdelinquency notice to the taxpayer or (2) the day on which notice and demand for immediate payment is given.

Example 4G-1 Failure-to-deposit penalty.

The Small Foundation (Small) was required to make a federal tax deposit of its withholding and payroll taxesof $250,000 electronically on or before January 15, 2018. Small instead mailed a check for these taxes to theIRS. Unless there is reasonable cause, Small is subject to a failure-to-deposit penalty of 10% ($25,000)because the failure to deposit in the correct manner continued for more than 15 days. Small should not besubject to the higher 15% penalty, however, because the IRS presumably will not send a delinquency noticeor demand for payment (since it actually has the money) that would trigger the higher rate.


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SELF-STUDY QUIZ


23. Which of the following organizations has correctly addressed an issue related to making estimated taxpayments?

a. To calculate its estimated tax payment, the SpringOrganization takes its unrelated business tax, subtractsits AMT, and adds any available tax credits.

b. TheSummerOrganization runs on the calendar year andmakes estimated tax payments onApril 15, June15, September 15, and December 15.

c. The Autumn Organization makes three estimated tax payments, each totaling one third of its requiredannual payment.

d. The Winter Organization, a large organization, bases all its estimated tax payments on 100% of thepreceding year’s tax qualification.

24. The Blankenship Group, an exempt organization, is ten days late paying its estimated tax payment of $3,000.The organization will be subject to a failure-to-deposit penalty of what amount?

a. $60.

b. $150.

c. $300.

d. $450.


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SELF-STUDY ANSWERS


23. Which of the following organizations has correctly addressed an issue related to making estimated taxpayments? (Page 112)

a. To calculate its estimated tax payment, the SpringOrganization takes its unrelated business tax, subtractsits AMT, and adds any available tax credits. [This answer is incorrect. According to Reg. 1.6655-1(g), forthe estimated taxpayment rules, the term taxmeans the unrelatedbusiness taxplus theAMT less availabletax credits, if any.]

b. The Summer Organization runs on the calendar year and makes estimated tax payments on April15, June 15, September 15, and December 15. [This answer is correct. According to IRC Sec.6655(c), estimated tax payments generally are made in four installments on the 15th day of the 4th,6th, 9th, and 12th months of the tax year. For calendar-year organizations like this one, those datesare April 15, June 15, September 15, and December 15.]

c. The Autumn Organization makes three estimated tax payments, each totaling one third of its requiredannual payment. [This answer is incorrect. Per IRC Sec. 6644(d)(1), each of an organization’s four (notthree) estimated tax payments is normally required to be 25%of the required annual payment, as that termis defined in the Code.]

d. The Winter Organization, a large organization, bases all its estimated tax payments on 100% of thepreceding year’s tax qualification. [This answer is incorrect. Under IRC Sec. 6655(d)(2), for a largeorganization like this one, the required annual payment cannot be based on 100%of the preceding year’stax except for the first required installment. Any deferral on the first installment caused by using 100% ofthe prior year’s tax must be added to the next required installment calculated using a percentage of thecurrent-year tax under the general rule.]

24. The Blankenship Group, an exempt organization, is ten days late paying its estimated tax payment of $3,000.The organization will be subject to a failure-to-deposit penalty of what amount? (Page 115)

a. $60. [This answer is incorrect. Per IRC Sec. 6656(b), the failure-to-deposit penalty is 2% of theunderpayment if the failure todeposit is for fivedaysor less.Though$60 is2%of$3,000, sinceBlankenshipwas later than five days, it faces a larger penalty.]rally are calculated on their own specific forms and thencarried to Form 3800 (General Business Credit).]

b. $150. [This answer is correct. According to the penalty structure outlined in IRC Sec. 6656(b), if anorganization fails to file for more than five days but less than fifteen, the penalty will be 5% of theunderpayment. Therefore, Blankenship’s penalty is calculated as $3,000 × .05 = $150.]

c. $300. [This answer is incorrect. According to IRCSec. 6656(b), if the failure to file is for more than 15 days,the penaltywill be 10%, unless it is shown that the failure is due to reasonable cause andnotwillful neglect.However, though $300 is 10% of $3,000, since Blankenship did not exceed 15 days in its failure to file, itfaces a penalty of another amount.]

d. $450. [This answer is incorrect. As discussed in IRC Sec. 6656(b), the failure-to-file penalty increases to15%of the underpayment if the tax is not deposited onor before the earlier of (1) the 10th day after the dateof the first delinquency notice to the taxpayer or (2) the day on which notice and demand for immediatepayment is given. However, though $450 is 15% of $3,000, because Blankenship was not delinquent forthis long and did not receive such notices, it is subject to a smaller fine.]


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EXAMINATION FOR CPE CREDIT

Companion to PPC’s 990 Deskbook—Course 1—Form 990-T (990TG181)

Testing Instructions

1. Following these instructions is an EXAMINATION FOR CPE CREDIT consisting of multiple choice questions.Youmay print and use the EXAMINATION FORCPECREDIT ANSWERSHEET to complete the examination.This course is designed so the participant reads the coursematerials, answers a series of self-study questions,and evaluates progress by comparing answers to both the correct and incorrect answers and the reasons foreach. At the end of the course, the participant then answers the examination questions and records answersto the examination questions on either the printed Examination for CPE Credit Answer Sheet or by loggingonto the Online Grading System. The Examination for CPE Credit Answer Sheet and Self-study CourseEvaluation Form for each course are located at the end of all course materials.

ONLINE GRADING. Log onto our Online Grading Center at cl.tr.com/ogs to receive instant CPE credit. Clickthe purchase link and a list of exams will appear. Search for an exam using wildcards. Payment for the examof $95 is accepted over a secure site using your credit card. Once you purchase an exam, you may take theexam three times. On the third unsuccessful attempt, the system will request another payment. Once yousuccessfully score 70% on an exam, youmay print your completion certificate from the site. The site will retainyour exam completion history. If you lose your certificate, youmay return to the site and reprint your certificate.

PRINT GRADING. If you prefer, youmay email, mail, or fax your completed answer sheet, as described below($95 for email or fax; $105 for regularmail). The answer sheets are found at the end of the course PDFs. Answersheetsmaybeprinted from thePDFs; they canalsobe scanned for email grading, if desired. The answer sheetsare identified with the course acronym. Please ensure you use the correct answer sheet. Indicate the bestanswer to the exam questions by completely filling in the circle for the correct answer. The bubbled answershould correspondwith the correct answer letter at the top of the circle’s columnandwith the question number.You may submit your answer sheet for grading three times. After the third unsuccessful attempt, anotherpayment is required to continue.

Youmay submit your completedExamination for CPECredit Answer Sheet, Self-study CourseEvaluation,and payment via one of the following methods:



Note: The answer sheet has four bubbles for each question. However, if there is an exam question with onlytwo or three valid answer choices, “Do not select this answer choice” will appear next to the invalid answerchoices on the examination.

2. If you change your answer, remove your previous mark completely. Any stray marks on the answer sheet maybe misinterpreted.

3. Each answer sheet sent for print grading must be accompanied by the appropriate payment ($95 for answersheets sent by email or fax; $105 for answer sheets sent by regular mail). Discounts apply for three or morecourses submitted for grading at the same time by a single participant. If you complete three courses, the pricefor grading all three is $271 (a 5% discount on all three courses). If you complete four courses, the price forgrading all four is $342 (a 10% discount on all four courses). Finally, if you complete five courses, the price for


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grading all five is $404 (a 15% discount on all five courses). The 15% discount also applies if more than fivecourses are submitted at the same time by the same participant. The $10 charge for sending answer sheets inthe regular mail is waived when a discount for multiple courses applies.

4. To receiveCPEcredit, completedanswer sheetsmustbepostmarkedor entered into theOnlineGradingCenterby February 28, 2019. CPE credit will be given for examination scores of 70% or higher.

5. When using our print grading services, only the Examination for CPE Credit Answer Sheet should besubmitted. DO NOT SEND YOUR SELF-STUDY COURSE MATERIALS. Be sure to keep a completed copyfor your records.

6. Please direct any questions or comments to our Customer Service department at (800) 431-9025.


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Determine the best answer for each question below. Then mark your answer choice on the Examination for CPECredit Answer Sheet. The answer sheet can be printed out from the back of this PDF or accessed by logging ontothe Online Grading System.

1. Gross income is reduced by which of the following for the purpose of determining whether an organization’sunrelated business income (UBI) meets the 990-T filing threshold?

a. Selling expenses and losses.

b. Fines and penalties.

c. Bribes and kickbacks.

d. Cost of goods sold.

2. Which of the following organizations only needs to complete the heading, Part III, Part IV, the signature area,and the statement portions of Form 990-T?

a. Mothers for Drug Free Schools had unrelated business income of $850.

b. Clean Air and Water, which uses its UBI to further its tax exempt purpose.

c. The Guns for All Lobbyist group, which pays the proxy tax on expenditures for lobbying.

d. Wheelie Meals, which has a net loss for its unrelated business activity in this tax year.

3. The Millman Foundation has $9,000 of UBI for the current tax year. Which parts of Form 990-T should thisnonprofit organization complete? (List all that apply.)

a. The heading, Part I, and Part II.

b. The heading, Part III, and Part IV.

c. The heading, Part I, Part II, and Page 2.

d. The heading, Part III, Part IV, Page 2, and appropriate statements.

4. Which of the following occurs when calculating consolidated unrelated business taxable income (UBTI) for agroup of organizations that qualify to file a consolidated Form 990-T?

a. The calculation of UBTI must be made separately for each member of the group.

b. Net operating losses (NOLs) are subtracted.

c. Unlimited charitable deductions are allowed.

d. Net loss from the disposition of debt-financed property is added.


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5. Which of the following can file a composite Form 990-T?

a. The trustee of multiple IRAs invested in a regulated investment company (RIC).

b. An organization filing Form 990-T solely to claim a refund of taxes paid previously.

c. A group of affiliated tax-exempt organizations including a title holding company (TCH).

d. An organization that qualifies for a credit on its small employer health insurance.

6. Helping Hands is a typical tax-exempt organization that runs on the calendar year. When is Helping Handsrequired to file its Form 990-T?

a. April 15.

b. May 15.

c. August 15.

d. November 15.

7. Hands Across the World is a Section 501(c)(3) organization. Which of the following must be made availablefor public inspection?

a. Form 990-T (Exempt Organization Business Income Tax Return).

b. Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations).

c. Form 8832 (Entity Classification Election).

d. Form 8941 (Credit for Small Employer Health Insurance Premiums).

8. Logan Enterprises hires the CPA firm of Abernathy &Meyers to prepare its tax return. Phil, a partner at the firm,is the signing preparer, but Desiree also prepares a substantial amount of the return. Who has the primaryresponsibility for the return’s overall substantive accuracy?

a. Logan Enterprises.

b. Phil.

c. Desiree.

d. Phil and Desiree.

9. All of the following organizations are engaging in a trade or business, except:

a. Equality for All provides legal services pro bono to charity clients and also provides legal services to thepublic for a fee.

b. Clean Waters operates a shop that sells filters, glasses, jars, and other water-related paraphernalia.

c. The Altman Foundation sells items door-to-door to fund its annual scholarships, but in the current yeardoes not make a profit.

d. After School Fundamentals sends key chains to all potential donors along with letters describing newactivities that need funding.


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10. Which of the following organizations is performing an activity that would be considered regularly carried on?

a. The Cancer Alliance holds an annual fundraiser that takes one month of planning.

b. Hungry Mouths operates a food truck for two weeks at a local festival.

c. The Breakthrough Foundation sells spaces in its parking lot on Saturday nights.

d. Saint Peter’s church sells fish dinners two Fridays during Lent to members and the community.

11. What determines whether an organization’s activity is considered substantially related?

a. The organization’s exempt purpose.

b. How money made from the activity is used.

c. The frequency and continuity of the activity.

d. Time and effort spent on the activity.

12. How does volunteer labor affect the definition of an unrelated trade or business?

a. An activity substantially performed by volunteers is excluded from the UBI rules.

b. If paid staff members are part of the activity, the volunteer exclusion does not apply.

c. Gaming activities automatically qualify as part of the volunteer exclusion if run by a nonprofit organization.

d. Noncash remuneration is not considered compensation when determining if the volunteer exclusion ismet.

13. In most states, what is the only game of chance not usually considered an unrelated trade or business(assuming the appropriate conditions are met)?

a. Raffles.

b. Poker.

c. Lotteries.

d. Bingo.

14. Under what circumstances would gain or loss from an organization’s asset disposition be most likely to beexcluded from UBI?

a. The property was originally acquired for reasons unrelated to the organization’s exempt purpose.

b. The organization sells such assets regularly and for a high price.

c. The organization made extensive improvements to the property before selling it.

d. The organization held the property for many years before selling it.

15. Which of the following nonprofit organizations is most likely to report UBI on gross receipts or sales?

a. Blake County Hospital sells flowers and cards in its gift shop.

b. The Metro Museum of Art sells a de minimis amount of unrelated items in its gift shop.

c. The Vernon Zoo sells stuffed animals in its gift shop.

d. Jamison University sells clothing and coffee mugs with the school logo in its bookstore.


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16. What is the most common type of recapture income on a disposition of property?

a. Section 1245 recapture.

b. Section 1250 recapture.

c. Section 1255 recapture.

d. Section 291 recapture.

17. Knowledge Plus, a nonprofit organization, owns a partnership interest. Which of the following may occur?

a. Knowledge Plus can offset up to $3,000 of net capital that was otherwise allowable from the partnershipinterest against its other UBI.

b. Any partnership items that flow through to Knowledge Plus will lose their character for UBI purposes.

c. KnowledgePluswill need to report capital gains, rental income, anddebt-financed incomeonForm990-T,Part 1.

d. If the partnership’s activities are unrelated to the organization’s purpose, Knowledge Plus may incur UBI.

18. Which of the following nonprofit organizations is exempt from the requirement to prepare Schedule C of Form990-T for rental income?

a. A hospital.

b. A church.

c. A trust.

d. A social club.

19. What is the minimum amount of stock a nonprofit organization must own in a corporation for the organizationto have control over the corporation?

a. 30%.

b. 50%.

c. 51%.

d. 80%.

20. Which of the following organizations is most likely to have UBI?

a. The Red Organization provides management services to several large clients on a regular basis for adiscounted rate.

b. The Blue Organization provides administrative services to another nonprofit organization on a limitedbasis.

c. The Yellow Organization provides unique consulting services that are not commercially available fromanother source.

d. The Green Organization provides incidental services to a taxable affiliate in a controlled group to furtherits exempt purpose.


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21. The existence of which factor makes income from a travel tour more likely to be UBI?

a. The tour is related to the organization’s exempt activity.

b. Qualified study leaders are selected to lead the tour.

c. The organization has contacts in the area where the tour will be held.

d. The tour is structured to maximize the participants’ fun and enjoyment.

22. Which of the following organizations has correctly set aside income that will be treated as exempt functionincome and not be subject to taxes?

a. The Gentleman’s Social Club sets aside funds to pay health insurance for its members.

b. The Altman Voluntary Employees’ Beneficiary Association (VEBA) sets aside funds from an unrelatedbusiness for educational purposes.

c. The Wakefield Supplemental Unemployment Benefit Trust (SUBT) sets aside funds for life insurancepayments but holds them in its general account.

d. The Ladies Who Lunch Social Club sets aside funds for charitable purposes as well as reasonableadministration costs for the charitable activities.

23. When can a social club defer its tax liability on the sale of property?

a. The property was used as part of the club’s exempt function.

b. It uses the proceeds to buy more property to use for its exempt function.

c. It uses the proceeds to buy replacement property within seven years.

d. The property was not physically used by the club.

24. Where would a social club, VEBA, or SUBT report debt-financed income on its Form 990-T?

a. Schedule E.

b. Line 9 of Part I and Schedule G.

c. Line 6 of Part I and Lines 14–28 of Part II.

d. Line 1a of Part I.

25. An organization’s UBTI is which of the following?

a. Gross UBI over allowable deductions.

b. Gross income minus UBI.

c. Gross income over UBI minus allowable deductions.

d. Gross UBI plus refunds or tax credits.


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26. According to the IRS, when allocating fixed overhead expenses for facilities an organization uses for bothunrelated and exempt function activities, what is the denominator?

a. Number of days the facility is used for unrelated business activities during the year.

b. Number of days the facility is available for use during the year.

c. Number of days the facility is actually used during the year.

d. Number of days the facility is used for exempt function activities during the year.

27. Which of the following rules applies to an organization’s interest expenses?

a. Interest allocable to producing designated property is deductible.

b. Original issue discount (OID) is not deductible as an interest expense.

c. Municipal bond interest is included in UBI.

d. Interest expense from straddles is capitalized.

28. Generally speaking, an organization can deduct foregone interest on a below-market loan of what amount?

a. Less than $5,000.

b. More than $10,000.

c. Less than $25,000.

d. More than $50,000.

29. Peaceful Minds Inc., a tax-exempt corporate organization, has UBTI of $10,000 in the current year. Generally,what is the maximum amount of a charitable contribution Peaceful Minds can deduct against this UBTI?

a. $1,000.

b. $2,500.

c. $5,000.

d. $10,000.

30. A charitable contribution of which of the following may be deducted for an amount other than the property’sfair market value (FMV)?

a. A building.

b. Land.

c. A copyright.

d. A painting.


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31. How does a depreciation deduction work when a tax-exempt organization has UBI?

a. The full amount of deprecation can be deducted.

b. Only depreciation on property associated with the unrelated business activity can be deducted.

c. If the property is at least partially used for the unrelated business activity, the entire amount of depreciationcan be deducted.

d. The IRS requires that tax-exempt organizations use straight-line depreciation when calculating thisdeduction.

32. Which of the following is considered qualified tangible property when calculating a tax-exempt organization’sdepreciation deduction?

a. Off-the-shelf computer software.

b. Leasehold improvement property.

c. Restaurant property.

d. Retail property.

33. Parkham Inc. starts business in the current tax year. It incurs $7,500 of start-up expenditures. Howmuch of thestart-up expenditures can Parkham deduct in the current year?

a. $750.

b. $2,500.

c. $5,000.

d. $7,500.

34. The IRS will deny the deduction of which of the following?

a. Disaster expenses related to a federally declared disaster area.

b. Loss or credit deducted against UBI derived from a prohibited tax shelter transaction.

c. Organizational costs incurred when creating a tax-exempt corporate organization.

d. Net operating losses carried backwards or forwards.

35. When multiple tax-exempt organizations are members of a controlled group, which organization has control?

a. The one with the highest amount of UBI.

b. The one owning more than 50% of the group’s beneficial interests.

c. The one that can remove and replace a minimum of 80% of the board of directors.

d. The one with the most board members that overlap with the other organizations.


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36. Municipal Hospital is a calendar year organization. It must pay any balance shown on line 48 of Form 990-Tno later than what date?

a. December 31 of the current tax year.

b. March 15 of the next year.

c. May 15 of the next year.

d. December 31 of the next year.

37. When offsetting its UBTI with general business credits (GBCs), which should an organization use first?

a. The earliest credits carried forward to the current year.

b. Credits generated in the current year.

c. The earliest credits carried back to the year.

d. The organization can choose the most beneficial order for using the credits.

38. The Bowville Chamber of Commerce (BCC) is a Section 501(c)(6) organization that annually uses 25% of itsmembership dues for lobbying expenditures. During the current tax year, BCC spends $10,000 on lobbyingexpenditures and elects not to notify its membership. BCC is subject to a proxy tax of what amount?

a. $1,000.

b. $2,500.

c. $3,500.

d. $5,000.

39. Which of the following makes sure that entities with income from an unrelated trade or business and little orno UBTI still pay some income tax?

a. The proxy tax.

b. The alternative minimum tax (AMT).

c. The general business credit (GBC).

d. Mandatory electronic tax payments.

40. For estimated tax payments to be required, an exempt organizationmust expect to owewhatminimumamountof UBIT?

a. $500.

b. $1,000.

c. $2,500.

d. $5,000.


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GLOSSARY

Affinityprograms:Whenanonprofit organizationmakes itsmembership list available toa commercial organization,which then solicits the members to enlist new customers. The commercial organization typically pays the nonprofitorganization a fee for each member enlisted plus a small percentage of the purchases members make.

Agency: The fiduciary relationship that arises when one person (the principal) agrees with another (the agent) thatthe agent shall act on the principal’s behalf and subject to the principal’s control.

Applicable reinsurance entity: A not-for-profit organization created to help stabilize premiums for coverage in theindividual and small group markets in a state during the first three years of operation of its American Health BenefitExchange.

Below-market loan: A demand loan where interest is payable on the loan at a rate less than the applicable federalrate or a term loan where the amount loaned exceeds the present value of all payments due under the loan.

Control: When identifying UBI from a controlled organization, this means that one organization has the power toremove and replace at least 80% of the board of directors. In other context, it is defined as ownership of more than50% of the beneficial interests in an entity.

Gross income: Gross receipts or sales (net of any returns or allowances) less cost of goods sold. It also includesany incomeanonprofit organization receives from investments and from incidental or outsideoperationsor sources.

Incidental distribution: One made without the request or express consent of the distribute and accompanied bya request for a donation and a statement that the item distributed need not be returned regardless of whethercontribution is made.

Nonsigning preparer: A tax return preparer who prepares all or a substantial portion of the return or refund claimbut is not the signing preparer.

Qualifiedconventionor tradeshow:One that isconductedbyaqualifyingorganization,at leastpartly foreducatingits members, promoting products and services of its members’ industry, or educating persons attending the showconcerning new developments or products and services related to its exempt activities, and is designed to achievethis purpose through the character of a significant portion of the event’s exhibits or the character of the conferencesand seminars held at the event.

Qualified convention or trade show activities: Ones that are traditional convention or trade show activities andcarried out by a qualified organization in conjunction with a qualified convention or trade show.

Qualified public entertainment activity: One that is traditionally conducted at fairs or expositions promotingagricultural and educational purposes.

Regularly carried on: Activities performed by an organizations that have a frequency and continuity and arepursued in a manner comparable to similar commercial activities of nonexempt organization.

Required annual payment: When making estimated tax payments, this is the lesser of (1) 100% of the tax for thecurrent year or (2) 100% of the tax shown on the organization’s Form 900-T for the preceding year.

Section 1245 property: Property that is (1) depreciable (or amortizable) and (2) one of the specific types set forthin IRC Sec. 1245(a)(3) and Reg. 1.1245-3.

Section 1250 property: Any depreciable real property that is not classified as Section 1245 property.

Signing preparer: A tax return preparer who has the primary responsibility for the overall substantive accuracy ofthe return or refund claim.

Straddle: Holding offsetting positions in personal property that are designed to reduce ownership risks.


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Tax: In regards to the estimated tax payment rules, this means (1) the unrelated business tax plus (2) the alternativeminimum tax less (3) available tax credits, if any.

Tax position: Any issue, position, or action taken or expected to be taken on a federal tax return, including thedecision to exclude certain income or transactions from the return.

Tax return preparer: Any person who prepares all or a substantial portion of any tax return (including Forms 900,900-EZ, 990-PF, and 900-T) for compensation or who employs one or more persons to do so for compensation.

Tradeor business: Any activity carried onwith a profitmotive from the sale of goodsor the performance of services.

Unrelated business taxable income (UBTI): The excess, if any, of an organization’s gross unrelated businessincome (UBI) over allowable deductions.

Unrelated trade or business: All of the following conditions must exist for an activity to have this label: (1) theorganization is conducting a trade or business for the production of income from selling goods or performingservices, (2) the trade or business is regularly carried on, and (3) the activity is “not substantially related” to thecarrying out of the organization’s exempt purpose.


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INDEX

This index is a list of general topics discussed in this course. More specific key word searches can be performed usingthe search feature of this PDF.

A

ACCOUNTING PERIODS AND METHODS¯ Methods¯¯ Charitable contributions of accrual-basiscorporations 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Unrelated business income 54. . . . . . . . . . . . . . . . . . . . . . . . . .

ADVERTISING¯ Regularly carried on 26. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

AGENCY RULES¯ Impact on unrelated business income 67. . . . . . . . . . . . . . . . . . . .

ALLOCATIONS¯ Expenses¯¯ In determining UBTI 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Taxable income brackets, controlled group 105. . . . . . . . . . . . . . .

ALTERNATIVE MINIMUM TAX¯ ACE depreciation adjustment 111. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Foreign tax credit 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Minimum tax credit 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Small corporations exempt¯¯ Defined 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Tax on unrelated business income 111. . . . . . . . . . . . . . . . . . . . . . .

APPLICABLE REINSURANCE ENTITIES¯ Defined 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Required to file Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ASSETS¯ Sales of 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Transfer to exempt entity 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B

BINGO GAMES¯ Income from 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

BONDS, TAX-EXEMPT¯ Unrelated business income 62. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

BROWNFIELD PROPERTY¯ Gain or loss on disposition 33, 40. . . . . . . . . . . . . . . . . . . . . . . . . . .

C

CAPITAL INTENSIVE ACTIVITY¯ Unrelated trade or business 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CAPITAL LOSSES¯ Unrelated business income 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CARRYBACK AND CARRYOVER¯ General business credit 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Net operating loss, unrelated business taxable income 100. . . . .

CHARITABLE CONTRIBUTIONS¯ Unrelated business taxable income 89. . . . . . . . . . . . . . . . . . . . . . .¯¯ Book inventory 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Computer technology and equipment 89. . . . . . . . . . . . . . . . .¯¯ Deduction limitations 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Food inventory 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Intellectual property 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Scientific research property 89. . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Substantiation 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CHURCH¯ Unrelated business income 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COMMERCIALITY DOCTRINE¯ Unrelated trade or business 24. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONTRIBUTIONS RECEIVED¯ Disposition of donated property 33. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Sale of donated merchandise 33. . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONTROLLED ORGANIZATIONS¯ Allocation of taxable income bracket 105. . . . . . . . . . . . . . . . . . . . .¯ Unrelated business income 67. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONVENTION OR TRADE SHOW¯ Unrelated trade or business 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COUNTRY CLUB¯ Gross receipts of 54. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CREDITS¯ Carryback and carryforward of 106. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Disabled access 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Foreign tax 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Gasoline and special fuels 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ General business 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Health insurance premiums 106. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Minimum tax 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Qualified electric vehicles 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Recapture of 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Research 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

D

DEBT MANAGEMENT PLAN SERVICES¯ Unrelated trade or business 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DEDUCTIONS, UNRELATED BUSINESS TAXABLEINCOME

¯ Charitable contributions 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Depreciation 96. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Disaster expenses 101. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Dual use of facilities or personnel 83. . . . . . . . . . . . . . . . . . . . . . . .¯ General rules 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Net operating loss deduction 100. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Organizational expenses 100. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Start-up expenses 100. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Substantiation 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DEPRECIATION¯ Bonus first-year 96. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Property converted to a taxable use 96. . . . . . . . . . . . . . . . . . . . . .¯ Recapture of sale of property 57. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Sale of depreciable property 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Section 179 deduction 96. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Unrelated business taxable income 96. . . . . . . . . . . . . . . . . . . . . . .

DISPOSITION¯ Donated property 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DISREGARDED ENTITIES¯ Inclusion in parent’s Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . .

DONATED PROPERTY¯ Sale of 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DUAL USE ASSETS OR FACILITIES¯ Unrelated business income 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DUE DATES¯ Estimated tax payments 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


132

E

EDUCATIONAL IRA¯ Requirement to file Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . .

ELECTIONS¯ Apply current-year overpayment to estimated tax 112. . . . . . . . . .¯ Deduct contributions made after year-end 89. . . . . . . . . . . . . . . . .¯ NOL carryover, unrelated business 100. . . . . . . . . . . . . . . . . . . . . .¯ Proxy tax in lieu of notifying members oflobbying expenditures 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Set-aside to minimize UBTI 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ELECTRONIC FUND TRANSFER RULES¯ Estimated tax payment 115. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Failure to use, penalty on 115. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Mandatory payment method 115. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Tax due, payments of 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ESTIMATED TAX¯ Amount due 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Deposit with Form 8109 105, 112. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Electronic fund transfer rules 115. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990-W 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Large organizations 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Proxy tax not included 111, 112. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Tax on unrelated business income 112. . . . . . . . . . . . . . . . . . . . . . .

EXCISE TAXES¯ Proxy tax on political expenditures 111. . . . . . . . . . . . . . . . . . . . . .

EXEMPT FUNCTION ACTIVITIES¯ Commercial exploitation 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Sales of products of 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXPENSE REIMBURSEMENTS¯ Out-of-pocket expenses of volunteers 33. . . . . . . . . . . . . . . . . . . . .

EXPENSES¯ Unrelated business 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXPLOITATION¯ Exempt activity 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Unrelated business taxable income 83. . . . . . . . . . . . . . . . . . . . . . .

F

FINES¯ Unrelated business taxable income 83. . . . . . . . . . . . . . . . . . . . . . .

FORMS, COMPLETING¯ 4797 (Sales of Business Property) 57. . . . . . . . . . . . . . . . . . . . . . . .¯ 8283 (Noncash Charitable Contributions) 89. . . . . . . . . . . . . . . . . .¯ 8826 (Disabled Access Credit) 106. . . . . . . . . . . . . . . . . . . . . . . . . .¯ 8827 (Credit for Prior Year Minimum Tax—Corporations) 106. . . .¯ 990-T (Exempt Organization Business IncomeTax Return)¯¯ Part II, Deductions Not Taken Elsewhere 83. . . . . . . . . . . . . . .¯¯ Part III, Tax Computation 111. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Part I, Unrelated Trade or Business Income 78. . . . . . . . . . . . .¯¯ Schedule C, Rent Income (From Real Propertyand Personal Property Leased With Real Property) 62. . . . . .

¯¯ Schedule F, Interest, Annuities, Royalties, andRents From Controlled Organizations 67. . . . . . . . . . . . . . . . . .

¯¯ Schedule G, Investment Income of aSection 501(c)(7), (9), or (17) Organization 72. . . . . . . . . . . . .

¯¯ Schedule I, Exploited Exempt Activity Income,Other Than Advertising Income 29. . . . . . . . . . . . . . . . . . . . . . .

¯ 990-W (Estimated Tax on UBTI for Tax-ExemptOrganizations) 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FORMS, FILING OF¯ Form 990-T¯¯ Churches 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Completing Part I 78. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Statute of limitations 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ When to file 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

G

GAINS AND LOSSES¯ Unrelated business¯¯ Activity 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Income 40, 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GAMING ACTIVITIES¯ Reporting¯¯ Unrelated trade or business 33. . . . . . . . . . . . . . . . . . . . . . . . . .

GOODWILL¯ Exploitation of an exempt activity 83. . . . . . . . . . . . . . . . . . . . . . . . .¯ Unrelated trade or business 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GROSS RECEIPTS¯ Unrelated business income 54. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GROUP LEGAL SERVICES ORGANIZATIONS¯ Unrelated business income 62. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

I

INCIDENTAL ACTIVITY¯ Trade or business, not constituting 24. . . . . . . . . . . . . . . . . . . . . . .

INDIVIDUAL RETIREMENT ACCOUNTS¯ Form 990-T reporting 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INSTANT BINGO¯ Income from 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INTEREST¯ Allocable interest expense 87. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Deferred interest expense 87. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Expense, deductibility in unrelated businesstaxable income 87. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Related parties 87. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ UNICAP rules 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INVESTMENTS¯ Unrelated business income 40, 72. . . . . . . . . . . . . . . . . . . . . . . . . . .

L

LARGE ORGANIZATIONS/FOUNDATIONS¯ Estimated tax rules 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LOBBYING¯ Proxy tax 3, 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

M

MEALS AND ENTERTAINMENT¯ Unrelated business taxable income, deduction limits 83. . . . . . . .

MEDICAL SAVINGS ACCOUNT¯ Requirement to file Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . .

MEMBERSHIP DUES¯ Unrelated business income 68. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

MINIMUM TAX CREDIT¯ Tax on unrelated business income 106. . . . . . . . . . . . . . . . . . . . . . .

N

NET OPERATING LOSS¯ Carryover, unrelated business 100. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Unrelated business taxable income 100. . . . . . . . . . . . . . . . . . . . . .

O

ORIGINAL ISSUE DISCOUNT¯ Deducting interest 87. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


133

P

PARKING FACILITIES¯ Unrelated business income from 71. . . . . . . . . . . . . . . . . . . . . . . . .

PARTNERSHIPS¯ Unrelated business income 61. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PENALTIES¯ Failure to use Electronic Funds Tax Payment System 115. . . . . .¯ Underpayment of estimated tax¯¯ Tax on unrelated business income 112. . . . . . . . . . . . . . . . . . .

¯ Unrelated business taxable income 83. . . . . . . . . . . . . . . . . . . . . . .

PERSONAL PROPERTY¯ Unrelated business income from leasing 40. . . . . . . . . . . . . . . . . .

PROFIT MOTIVE¯ Unrelated trade or business 24. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PROGRAM SERVICES¯ Trade or business activity within 24. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Unrelated trade or business profits used to fund 29. . . . . . . . . . . .

PROXY TAX¯ Estimated tax calculation 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Lobbying expenditures 3, 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PUBLIC ENTERTAINMENT¯ Unrelated trade or business 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Q

QUALIFIED STATE TUITION PROGRAM¯ Requirement to file Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . .

R

RECAPTURE OF DEPRECIATION¯ Sections 291, 1245, 1250, 1252, 1254, and1255 gains 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

RELATED ENTITIES¯ Unrelated business taxable income 83. . . . . . . . . . . . . . . . . . . . . . .

RENTAL INCOME AND EXPENSES¯ Unrelated business income 40, 62. . . . . . . . . . . . . . . . . . . . . . . . . . .

RESEARCH INCOME¯ Unrelated business income 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ROTH IRA¯ Requirement to file Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . .

ROYALTY INCOME¯ As unrelated business income 40. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Exempt from unrelated business income 40. . . . . . . . . . . . . . . . . .¯ From mailing lists 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

S

SALES¯ Casual, unrelated trade or business 26. . . . . . . . . . . . . . . . . . . . . .¯ Donated assets 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Exempt function products 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Unrelated business income 54, 57, 72. . . . . . . . . . . . . . . . . . . . . . .

SEASONAL ACTIVITY¯ Unrelated trade or business 26. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 291 RECAPTURE¯ Unrelated business income 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 1245 GAIN AND LOSS¯ Unrelated business income 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 1250 PROPERTY¯ Unrelated business income 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SECURITIES¯ Unrelated business income 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SET-ASIDES¯ Unrelated business income 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SHARE-CROP LEASES¯ Unrelated business income 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SIMPLE RETIREMENT ACCOUNT¯ Requirement to file Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . .

SIMPLIFIED EMPLOYEE PENSION PLAN¯ Requirement to file Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . .

SOCIAL AND RECREATION CLUBS¯ Sale and liquidation 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Special reporting for unrelated business income 78. . . . . . . . . . .¯ Unrelated business income 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SPECIFIED PAYMENTS¯ Unrelated business income 67. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SPONSORSHIP INCOME¯ Qualified, excluded from unrelated business income 40. . . . . . . .

STATUTE OF LIMITATIONS¯ Filing of Form 990-T 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Net operating loss 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SUPPLEMENTAL UNEMPLOYMENT BENEFITTRUSTS (SUBTs)

¯ Unrelated business income 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

T

TABLES¯ Forms to report gaming activities 33. . . . . . . . . . . . . . . . . . . . . . . . .¯ Low-cost article amounts 24. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

TAX DUE¯ Payment due date¯¯ Disaster relief 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Payment method 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Electronic fund transfer 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 8109 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ With Form 990-T 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Tax on unrelated business income 105. . . . . . . . . . . . . . . . . . . . . . .

TAX RATES¯ Apportionment for controlled group 105. . . . . . . . . . . . . . . . . . . . . .¯ Tax on unrelated business income 105. . . . . . . . . . . . . . . . . . . . . . .

TAX SHELTER¯ Participation in, disclosure of 101. . . . . . . . . . . . . . . . . . . . . . . . . . .

TIMBER¯ Sale of, exclusion from unrelated business income 57. . . . . . . . .¯ Sale of, royalty income 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

TRAVEL¯ Unrelated business taxable income, deduction limits 83. . . . . . . .

TRAVEL TOURS¯ Unrelated business income 70. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

U

UNICAP¯ Unrelated business income 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

UNRELATED BUSINESS TAXABLE INCOME (UBTI)¯ Administrative services fees 69. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Affinity card income 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


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¯ Associate member dues 68. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ At-risk limitation rules, implications of 29. . . . . . . . . . . . . . . . . . . . .¯ Charitable contributions 89. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Church 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Conservation easement, social club 72. . . . . . . . . . . . . . . . . . . . . .¯ Controlled organizations 67. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Depreciation 96. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Description and reporting on Form 990-T 78. . . . . . . . . . . . . . . . . .¯ Dual use assets or facilities 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Dual use of facilities or personnel 83. . . . . . . . . . . . . . . . . . . . . . . .¯ Exempt activity, income from exploiting 29. . . . . . . . . . . . . . . . . . .¯ Expenses, deductibility in computing UBTI 83. . . . . . . . . . . . . . . .¯ Form 990-T, filing of¯¯ Completing Part I 78. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ When required 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Gains and losses, reporting 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Gross income 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Gross receipts or sales 54. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Income excluded from 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Licensing arrangements 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Management services fees 69. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Member dues 68. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Membership lists, sale of 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Net operating loss deduction, carryover, and carryback 100. . . .¯ Organizational expenses 100. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Passive loss limitation rules, implications of 61. . . . . . . . . . . . . . . .¯ Rental income 40, 62. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Retail sales 54. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ S corporation income 61. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Services, effect of on royalty income 40. . . . . . . . . . . . . . . . . . . . . .¯ Special rules—Section 501(c)(7), (9), and (17)organizations 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Specified payments by controlled organizations 67. . . . . . . . . . . .¯ Start-up expense 100. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Subdivision of real estate 40. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Substantiation of deductions 83. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Tax on¯¯ Alternative minimum tax 111. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Credits available to offset 106, 112. . . . . . . . . . . . . . . . . . . . . .¯¯ Estimated tax payments 112. . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Proxy tax on lobbying expenditures 111. . . . . . . . . . . . . . . . . .¯¯ Rate schedules 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Tax shelter participation 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Timber sales 57. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Transfer of assets to taxable entity 57. . . . . . . . . . . . . . . . . . . . . . . .¯ Travel tours 70. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

UNRELATED TRADE OR BUSINESS¯ Activity¯¯ Advertising 26. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Bingo games 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Constituting a trade or business 24. . . . . . . . . . . . . . . . . . . . . .¯¯ Convenience of members, students, and patients 33. . . . . . .¯¯ Convention or trade show 33. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Debt management plan services 29. . . . . . . . . . . . . . . . . . . . . .¯¯ Disposition of brownfield property 33. . . . . . . . . . . . . . . . . . . . .¯¯ Excluded from the definition of unrelated tradeor business 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Games of chance 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Parking facilities 71. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Profit motive 24. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Recurring losses 24. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Regularly carried on 26. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Sale of donated merchandise 33. . . . . . . . . . . . . . . . . . . . . . . .¯¯ Substantially related 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Unprofitable 24. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Agency rules, impact on 67. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ De minimis activities 24. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Substantial, jeopardizing exempt status 29. . . . . . . . . . . . . . . . . . .

V

VOLUNTARY EMPLOYEES’ BENEFICIARYASSOCIATIONS (VEBAs)

¯ Unrelated business income 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

VOLUNTEERS¯ Unrelated trade or business, impact on¯¯ Activity staffed with 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Indirect compensation 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Noncash remuneration 33. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


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COURSE 2

FORM 1023 (990TG182)

OVERVIEW

COURSE DESCRIPTION: This interactive self-study CPE course discusses Form 1023 (Application forRecognition of Exemption). Organizationswho file a Form 990may also need to fileForm 1023 to have their tax-exempt status recognized by the IRS. Lesson 1discusseshowandwhenanorganizationshould file forexemption.Lesson2coversproviding information about the organization and its activities and operations onForm1023. Lesson3 examines thedifferencesbetweenbeing classified as a publiccharity or a private foundation. Finally, Lesson 4 concludes the course with adiscussion of providing financial data on Form 1023.


February 2018














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Lesson 1—Determining How and When to File for Exemption

Completion of this lesson will enable you to:¯ Identify the benefits of tax-exempt status, which organizations are automatically exempt andwhich have to file,and how to apply for a group exemption letter.

¯ Determine the bestway to address procedural issues related to Form1023, the effective date of the exemption,when public inspection is needed, how to revoke or modify the exemption, how to appeal an adversedetermination, and how to confirm tax-exempt status.

Lesson 2—Providing Information about the Organization and Its Activities and Operations

Completion of this lesson will enable you to:¯ Recognize the information required on Parts I, II, III, IV, and V of Form 1023.¯ Identify the necessary information for filling out Parts VI, VII, and VIII of Form 1023 and Parts I–VI of Form1023-EZ.

Lesson 3—Determination of Public Charity versus Private Foundation Status

Completion of this lesson will enable you to:¯ Recognize thedifferencesbetweenqualifying as a public charity and aprivate foundation, aswell as the 331/3%test, facts and circumstances,more than one-third, and one-third or less tests for qualifying as a public charity.

¯ Determinehow toqualifyasapubliccharityunder the rules thatgovernsupportingorganizations,how toqualifyas a private operating foundation, what makes a grant unusual, how to provide information about contributingsources, whenSchedules A–Hof Form1023 are needed, andwhen safe harbors for organizations that providelow-income housing come into effect.

Lesson 4—Providing Financial Data

Completion of this lesson will enable you to:¯ Identify thepurposeofPart IXofForm1023,applicable reportingperiods, theaccountingmethod,how to reportrevenues and expenses, how to list assets, how to classify liabilities, and how to report fund balances, netassets, and substantial balance sheet changes.










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Lesson 1: Determining How and When to File forExemptionIntroduction

The first step to secure tax-exempt status for most organizations described in IRC Sec. 501(c)(3) is to file anapplication (i.e., Form 1023) for recognition of exempt status with the IRS. As discussed throughout this course, theapplication provides the IRS with information about the organization, including its activities, operations, andfinancial condition. Tax-exempt status is recognized (or denied) by the issuance of a determination letter from theIRS.

Organizations not described in IRC Sec. 501(c)(3) generally file an application for recognition of exempt statususing either Form 1024 or Form 1024-A (only available in draft form at the time of this publication). A discussion ofthese forms is beyond the scope of this course.


Completion of this lesson will enable you to:¯ Identify the benefits of tax-exempt status, which organizations are automatically exempt andwhich have to file,and how to apply for a group exemption letter.

¯ Determine the bestway to address procedural issues related to Form1023, the effective date of the exemption,when public inspection is needed, how to revoke or modify the exemption, how to appeal an adversedetermination, and how to confirm tax-exempt status.

The Benefits of Tax-exempt Status

Tax-exempt status under the Internal Revenue Code confers many benefits on a nonprofit organization. Aside fromthe obvious benefit of exemption from paying federal income tax, Section 501(c)(3) organizations enjoy anincreased ability to raise funds because amounts contributed to such organizations are deductible for income,estate, and gift tax purposes. In addition, tax-exempt organizations may benefit from reduced postal mailing ratesand financing at lower interest rates. However, to obtain these benefits, an organization must comply with strictrules to ensure that it is organized and operated for exempt purposes.

Organizations That Have Automatic Exemptions

Types of Organizations Automatically Exempt

The following types of organizations are automatically exempt and do not need to apply for exempt status:

1. Churches, interchurch organizations of local units of a church, conventions or associations of churches,or integrated auxiliaries of a church, such as a men’s or women’s organization, religious school, missionsociety, or youth group.

2. Any organization (other than a private foundation) normally having annual gross receipts of no more than$5,000. (Thedefinition ofnormally is discussed later in this lesson. For the rules onwhether anorganizationis a private foundation, see Lesson 3.)

3. Subordinate organizations (other than private foundations) covered by a group exemption letter.

Organizations Considered to Be “Churches”

Because freedom of religion is a First Amendment right, it has been challenging for the IRS to define what a churchis for granting federal tax exemptions. The IRS has criteria it uses to determine if an organization is a church forexemption purposes.


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An in-depth discussion of such criteria is beyond the scope of this course, but more information is available inPPC’s 990 Deskbook.

Organizations Automatically Exempt under the Gross Receipts Test

An organization normally has gross receipts of $5,000 or less if all of the following apply:

1. Gross receipts during its first tax year are $7,500 or less.

2. Gross receipts during its first two tax years combined are $12,000 or less.

3. Total gross receipts during the immediately preceding two years plus the current year are $15,000 or less(for an organization that has existed for at least three years).

An organization’s gross receipts include all amounts received during its annual accounting period without reduc-tion for any costs or expenses. Gross receipts include contributions, gifts, grants, dues, assessments from mem-bers, receipts frombusiness activities (including unrelated business income), proceeds from the sale of assets, andall investment income.

An organization failing to meet the three tests previously listed at any time during its first three years must file anexemption application within 90 days after the end of the year in which the failure occurs. An organization thatmisses this 90-day deadline can seek relief under Reg. 301.9100-3 if it acted reasonably and in good faith and ifgranting relief will not prejudice the interests of the government.

Example 1B-1 Failure to meet gross receipts test during three-year period.

The Shakespeare Society of Topeka (SST) was formed in 2016 to produce plays to be presented in publicsecondary schools. SST is not a private foundation, and the projected gross receipts for its first five years ofoperations were $4,000 per year. The Society keeps its books and records on a calendar-year basis. It filedForms 990-EZ for the years ended December 31, 2016, and December 31, 2017 (although filing was notrequired because of the $50,000 gross receipts exception). No exemption application was filed for SST sinceSST’s accountant believed the organization would fall under the “gross annual receipts of $5,000 or less”exception. SST had gross receipts of $6,000 in 2016 and $7,000 in 2017.

Since the Society’s gross receipts were under the $7,500 limit for the first year, it was not required to file anexemption application at that time. However, in the second year, the sum of SST’s gross receipts for its firstand second years is $13,000, which exceeds the $12,000 limit. If SST files an exemption application (Form1023 or 1023-EZ) within 90 days after the end of its second year (by March 31, 2018) and tax-exempt statusis approved by the IRS, SST will be considered tax-exempt from the date of its formation. If an exemptionapplication is filed after March 31, SST can only be considered tax-exempt from the date the application isreceived by the IRS (i.e., the date of the postmarked envelope containing the application) unless it qualifies forrelief under Reg. 301.9100-3.

If an organization passes the gross receipts test for the first three years (i.e., the organization normally had grossreceipts of $5,000 or less), it is still required to file an exemption application if it fails the gross receipts test in a futureyear. If the organization files a subsequently approved exemption application within 90 days after the close of theyear in which the gross receipts test is failed (or within an extended period as allowed by Reg. 301.9100-3), itstax-exempt status continues uninterrupted. If the organization files a subsequently approved exemption applicationafter this deadline, its tax-exempt status will not be in force for the period beginning on the first day of the year inwhich the gross receipts test was failed and ending with the date the exemption application is considered receivedby the IRS. (It will not lose its tax-exempt status for the previous years during which the gross receipts test wasmet.)

Example 1B-2 Failure to meet gross receipts test after expiration of three-year period.

Assume the same facts as in Example 1B-1, except SST’s gross receipts were $6,000 for 2016, $5,000 for2017, $3,500 for 2018, and $7,000 for 2019. SST meets the gross receipts test in each of its first three yearsof operations. On May 1, 2020, SST discovers that the organization fails the gross receipts test for 2019(because its total gross receipts for 2017–2019 exceed $15,000).


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SST’s exempt status for its first three years of operations remains in effect. Because it is too late to file anexemption application within 90 days after the end of the tax year in which the test was failed (and assumingSST does not qualify for relief under Reg. 301.9100-3), the tax exemption for 2019 has been lost as of January1, 2019. Tax-exempt status will be reinstated as of the date a subsequently approved exemption applicationis mailed to the IRS. (Special rules that may allow for an extension of time to file an exemption application inthis situation are discussed later in this lesson.)

Benefits of Applying When Automatically Exempt

Organizations that are automatically tax-exempt may still want to apply for recognition of their exempt status. Afavorable determination letter from the IRS can help assure the organization’s contributors that donations to it aretax deductible. In addition, official recognition of tax-exempt status may make it easier for the organization to takeadvantage of various benefits (e.g., reduced postage rates) that generally require proof of federal exemption. Proofof federal exemption is particularly important to state or county schools or hospitals (or other organizations) thatprovide Section 403(b) annuities to their employees. The tax-favored status of these annuities is only available toemployees of Section 501(c)(3) organizations. Another reason an automatically exempt organizationmight file is toconfirm that the organization is exempt (e.g., an entity that calls itself a church might not meet the IRS definition ofa church). Furthermore, filing an exemption application, while currently not required, may prevent future oversights.An entity that initially is exempt under the $5,000 gross receipts test may grow beyond the exemption amountwithout anyone in the organization realizing the need for filing Form 1023.

The Types of Organizations That Are Required to File for Exempt Status

General Rules

The IRS evaluates the tax-exempt status of organizations based on one of the following five procedures (dependingon the type of organization seeking exemption):

1. Some organizations are automatically considered tax-exempt organizations and are not required to file forexemption (e.g., churches).

2. Section 501(c)(3) organizations that are not described in item 1 and certain other organizations arerequired to file Form1023 [Application forRecognitionofExemptionUnderSection501(c)(3) of the InternalRevenue Code] or Form 1023-EZ [Streamlined Application for Recognition of Exemption Under Section501(c)(3) of the Internal Revenue Code], which must be approved by the IRS.

3. Other organizations (such as labor groups and civic leagues) file for recognition of their exemption onForm 1024 [Application for Recognition of Exemption Under Section 501(a)].

4. A small groupof organizations, including teacher retirement funds and state chartered credit unions, applyfor exempt status by writing a letter (i.e., no form is required) to the IRS at the same address used for filingForm 1023.

5. Certain qualified nonprofit health insurance insurers that receive a loan or a repayable grant under theConsumer Operated and Oriented Plan programs established by the Department of Health and HumanServices can be tax exempt under IRC Sec. 501(c)(29) if they satisfy certain requirements. Rev. Proc.2015-17 explains how and when Section 501(c)(29) organizations may apply for exempt status.

Organizations Required to File an Exemption Application (Form 1023 or Form 1023-EZ)

Organizations required to file an exemption application to be recognized as tax-exempt include the following:

1. Organizations described in IRC Sec. 501(c)(3). Entities formed for religious, charitable, scientific, literary,testing for public safety, or educational purposes; or to foster national or international amateur sports


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competition; or for the prevention of cruelty to children or animals. (The automatic exemption for churcheswas previously discussed.)

2. Organizationsdescribed in IRCSec. 501(e).Cooperative hospital serviceorganizations (i.e., organizationsdesigned to perform on a group basis such centralized functions as purchasing, data processing).

3. Organizations described in IRC Sec. 501(f). Cooperative service organizations of operating educationalorganizations.

4. Organizations described in IRC Sec. 501(k). Child care organizations.

5. Organizations described in IRC Sec. 501(n). Charitable risk pool organizations.

Example 1C-1 Status of cooperative hospital service organizations.

Charitable Hospital and Benevolent Hospital are both Section 501(c) tax-exempt organizations. During thecurrent year, they organized a cooperative hospital service organization (CHSO) to purchasemalpractice andworkers’ compensation insurance for member hospitals. Generally, as discussed in item 2 previously, suchorganizations can qualify for tax-exempt status under IRC Sec. 501(e) (if an exemption application is filed torequest recognition of such status).

Variation: If the organization is organized to actually provide malpractice and workers’ compensation insur-ance as an insurer to member hospitals rather than purchasing it on their behalf from outside insurancecompanies, it will not qualify for tax-exempt status.

Organizations attempting to qualify for exempt status under IRC Sec. 501(c)(3) can be formed as corporations(including limited liability companies), community chests, funds, foundations, or unincorporated associations. Forthis purpose, a trust is a fund or foundation. Note that individuals and partnerships cannot qualify for Section501(c)(3) tax-exempt status.

Organizations Permitted to File Form 1023-EZ

Certain organizations can apply for tax-exempt status by submitting Form 1023-EZ [Streamlined Application forRecognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code] rather than Form 1023. Suchform is intended to expedite the exemption application process for smaller organizations. An organization may notrequest expedited handing of a Form 1023–EZ.

Eligibility to file Form 1023-EZ is based upon size and several specific disqualifying factors. An applicant’s pro-jected annual gross receipts cannot exceed $50,000 in any of the past three years, or any of the next two years(including the current year). In addition, total assets cannot exceed $250,000 in fair market value. A good faithestimate of the fair market value of the organization’s assets is sufficient.

However, certain organizations that satisfy the size limitations to use Form 1023-EZ are nevertheless required to useForm 1023. Such organizations include—

1. a foreign organization;

2. an organization (or a successor) for which exempt status was previously revoked for a reason other thanthe failure to file Form 990, 990-EZ, or 990-N;

3. a supporting organization as defined in IRC Sec. 509(a)(3);

4. an organization that intends to maintain donor-advised funds;

5. anorganization that participates (or intends toparticipate) in a partnershipwith partners other thanSection501(c)(3) organizations; or


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6. one of several other types of organizations, including a church, school, hospital, credit counselingorganization, limited liability company, and a successor to a for-profit entity.

A complete list of organizations that are precluded from using Form 1023-EZ is provided in a Form 1023-EZEligibility Worksheet. This Eligibility Worksheet consists of 26 questions to be answered “Yes” or “No” prior tocompleting Form 1023-EZ. It is structured such that a “Yes” answer to any question means that Form 1023-EZcannot be used.

General Tests for Section 501(c)(3) Exemption

An organization seeking exempt status under IRC Sec. 501(c)(3) must meet the following conditions:

1. The entity must be organized and operated exclusively for one or more of the charitable purposes listedpreviously in item 1. of “Organizations Required to File an Exemption Application (Form 1023 or Form1023-EZ).” Activities that demonstrate an illegal purpose, tend to induce the commission of a crime, or areagainst public policy do not have a charitable purpose.

2. None of the entity’s net earnings can inure to the benefit of private shareholders or individuals.

3. The entity must not, as a substantial part of its activities, attempt to influence legislation or participate toany extent in a political campaign for or against any candidate for public office.

Recognition as a Public Charity

Exempt status can be recognized before an organization’s operations begin if proposed operations are describedin sufficient detail for the IRS to conclude that the organization will meet the requirements of the section under whichexemption is claimed.

A new Section 501(c)(3) organization that demonstrates a reasonable likelihood of public support in its applicationfor exempt status will be recognized as a public charity without any follow-up requirements. The organizationretains its public charity status for its first five years regardless of the public support actually received during thattime. Instead, beginning with the organization’s sixth taxable year, it must establish that it meets the public supporttest by showing that it is publicly supported on its Schedule A to Form 990.

Group Exemption Letters

General Rules

An exempt organization with subsidiaries can request a group exemption letter on behalf of its subsidiaries. (Theexemption application is not used to make such requests.) The benefits to a subsidiary organization of inclusion ina group exemption include (1) exclusion from filing Form 1023, Form 1023-EZ, or Form 1024; (2) the ability (but notthe requirement) to be included in a group Form 990 return and, thus, avoid filing a separate Form 990; and (3)enjoyment of the goodwill resulting from affiliation with the central organization. However, organizations consider-ing inclusion in a group exemption should note that generally no group Form 990-T can be filed to report unrelatedbusiness income; effectively, a separate Form 990, Schedule A, must be filed for each subsidiary, and a subsidiaryorganization will not be listed in the IRS online tool—EO Select Check (an online search tool that allows users tocheck certain information about an organization’s federal tax status and filings), which may limit donations.

The central organization can apply for the group exemption letter when it submits its own exemption application orafter the IRS recognition of its exempt status. (The central organization cannot include itself in the group exemptionrequest.) If a central organization applies for exempt status when it requests a group exemption letter for subordi-nates, it must provide all of the information for its own exemption (i.e., Form 1023 or 1023-EZ, copies of organizingdocuments, etc.) in addition to the information described in this discussion for its subordinates. If the exempt statusof a central organization is recognized by the IRS before the central organization applies for a group exemption, itmust submit the necessary information for its subordinates, plus a statement that includes (1) its employeridentification number, (2) the date of the letter recognizing its exempt status, (3) the location of the IRS office that


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issued the exemption, and (4) copies of any amendments to its governing instruments or internal regulations thathave been made subsequent to the granting of its original exemption.

Definition of Subordinate Organization

Subordinate organizations eligible for inclusion in a group exemption are chapters, locals, posts, or units of acentral organization. Subordinate organizations must establish that they are affiliated with the central organizationand are subject to its general supervision and control. Rev. Proc. 80-27 does not define “general supervision andcontrol” of the subordinate organization. However, apparently little interaction between the central organization andits subsidiaries is required. Each organization covered by the group exemption must be exempt under the sameparagraph of IRC Sec. 501(c) (although not necessarily the same paragraph under which the central organizationis exempt) and should be on the same accounting period as the central organization if it will be included in groupannual (Form 990) returns.

An organization cannot be included in a group exemption if it—

1. does not have an organizing document (e.g., articles of incorporation or a trust agreement);

2. is organized and operated in a foreign country; or

3. is a private foundation.

Information Required in the Application

The central organization must submit the following information for subordinate organizations that wish to beincluded in a group exemption:

1. Information verifying that the subordinates are—

a. affiliated with the central organization at the close of its annual accounting period,

b. subject to its general supervision or control,

c. all eligible to qualify for exemption under the same paragraph of IRC Sec. 501(c),

d. not private foundations if the application involves Section 501(c)(3),

e. all using the same accounting period as the central organization (if the subordinates plan to file anannual return on a group basis each year), and

f. all organizations that were formedwithin the 27-month period [15months per Reg. 1.508-1(a)(2) plusa 12-month automatic extension allowed by Reg. 301.9100-2] preceding the date the groupexemption letter is being filed.

2. Adetaileddescriptionof thepurposesandactivitiesof thesubordinateorganizations, including thesourcesof receipts and the type of expenditures.

3. A sample copy of a uniform governing instrument (if such an instrument has been adopted by thesubordinates) or copies of representative instruments.

4. An affirmation by a principal officer of the central organization that the information about the purpose andactivities of the subordinate organizations provided in the group exemption letter is true and correct(i.e., the subordinates are operating in accordance with their stated purposes).

5. A statement that each subordinate included in thegroupexemption letter hasbeenauthorizedby anofficerof the subordinate to be included in the group exemption.

6. A list of any subordinates included in the group exemption that have previously obtained from the IRS aruling or determination letter regarding exempt status.

7. An affirmation by a principal officer of the central organization that the subordinate organizations includedin the group exemption are not private foundations [if the group exemption involves Section 501(c)(3)organizations].


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8. A list of names, mailing addresses, actual addresses (if different), and employer identification numbers ofthe subordinate organizations included in the group exemption letter.

9. Information confirming that any subordinate organization that is a school (including a school affiliatedwitha church) is in compliance with the racial nondiscrimination policies set out in Rev. Rul. 71-447 and Rev.Proc. 75-50.

10. Information confirming that any school affiliated with a church is racially nondiscriminatory in accordancewith Rev. Rul. 75-231.

This information should be provided in a letter (rather than on an exemption application) signed by a principalofficer of the central organization. The letter should be mailed to the Internal Revenue Service: P.O. Box 12192,Covington, KY 41012-0192.

The central organization will receive a determination letter from the IRS as to the exempt status of its subordinates. Ifa favorable determination is received, a group identification number will be assigned to the group. This group numbermust appear on any Form 990 (or Form 990-EZ) filed for a subordinate organization included in the group exemptionletter [whether the subordinate organization files its own Form 990 (or Form 990-EZ) or is included in a group return].

Required Annual Filing

For a group exemption letter to remain in force, the central organization must annually submit certain informationto the IRS, in addition to filing Form 990 for the central organization and subordinate organizations. The informationshould be sent to: Ogden Service Center, Mail Stop 6721, Ogden, UT 84201-14749 per IRS Publication 557) at least90 days before the end of the central organization’s tax year and should include the following:

1. All changes in the purposes, character, or method of operation of the subordinates included in the groupexemption letter.

2. A separate list by category of subordinates that fit within each of the following categories:

a. Subordinates that have changed their names or addresses during the year.

b. Subordinates that are no longer included in the group exemption letter because they have ceased toexist, disaffiliated with the central organization, or withdrawn their authorization to be included in thegroup exemption letter.

c. Subordinates tobeadded to thegroupexemption letter because theyarenewlyorganizedoraffiliatedor because they have recently authorized the central organization to include them.

Each list should include the name, mailing address (and actual address, if different), and employeridentification number of the subordinates listed.

3. If a subordinate is being added to the group exemption, the central organization must supply the sameinformationabout thenewsubordinate thatwouldhavebeen required if the subordinatehadbeen includedin the original application for a group exemption. However, if the information the central organizationpreviously provided about its subordinate organizations is materially the same for the new subordinate, astatement to that effect may be submitted in lieu of providing specific information on the new subordinate.

Events Causing Loss of Group Exemption

A group exemption letter can be terminated or revoked, either for a subordinate organization or for the group as awhole. A group exemption ceases to apply to a subordinate organization if—

1. the central organization notifies the IRS that the subordinate no longer conforms to the requirements forinclusion in the group exemption,

2. the central organization notifies the IRS that the subordinate no longer authorizes its inclusion in the groupexemption, or

3. the subordinate organization fails to file a required annual information return (e.g., Form 990 for anorganization whose annual return is not part of a group filing).


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A group exemption ceases to apply to the entire group of subordinate organizations affiliated with a centralorganization if the central organization—

1. ceases to exist,

2. ceases to qualify for exemption under IRC Sec. 501(c),

3. fails to submit the information required annually regarding the subordinate organizations (discussedpreviously under the heading “Required Annual Filing”),

4. fails to file its annual information return (e.g., Form 990), or

5. is notified by the IRS that the groupno longermeets the conditions for continued effectivenessof the groupexemption.

Example 1D-1 Revocation of the central organization’s exempt status.

Stop the Ozone Deterioration, Inc. (STOD), was formed several years ago and received a favorable determi-nation letter from the IRS indicating it qualified as a Section 501(c)(3) organization. STOD has 23 localchapters that received a group exemption in 1995 and subsequently filed a combined Form 990. In the currentyear, STOD’s exempt status was revoked because it no longer operated exclusively for charitable purposes.If STOD’s local chapters wish to maintain their exempt status, they have two options:

1. One of the chapters can apply for exempt status and then apply for a group exemption for the other 22chapters (or any lesser number of chapters that authorize inclusion). The former subordinate applying forexempt status would become the new central organization. This alternativemay not be acceptable to anychapter that does not want to be under the control of the new central organization.

2. Each of the subordinate chapters may apply separately for tax-exempt status.

As long as the group exemption letter (if option 1 is selected) or the Forms 1023 or Forms 1023-EZ are filedwithin 27 months of the date on which STOD’s exempt status is revoked, each chapter’s exempt statuscontinues uninterrupted.

Filing Annual Returns for the Group

A central organization can file a “combined” annual return (Form 990) for all or any of its subordinates (the centralorganization must file a separate return), or the central organization and each of its subordinates can file separateForms 990 (or Forms 990-EZ). However, a consolidated Form 990-T cannot be filed—each subordinate organiza-tion and the central organization generally must file a separate Form 990-T if one is required.

Compliance Checks with Parent Organizations

A compliance check is a review by the IRS to determine if—

1. an organization adheres to recordkeeping and information reporting requirements and

2. its activities are consistent with its tax-exempt purpose.

Although there is no penalty for refusing to submit a compliance check, the IRS can open a formal examination,regardless of whether the organization agrees to participate in the compliance check.


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SELF-STUDY QUIZ


1. Which of the following organizations qualifies for an automatic exemption?

a. The Buckingham Foundation, a private foundation.

b. The Wellsey Group, which has annual gross receipts of $7,000.

c. The Downey Civic League.

d. The Women’s Auxiliary of Grandview Baptist Church.

2. Assuming all other qualifications aremet, which of the following organizations is allowed to file Form 1023-EZ?

a. Parlez Vous, a French nonprofit organization with interests in the U.S.

b. Fundraisers, which is classified as a supporting organization.

c. Hearth Warmers, which has total assets of $175,000.

d. Helping Hands, which has projected annual gross receipts of $70,000.

3. If a group exemption letter is in place, the central organization must annually submit which of the followingpieces of information to the IRS?

a. A list of all of its subordinates.

b. Any changes in purposes of its subordinates.

c. A sample copy of the uniform governing instrument.

d. Information verifying that the subordinates are affiliated with the central organization.


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SELF-STUDY ANSWERS


1. Which of the following organizations qualifies for an automatic exemption? (Page 137)

a. The Buckingham Foundation, a private foundation. [This answer is incorrect. Private foundations do notmeet the automatic exemptions described in Reg. 1.508-1(a)(3).]

b. TheWellseyGroup,whichhas annual gross receipts of $7,000. [This answer is incorrect. Anyorganization(other than a private foundation) normally having gross receipts of no more than $5,000 qualifies for anautomatic exemption under Reg. 1.508-1(a)(3). Therefore, the Wellsey Group is disqualified because itsannual gross receipts are too high.]

c. TheDowneyCivic League. [Thisanswer is incorrect.Organizationssuchas laborgroupsandcivic leaguesfile for recognition of their exemption on Form 1024, so they do not have an automatic exemption.]

d. The Women’s Auxiliary of Grandview Baptist Church. [This answer is correct. According to Reg.1.508-1(a)(3), churches, interchurch organizations of local units of a church, conventions orassociations of churches, or integrated auxiliaries of a church (such as a men’s or women’sorganization, religiousschool,missionsociety, or youthgroup) automatically qualify for tax-exemptstatus.]

2. Assuming all other qualifications aremet, which of the following organizations is allowed to file Form 1023-EZ?(Page 139)

a. Parlez Vous, a French nonprofit organization with interests in the U.S. [This answer is incorrect. Foreignorganizations are required to use Form 1023.]

b. Fundraisers, which is classified as a supporting organization. [This answer is incorrect. A supportingorganization, as defined in 509(a)(3), is required to use Form 1023.]

c. HearthWarmers,whichhas total assetsof$175,000. [Thisanswer iscorrect.According toRev.Proc.2018-5, for an organization to use Form 1023-EZ, its total assets cannot exceed $250,000 in fairmarket value. SinceHearthWarmersdoesnot exceed this amount, assumingall other qualificationsaremet (such as not exceeding the allowed amount of annual gross receipts), Hearth Warmers willbe allowed to file the streamlined Form 1023-EZ instead of Form 1023.]

d. HelpingHands, which has projected annual gross receipts of $70,000. [This answer is incorrect. Eligibilityto file Form1023-EZ is basedupon size and several specific disqualifying factors. An applicant’s projectedannual gross receipts cannot exceed $50,000 in any of the past three years, or any of the next two years(including the current year). Therefore, since Helping Hands has projected annual gross receipts of$70,000, it has exceeded this threshold and must file Form 1023.]

3. If a group exemption letter is in place, the central organization must annually submit which of the followingpieces of information to the IRS? (Page 141)

a. A list of all of its subordinates. [This answer is incorrect. PerReg. 601.201(n)(8)(iv), the central organizationmust annually submit a separate list by category of subordinates that fit within certain categories, such assubordinates that have changed their namesor addressesduring the year. Subordinates that donot fit intoone of the applicable categories would not have to be included in this list.]

b. Any changes in purposes of its subordinates. [This answer is correct. For a group exemption letterto remain in force, the central organization must annually submit certain information to the IRS, inaddition to filingForm990 for thecentralorganizationand thesubordinateorganizations.Accordingto Reg. 601.201(n)(8)(iv), all changes in the purposes, character, or method of operation of thesubordinates included in the group exemption letter is one such piece of information.]


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c. A sample copy of the uniform governing instrument. [This answer is incorrect. According to Reg.601.201(n)(8)(iii), when submitting information for subordinate organizations that wish to be included ina group exemption, one piece of information the central organization must send is a sample copy of auniform governing instrument (if such an instrument has been adopted by the subordinates) or copies ofthe representative instruments. This information is not required to be sent annually.]

d. Information verifying that the subordinates are affiliated with the central organization. [This answer isincorrect. This is part of the information that is required from the central organization by Reg.601.201(n)(8)(iii) for subordinate organizations that wish to be included in a group exemption. Thisinformation does not have to be submitted annually.]


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Procedural Issues to Consider

When to File

Unless an organization’s exemption application is due 90 days after the end of the year in which it failed the grossreceipts test, the exemption application is duewithin 27months from the end of themonth in which the organizationis formed. For example, a charitable corporation incorporated on September 1, 2016, must file an exemptionapplication on or before December 31, 2018. An organization that files an exemption application within this27-month period qualifies as a Section 501(c)(3) entity from the date of formation if the IRS subsequently issues afavorable determination letter. If an exemption application is not filed within this 27-month period, the organizationqualifies as a Section 501(c)(3) entity from the date a subsequently approved application is filed with the IRS, ratherthan from the date of formation.

A charitable corporation is considered formed when it comes into existence under the laws of the state in which itis incorporated. An unincorporated organization is considered formed on the date its constitution, trust agreement,or articles of association are adopted.

Example 1E-1 Determining the date of formation.

Aid to Africa, Inc. (AAI), is a nonprofit corporation formed to aid drought victims in Somalia. AAI is a Delawarecorporation, and its articles of incorporation were filed on December 15, 2016. Under state law, the organiza-tion is considered to be formed on the date the articles of incorporation are filed. The first organizationalmeeting of AAI was not held until February 15, 2017, and on that day AAI adopted its bylaws and opened abank account.

For determining when the 27-month period expires, the corporation was formed on December 15, 2016, eventhough no corporate activity occurred until February 2017. Thus, to receive retroactive approval of its exemp-tion, AAI must file Form 1023 or 1023-EZ by March 31, 2019.

Section 501(c)(4) Social Welfare Organizations

New social welfare organizations are required to notify the IRS that they are exempt from tax under Section501(c)(4). A social welfare organization formed after July 8, 2016, must notify the IRS within 60 days of its formationof its intent to operate under IRC Sec. 501(c)(4) by submitting online Form 8976 [Notice of Intent to Operate UnderSection 501(c)(4)]. Submitting Form 8976 is not a request for a determination letter, nor is the IRS’s acknowledg-ment of Form 8976 a determination of tax-exempt status. A $50 user fee must be submitted at www.pay.gov tocomplete the notification.

Where to File

Forms 1023, Forms 1024, and all letter applications for recognition of qualification or exemption are filed with theIRS office in Covington, KY, regardless of where an organization is domiciled. The mailing address is InternalRevenue Service, Attention: EO Determination Letters, Stop 31, P.O. Box 12192, Covington, KY 41012-0192. Theaddress for express mail or private delivery service is Internal Revenue Service, Attention: EO DeterminationLetters; Stop 31, 201 West Rivercenter Blvd., Covington, KY 41011. The IRS considers the postmark date on theapplication to be the date of filing or, if the application is not postmarked, the date it is received by the IRS. Forprivate delivery services specified by the IRS, the applicationmust be recorded electronically to the database of thedelivery service or the date given to the delivery service must be marked on the package.

Form 1023-EZ can only be filed electronically at www.pay.gov (search 1023-EZ).

User Fee

An organization requesting exempt status on Form 1023, 1023-EZ, or 1024 must pay a user fee (e.g., see Part XI ofForm 1023.) The amount of the fee for a Form 1023 or 1024 depends on whether the applicant’s average annualgross receipts have exceeded, or will exceed, $10,000 annually over a four-year period. An applicant that has


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already completed a four-year period uses the gross receipts actually received for the immediately preceding fouryears to determine its average annual gross receipts. An applicant that has not completed a four-year period shoulduse the gross receipts it expects to receive over its first four years. Effective February 1, 2017, the user fee for anapplicant submitting Form 1023-EZ is $275.

Because fees are subject to change, applicants are advised to check the IRS website at www.irs.gov (and search“exempt organization user fee”) or call the IRS Tax-Exempt Government Entity line at (877) 829-5500 for currentinformation. The applicable user fee can be paid by a personal or certified check, bank check, cashier’s check, ormoney order.

Interactive Form 1023 and Checklist

The IRS has created an interactive version of Form 1023, which is very useful in preparing a complete tax-exemptstatus application. It includes several prompts to answer questions about a particular item, as well as whenadditional information must be attached. This interactive version is available at www.stayexempt.irs.gov bysearching for “interactive 1023.” Completing Form 1023 is discussed in Lessons 2–4 of this course.

As part of the Form 1023 application package, the applicant must include (as the first item) the IRS’s Form 1023Checklist, which lists the order in which the required documents should be assembled. More importantly, properlycompleting this checklist will minimize the likelihood that the application will be returned for being incomplete.

Filing an Incomplete or Incorrect Application

Incomplete Application. The IRS sometimes needs additional information in order to process an application for taxexempt status. An organization has 28 days to respond to the information request. After 28 days, the application isterminated and the application fee will not be returned.

An incomplete Form 1023-EZwill not be processed, even if it has been successfully submitted throughwww.pay.gov.The Form 1023-EZ instructions indicate that the IRSmay, but is not required to, request additional information to verifythat the application is complete. If an organization’s Form 1023-EZ is not accepted for processing, it will be notifiedof the nonacceptance and the user fee paid will be refunded. An eligible organization may then submit a properlycompleted Form 1023-EZ with a new user fee. Alternatively, an eligible organization may apply for exempt status onForm 1023.

In addition, the IRS no longer processes substantially incomplete determination requests, including Forms 1023,1024, 1028, 8940 or other letter requests. It returns the application package and user fee. The applicant then mustresubmit the entire application package, including the missing information, and the correct user fee.

Example 1E-2 Resubmitting an incomplete Form 1023.

In June 2016, five individuals incorporated Help for the Homeless, Inc. (HHI) to raise money for homelessshelters. The group submitted Form 1023 to the IRS in August 2018. Although the application was filed timely,HHI submitted only its bylaws instead of a full conformed copy of the organizational documents (i.e., no copyof the articles of incorporation was included).

The IRS requested the missing information and required the completed Form 1023 to be resubmitted byDecember 31, 2018. The application was resubmitted with a complete set of conformed organizationaldocuments on December 15, 2018. HHI received a favorable determination letter from the IRS in July 2019.Because HHI complied with the IRS request for additional information on a timely basis, its tax-exempt statusis in force from the date of incorporation in June 2016.

Incorrect Application. If a Section 501(c)(3) organization uses the wrong form to apply for exempt status or appliesfor the wrong type of exemption, the IRS will notify the organization of the steps necessary to correct the problemand give it limited time to supply any additional forms or information.

Expeditious Handling of Application

An “expeditious handling” of an application for exempt status may be requested when the application is on Form1023. (Expeditious handling is not available for Form 1023-EZ applications.) The request must be made in writing,


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preferably in a separate letter submitted with Form 1023, or soon after the application is filed. The letter mustexplain a compelling need for special handling. Compelling reasons include the following:

1. A grant is pending and the failure to secure the grant may have an adverse impact on the organization’sability to continue operations.

2. A newly created organization’s purpose is to provide disaster relief to victims of emergencies.

3. There have been undue delays in issuing a determination letter caused by issues within the IRS.

After an application has been filed, a written request for expedited processing must be sent to the InternalRevenue Service, P.O. Box 2508, Room 4024, Cincinnati, OH 45201. If using a private delivery service, send therequest to the Internal Revenue Service, 550 Main Street, Room 4024, Cincinnati, OH 45202. Requests may befaxed to (855) 204-6184.

Checking on the Status of an Application

Normally, the IRS will acknowledge the receipt of an exemption application (Form 1023 or 1024) within a few weeksof the postmark date (or date of dispatch by private delivery service).

Upon receipt of Form 1023 or 1024 by the IRS, an exemption application is categorized as one that (1) can beapproved immediately based upon the information submitted; (2) needs minor additional information beforeprocessing; (3) is submitted on an obsolete form or does not include the items specified on the proceduralchecklist; or (4) requires additional development. According to the IRS website, the IRS will either issue a determi-nation letter or request additional information (via telephone, fax, or letter) within approximately six months of thedate an application was submitted if it falls into group (1), (2), or (3). However, an applicant whose applicationrequires additional development will be contacted only after it has been assigned to an EO specialist.

If an applicant has not received either a determination letter or a request for more information within six months fromfiling, the status can be checked by calling the IRS [TE/GE Customer Account Services (877) 829-5500]. Thefollowing information should be available at the time of the call:

1. The name of the organization on whose behalf the request was submitted.

2. The organization’s employer identification number (EIN).

3. The document locator number assigned to the request (if you have received one).

4. A proper power of attorney submitted with the exemption application unless you are legally authorized torepresent the organization, such as an officer or director.

Filing Requirements While an Application Is Pending

An organization that has filed for recognition of its exempt status must file any tax returns (e.g., Forms 990, 990-EZ,990-N, 990-PF, or 990-T) that become due while its exemption application is pending.

The Exemption’s Effective DateGeneral Rules

An organization that files Form 1023 or 1023-EZ timely (i.e., within 27 months after the month in which theorganization was formed) is eligible for tax exemption under Section 501(c)(3) from the legal date of formation. If anapplication is filed after the 27-month period, a favorable determination letter recognizing the organization’s exemptstatus under Section 501(c)(3) is normally effective only from the postmark date on the application (Form 1023) orthe submission date (Form 1023-EZ). However, there are exceptions to these rules.

Exceptions to Normal Effective Date

Some types of organizations are automatically tax-exempt under Section 501(c)(3) even though they never fileForm 1023 or 1023-EZ. Such an organizationmay still file Form 1023 or 1023-EZ in order to have formal recognition


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of its exempt status for various reasons. It can do so at any time and the formal recognition will still be effective fromthe date of incorporation or formation. In some instances, the 27-month filing period may not begin at the date oflegal formation.

When Form 1023 is filed after the 27-month filing deadline, Schedule E must be completed and attached to enablethe IRS to determine the appropriate effective date of exempt status.

The following organizations have no filing deadline because they are automatically tax-exempt from the legal dateof formation under Section 501(c)(3), regardless of whether they ever file Form 1023 or 1023-EZ:

1. A church, association of churches, or an integrated auxiliary of a church (line 1 of Schedule E).

2. A public charity with annual gross receipts that are normally $5,000 or less (line 2a of Schedule E).

3. An organization included as a subordinate in a group exemption letter (line 3a of Schedule E).

4. An organization created on or before October 9, 1969 (line 4 of Schedule E).

Additionally, certain filing deadlines differ from the standard 27-month filing deadline, as follows:

1. An organization that initially met the $5,000 gross receipts exemption has 90 days from the end of the tax yearin which gross receipts are normally more than $5,000 within which to file Form 1023 (line 2b of Schedule E).

2. An organization that ceases to be covered in a group exemption letter has 27months from the date of suchnotification in which to file Form 1023 (line 3b of Schedule E). Alternatively, an organization included as asubordinate in a timely filed group exemption request that was denied has 27 months from the postmarkdate of the IRS final adverse ruling letter in which to file Form 1023 (line 3c of Schedule E).

An applicant that does not file Form 1023-EZ within 27 months of formation can request an effective date earlierthan the date of submission. Such request is made in a letter explaining why the earlier requested effective date iswarranted. For example, an earlier effective date might be warranted based upon the exceptions noted previously.This correspondence (which should be sent only after receipt of a determination letter from IRS) and any support-ing documentation should be mailed to Internal Revenue Service, Exempt Organizations Determinations, Room4024, P.O. Box 2508, Cincinnati, OH 45201.

Extension of Time to File

An organization filing Form 1023 after the applicable deadline can request an extension of time to apply in order tobe recognized as exempt from its legal date of formation (line 5 of Schedule E).

The IRS will grant an extension if the organization submits evidence that (1) it acted reasonably and in good faithand (2) granting the extension will not prejudice the interests of the government. An organization is considered tohave acted reasonably and in good faith if it filed Form 1023 before the IRS discovered the failure to file. If this is notthe case, the organization may still be granted an extension by (1) showing that its failure to file was due to eventsbeyond its control or it was not aware of the requirement to file even though it exercised reasonable diligence; and(2) furnishing a detailed explanation for the late filing. An extension will not prejudice the interests of the governmentif it will not result in a lower tax liability for prior years than would have resulted if Form 1023 had been timely filed.

The explanation should include the following:

1. Disclosureofwhether theorganization consulted anattorneyor accountant or a responsible IRSemployeeto determine the organization’s filing requirements and, if so, the names and occupations or titles of thepersons contacted, the approximate dates, and the substance of the information obtained. (An extensiongenerally should be granted if the organization can prove it reasonably relied on the advice of a qualifiedtax professional or the written advice of the IRS.)

2. An explanation of how andwhen the organization learned about the 27-month deadline for filing Form 1023.Anextensionnormallywill begranted if theorganization canprove itwasnot awareof the 27-monthdeadline.


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3. Disclosure of any significant intervening circumstances beyond the organization’s control that preventedit from submitting the application on a timely basis or within a reasonable period of time after it learned ofthe filing requirement. Such circumstances will generally result in the granting of an extension.

4. Any other information that establishes good cause for not filing on a timely basis or justifies granting anextension.

If an extension is not requested, an organization can only be tax-exempt from the postmark date of its application.

Effective Date of Exemption When Substantial Amendment Is Required

When an organization submits a timely filed application, a favorable determination letter recognizing its exemptstatus is effective on the date of formation if its activities during the period before receipt of the determination letterconform to its described exempt purpose. When an organization must alter its activities or substantially amend itsorganizational documents to obtain exempt status, the exemption is effective on the date specified by the IRS in thedetermination letter.

Status of Organization That Files after Deadline

Line 6a of Schedule E, Form 1023 asks if the organization wants its exemption to be effective only from thepostmark date. If so, answer “Yes” to Part X, line 6a. If the answer is “No,” the organization will be treated as aprivate foundation. In addition, line 6b requires that line 7 of Schedule E be completed if the organization antici-pates significant changes in its future sources of support.

Making Forms 1023, 1023-EZ, 1024, and 1024-A Available for PublicInspection

A copy of an exempt organization’s application for recognition of federal tax exemptionmust be available for publicinspection. In addition, organizations generally must furnish a copy of the application to anyone who requests it inperson or in writing. A detailed discussion of the disclosure rules and the penalties for violating these rules isbeyond the scope of this course, but more information is available in PPC’s 990 Deskbook.

Regulations require that any letter or document issued by the IRS related to the organization’s application forrecognition of federal tax exemption be made available for public inspection. Thus, if an organization was deniedfederal tax-exempt status, the document denying tax-exempt status must be made available for public inspection.

Revoking an Exemption

Methods of Revocation

Once the IRS has issued a favorable ruling or determination letter, an organization’s exemption can be revokedby—

1. a subsequent IRS notice to the organization;

2. legislation (or a tax treaty);

3. the U.S. Supreme Court;

4. temporary or final regulations;

5. a revenue ruling, revenue procedure, or other guidance published in an Internal Revenue Bulletin; or

6. failing to file a required annual return or notice for three consecutive years [note that this is automatic underIRC Sec. 6033(j)].


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Instead of the IRS modifying an organization’s status (i.e., by changing the Code section under which an organiza-tion qualifies for exempt status), the status will be revoked for an organization that no longer qualifies under theCode section for which exemption was granted or selfdeclared. The organizationmust then apply for recognition ofexempt status under a different Code section.

If exempt status is revoked because of a material change in the character, purpose, or method of operation of theorganization that is inconsistent with its exempt purpose, revocation will normally be prospective only. However, ifthe organization omitted or misstated a material fact, operated in a manner materially different from that describedin its application for recognition of exempt status, or engaged in a prohibited transaction, the revocation may beretroactive to the date the organization originally qualified as exempt.

Example 1H-1 Prospective revocation of exemption.

Grammer School (Grammer) qualified as a tax-exempt private school under IRC Sec. 501(c)(3) beginning in2001. To be tax-exempt, a private school must, among other things, maintain a racially nondiscriminatoryadmissions policy. On September 15, 2015, Grammer changed its admissions policy to exclude applicants ofa particular national or ethnic origin. The IRS determined that the new policy was racially discriminatory andrevoked Grammer’s exempt status. After Grammer had exhausted all of its administrative remedies, a finaladverse determination letter was issued by the IRS on August 2, 2018. Grammer’s exempt status is revokedas of September 15, 2015—the date it changed its admissions policy rather than the date of formation.

Automatic Revocation for Not Filing Annual Return

An organization that is required to file Form 990, 990-PF, 990-EZ, or 990-N but fails to do so for three consecutiveyears automatically loses its exempt status. This automatic revocation is effective on the filing due date of the thirdyear’s return. For example, the exemption revocation of a calendar year organization that did not file for 2015, 2016,and 2017 would be effective as of May 15, 2018. Exempt organizations not required to file an annual return or noticeare not subject to automatic revocation. The list of organizations that have had their exempt status automaticallyrevoked are published at www.irs.gov (search “select check”). For each organization, the Auto-Revocation Listprovides the name, last known address, employer identification number (EIN), subsection of exemption, effectivedate of revocation, and date the name is published. The date of reinstatement is also listed (if applicable). See thediscussion later in this lesson under “Reinstatement.”

Relief Procedure. An organization that files for exempt status should begin filing Form 990, 990-PF, 990-EZ, or990-N while the application is pending. If it fails to do so and its exemption application is unduly delayed, it ispossible that the organization could lose exempt status before ever receiving it because of the automatic revocationrule. Under these circumstances, the IRS says the application will be treated as a request for reinstatement ofexempt status that will be effective the same day it was automatically revoked.

Effect of Revocation

On Organization. An organization that has lost its tax-exempt status may be required to file one of the followingfederal income tax returns:

¯ Form 1120 (U.S. Corporation Income Tax Return).

¯ Form 1041 (U.S. Income Tax Return for Estates and Trusts).

On Contributors. When a Section 501(c)(3) organization receives a favorable determination letter, it is listed in theIRS online tool—EO Select Check. Contributions to listed organizations are tax-deductible. When an organizationlisted in EO Select Check (Pub. 78 data) has its tax-exempt status revoked, subsequent contributions made to theorganization are normally not deductible. Contributions to such an organization continue to be deductible if madebefore (1) the date an announcement is published in the Internal Revenue Bulletin stating that contributions to theorganization are no longer deductible, or (2) a date specified in such an announcement as the date deductibility isterminated. However, the IRS may disallow any contribution made after the date of revocation by a contributor whohad knowledge of the revocation, was aware that such revocation was imminent, or was in part responsible for, orwas aware of, the activities that caused the revocation. Recent revocations and deletions from the cumulative listare available at www.irs.gov (search “select check”).


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On Group Exemption Subordinates. The IRS addressed a few scenarios regarding subordinates operating undera group exemption ruling.

1. If the subordinate is covered under a group exemption ruling but fails to file its return for three consecutiveyears and loses its exemption, it must apply for exemption to be reinstated (i.e., it cannot merely be addedto the group exemption roster filed with the IRS).

2. If a subordinate lost its exemption for failure to file for threeconsecutive yearsandapplied for (and received)reinstatement, it no longer needs to be included in the group exemption list filed with the IRS because thesubordinate now has its own individual tax exemption.

3. If the subordinate properly filed all of its returns but the parent/central organization lost its exemption, thecontinued effectiveness will be based on the continued qualification of the parent/central organization forexemption. If the group exemption is no longer effective, the subordinate may be required to file incometax returns. In addition, the subordinatemaywant to file its own application for exemption to be recognizedas tax-exempt.

Reinstatement

The IRS cannot undo an automatic revocation because it is by operation of law and not by an IRS determination. Anorganizationmust apply to have its tax-exempt status reinstated, even if not originally required to file an application.The application for reinstatement may be on Form 1023, or if the organization qualifies, on Form 1023-EZ (seeLesson 2 for the rules applicable to the use of Form 1023-EZ). An organization may also request a retroactivereinstatement as part of its application.

The IRS provided guidance for retroactively reinstating an organization’s tax-exempt status in the followinginstances:

1. A small organization eligible to file Form 990-EZ (Short Form Return of Organization Exempt from IncomeTax) or Form 990-N (e-postcard) for each of the three consecutive years but failed to file returns, causingits revocation. A streamlined retroactive reinstatement (discussed later in this section) is available if theorganization has not previously had its tax-exempt status automatically revoked.

2. Any organization that failed to qualify for the streamlined reinstatement under item 1 (e.g., the organizationwas required to file Form 990) if the application is made no more than 15 months from the later of therevocation letter date or the date listed on the IRS website as revoked. The organization must showreasonable cause for not filing at least one of the returns in the three consecutive years that it failed to file.See the discussion of reasonable cause later in this lesson.

3. All organizations that failed to file returns within the three-year period and did not file an application forreinstatement within 15 months from the date the IRS revoked the organization’s tax-exempt status. Theorganization must show reasonable cause for not filing for all three periods.

Streamlined Retroactive Reinstatement. This procedure is available for organizations that have not previously hadtheir exempt status automatically revoked. The organization should complete and submit an application (on Form1023, or if the organization qualifies, on Form 1023-EZ) with the following notation at the top, “REVENUE PROCE-DURE 2014-11, STREAMLINED RETROACTIVE REINSTATEMENT,” and pay the appropriate user fee nomore than15 months after the later of the date of revocation or the date the organization appeared on the IRS’s revocation list.

No penalty will be assessed, for failure to file annual returns if the organization properly filed paper Form 990-EZwith the IRS at Department of Treasury, Internal Revenue Service Center, Ogden, UT 84201-0027 for the threeconsecutive tax years that caused the revocation. The returns should note “RETROACTIVE REINSTATEMENT” onthe Form 990-EZ filed. Organizations that were eligible to file Form 990-N do not have to file a prior year Form 990-Nor 990-EZ.

Retroactive Reinstatement of Tax-exempt Status Within 15 Months. Organizations that do not qualify for thestreamlined processmay apply for retroactive application if the organization completes and submits an application


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within 15months from the date of revocation or the date the organization is listed on the revocation list and pays theappropriate user fee. The following notation should be written at the top of the application, “REVENUE PROCE-DURE 2014-11, RETROACTIVE REINSTATEMENT.”

The application must include—

1. a reasonable cause statement that specifies why a return was not filed in at least one of the three years,

2. an explanation of the steps put in place to ensure returns will be filed in the future, and

3. a statement that paper returns have been filed for all years required.

Retroactive Reinstatement Filed More than 15 Months after Revocation. Any organization that fails to apply forreinstatement of tax-exempt status within 15 months of revocation can apply after the 15-month period expires ifcertain requirements are met. The organizationmust satisfy all the requirements reflected previously under retroac-tive reinstatement within 15 months. However, the organization’s reasonable cause statement must explain itsfailure to file required returns for all three periods (not just one).

Factors considered in establishing reasonable cause (with no single factor being either necessary or determinative)include—

1. good faith reliance upon erroneous written information from the IRS (or presumably from tax counsel aswell);

2. the occurrence of events beyond the organization’s control that prevented the required filing;

3. evidence that theorganizationhasundertakensignificant steps toavoidormitigate the failure to file a returnor notice and to prevent future failures; and

4. an established history of compliance with reporting requirements, aside from the three-year lapse.

Regardless of the factor(s) offered to support reasonable cause, the organizationmust submit evidence to substan-tiate it.

User Fees. The appropriate user fee must accompany the application as discussed earlier in this lesson. Seewww.irs.gov (and search “exempt organization user fees”) for the current fees.

Refund of Tax Paid. If an organization files an income tax return and pays income tax, and the IRS reinstatestax-exempt status, an amended income tax return should be filed to request a refund. If the organization receiveda delinquency or penalty notice for the period the organization was not exempt and the IRS reinstates tax-exemptstatus, the organization should send a letter to the IRS address indicated in the notice and include—

1. a request to remove the tax due and/or abate of the penalty,

2. an explanation that it was not liable because exempt status was reinstated, and

3. a copy of the new determination letter reinstating tax-exempt status.

Appealing an Adverse Determination

Appeals Procedures

An organization has the right to protest and appeal an adverse determination letter from the IRS through the IRSAppeals Office. The protest must be submitted within 30 days after the date of the adverse determination.

The protest should contain—

1. the organization’s name, address, daytime telephone number, and employer identification number;


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2. a statement that the organization wants to protest the determination;

3. the date and IRS identification symbols on the determination letter or a copy of such letter;

4. a statement of facts supporting the organization’s position in any contested factual issue;

5. a statement outlining the law or other authority the organization is relying on; and

6. a statement requesting a conference at the Appeals Office, if one is desired.

The statement of facts in item 4. must be declared true, under penalties of perjury, by adding to the protest thefollowing declaration signed by a principal officer of the organization:

“Under penalties of perjury, I declare that I have examined the statement of facts presented in this protestand in any accompanying schedules and statements and, to the best of my knowledge and belief, it istrue, correct, and complete.”

If the organization’s representative submits the protest, a substitute declaration must be included, stating—

1. that the representative prepared the protest and accompanying documents and

2. whether the representative knows personally that the statements of fact contained in the protest andaccompanying documents are true and correct (or if he does not have personal knowledge, believes thestatements of fact to be true and correct).

The Appeals Office will consider all information, written and oral, provided by the organization and issue a writtendetermination letter. An adverse decision by the Appeals Office may be appealed through the courts. (See thediscussion of judicial remedies later in this lesson.)

Example 1I-1 Appealing an initial adverse determination from EO Rulings and Agreements.

Ben’s Basement Bingo, Inc. (BBB), applied for exempt status by timely filing Form 1023 in September 2017.The application was subsequently referred to EO Rulings and Agreements National Office. On August 31,2018, EO Rulings and Agreements issued an adverse determination letter to BBB. If BBB decides to appealthe adverse determination, it has 30 days from the date of the determination to submit an appeal to theAppeals Office.

Judicial Remedies

If an organization receives a final adverse determination, either upon submission of its original application or uponthe revocation of its exemption, it can pursue judicial remedies. Organizations that have paid tax because of anunfavorable determination can file suit for a refund in U.S. District Court or in the U.S. Court of Federal Claims. (Taxwould result from having to pay income tax, FICA, or FUTA when it loses its exempt status and becomes subject tothe corporation or trust tax laws.) If an organization has not paid any tax resulting from the unfavorable determina-tion, it can file suit for a redetermination of the tax deficiency in the U.S. Tax Court. Because of the time necessaryto obtain judicial relief, and because contributions to the organization during this period are not deductible to thecontributor, the organization usually will be out of business before the date of judicial resolution. (Generally,charitable organizations are not allowed any injunctive relief when faced with the loss of their exempt status.)

To help overcome this potentially adverse situation, Congress permits Section 501(c)(3) organizations to seek adeclaratory judgment when there is controversy over their exempt status. Contributions made to an organizationduring the litigation for declaratory judgment are deductible to the contributor even if the organization subsequentlyfails to qualify as a charity. An organization may pursue a declaratory judgment in its choice of the U.S. Tax Court,the U.S. Court of Federal Claims, or the U.S. District Court for the District of Columbia.

An organization cannot seek a declaratory judgment until all of its administrative remedies have been exhausted.The administrative steps that must be completed before seeking a declaratory judgment are set out in Rev. Proc.


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2018-5 2018-1 IRB 233, Sec. 10.05. A suit for declaratory judgment normally must be filed within 90 days after theIRS mails an adverse notice of final determination to the organization by registered or certified mail. However, if theIRS fails to issue a determination about an organization’s status within 270 days after Form 1023 is submitted (or iflater, within 270 days of when the Form 1023 is considered substantially completed), and the organization hasfulfilled on a timely basis all of its responsibilities connected to the determination request, a suit for declaratoryjudgment may be filed at the end of the 270-day period.

If the organization’s suit is successful, and the court finds that the organization is exempt from tax, the IRS will issuea favorable determination letter. However, the organization must reaffirm in writing that the underlying facts andapplicable law are unchanged from the period considered by the court.

Example 1I-2 Deadline for filing a declaratory judgment.

Assume the same facts as in Example 1I-1. After BBB filed its Form 1023 in September 2017, the IRSrequested evidence that BBB’s articles of incorporation had been filed with state authorities. The requestedinformation was sent to the IRS on October 31, 2017. After receipt of the adverse determination letter onAugust 31, 2018, BBB filed a protest but failed to sway the EO Rulings and Agreements. The Appeals Officesent a final adverse determination by registered mail on January 2, 2019.

Since BBB received an adverse determination letter, it can file for a declaratory judgment any time during the90-day period after the date the IRS mailed the letter (i.e., any time up to April 1, 2019). In contrast, if BBBnever receives a determination letter from the IRS, it can file for a declaratory judgment after waiting 270 daysfrom when the perfected Form 1023 was mailed (i.e., 270 days after October 31, 2017).

Confirming the Entity’s Tax-exempt Status

Occasionally, it is desirable to confirm that an entity is tax-exempt under IRC Sec. 501(c)(3). When a Section501(c)(3) organization receives a favorable determination letter, it is listed in the IRS online tool—EO Select Check.This, along with other useful information about organizations’ exempt status can be found on the IRS website atwww.irs.gov (search “select check”). This information is updated monthly. Users can search for organizationsthat—

1. are eligible to receive tax-deductible charitable contributions (donors may rely on this list in determiningdeductibility of contributions),

2. havehad their tax-exempt statusautomatically revokedbecause theyhavenot filedForm990series returnsor notices annually as required for three consecutive years (Auto-Revocation List), or

3. have filed a Form 990-N (e-Postcard) annual electronic notice. (Most small organizations whose annualgross receipts are normally $50,000 or less are required to electronically submit Form 990-N unless theychoose to file a completed Form 990 or Form 990-EZ.)

However, many Section 501(c)(3) organizations are not listed in EO Select Check because they—

1. were not required to get determination letters and, therefore, did not (e.g., over 300,000 churches areautomatically exempt without exemption letters);

2. are exempt under a group exemption letter;

3. are a governmental unit; or

4. were mistakenly omitted by the IRS.


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SELF-STUDY QUIZ


4. Which of the following statements best describes a procedural issue related to filing Form 1023?

a. Form 1023 is filed at the IRS office in the state in which the organization is domiciled.

b. If the organization is awarded tax-exempt status, its user fee is waived.

c. The IRS will process determination requests that are largely incomplete.

d. When expeditious handling is requested for Form 1023, it must be done so in writing.

5. Which of the following may occur in relation to the effective date of an organization’s tax exemption?

a. When Form 1023 is filed after the normal deadline, it must be accompanied by an explanatory letter.

b. An applicant that files Form 1023-EZ after the deadline will have a later effective exemption date.

c. Section 501(c)(3) entities may file to receive formal recognition of their status.

d. The IRS automatically grants extensions of time to file Form 1023 if the proper forms are filed.

6. An organization that loses its tax-exempt status may have to do which of the following?

a. Leave Line 6a of Part X of Form 1023 blank.

b. File Form 1120 or 1041.

c. File Form 990, 990-PF, 990-EZ, or 990-N.

d. Have a compliance check.

7. Whenprotestinganadversedetermination letter, anorganizationshould includeall of the following information,except?

a. Its employer identification number.

b. A statement of facts regarding the issue.

c. The date that the organization filed Form 1023.

d. An outline of the law that the organization is relying on.


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SELF-STUDY ANSWERS


4. Which of the following statements best describes a procedural issue related to filing Form 1023? (Page 148)

a. Form 1023 is filed at the IRS office in the state in which the organization is domiciled. [This answer isincorrect. Forms 1023, Forms 1024, and all letter applications for recognition of qualification or exemptionare filed with the IRS office in Covington, KY, regardless of where an organization is domiciled.]

b. If the organization is awarded tax-exempt status, its user fee is waived. [This answer is incorrect. Anorganization requesting exempt status on Form 1023, 1023-EZ, or 1024 must pay a user fee. The amountof the fee for a Form1023 or 1024 depends onwhether the applicant’s average annual gross receipts haveexceeded, or will exceed, $10,000 annually over a four-year period. There is no waiver for the user fee.]

c. The IRSwill process determination requests that are largely incomplete. [This answer is incorrect. The IRSno longer processes substantially incomplete determination requests, including Forms 1023, 1024, 1028,8940 or other letter requests. It returns the application package and user fee. The applicant then mustresubmit the entire application package, including the missing information, and the correct user fee.]

d. When expeditious handling is requested for Form 1023, it must be done so in writing. [This answeris correct. An “expeditious handling” of an application for exempt status may be requested whenthe application is on Form 1023 (but not on Form 1023-EZ). The request must be made in writing,preferably in a separate letter submitted with Form 1023, or soon after the application is filed.]

5. Whichof the followingmayoccur in relation to theeffectivedateofanorganization’s taxexemption? (Page 150)

a. When Form 1023 is filed after the normal deadline, it must be accompanied by an explanatory letter. [Thisanswer is incorrect. When Form 1023 is filed after the 27-month filing deadline, Schedule E (not anexplanatory letter) must be completed and attached to enable the IRS to determine the appropriateeffective date of exempt status.]

b. An applicant that files Form 1023-EZ after the deadline will have a later effective exemption date. [Thisanswer is incorrect. Anapplicant thatdoesnot file Form1023-EZwithin27monthsof formationcan requestan effective date earlier than the date of submission. Such request is made in a letter explaining why theearlier requested effective date is warranted.]

c. Section 501(c)(3) entities may file to receive formal recognition of their status. [This answer iscorrect. Organizations that are automatically exempt under IRC Sec. 501(c)(3) may still file Form1023 or 1023-EZ in order to have formal recognition of their tax-exempt status for various reasons.They can do so at any time and the formal recognition will still be effective from the date ofincorporation or formation.]

d. The IRS automatically grants extensions of time to file Form1023 if the proper forms are filed. [This answeris incorrect. The IRS will grant an extension of time to file if the organization submits evidence that (1) itacted reasonably and in good faith and (2) granting the extension will not prejudice the interests of thegovernment. Therefore, it is possible for the IRS to deny such an extension.]

6. An organization that loses its tax-exempt status may have to do which of the following? (Page 152)

a. Leave Line 6a of Part X of Form 1023 blank. [This answer is incorrect. Line 6a of Schedule E, Form 1023,asks if the organizationwants its exemption to be effective only from the postmark date. If so, answer “Yes”to Part X, line 6a. Since this line deals with applying for tax-exempt status, this procedure would not behelpful once such status is lost.]

b. File Form 1120 or 1041. [This answer is correct. An organization that has lost its tax exempt statusmay be required to file a federal income tax return—either Form 1120 (U.S. Corporation Income TaxReturn) or (2) Form 1041 (U.S. Income Tax Return for Estates and Trusts).]


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c. File Form 990, 990-PF, 990-EZ, or 990-N. [This answer is incorrect. Tax-exempt organizations are requiredto file one of these annual tax returns. Once this status is lost, the Forms 990 would not be appropriate.]

d. Have a compliance check. [This answer is incorrect. A compliance check is a review by the IRS todetermine if (1) an organization adheres to recordkeeping and information reporting requirements and (2)its activities are consistent with its tax-exempt purpose. This may be necessary when filing a groupexemption letter, but would not be a requirement once tax-exempt status is lost.]

7. Whenprotestinganadversedetermination letter, anorganizationshould includeall of the following information,except? (Page 155)

a. Its employer identification number. [This answer is incorrect. According to Reg. 601.201(n)(5), the protestshould contain the organization’s name, address, daytime telephone number, and employer identificationnumber.]

b. A statement of facts regarding the issue. [This answer is incorrect. Per Reg. 601.201(n)(5), one piece ofinformation that is necessary in a protest is the statement of facts supporting the organization’s positionin any contested factual issue. It must be declared true under penalties of perjury.]

c. The date that the organization filed Form 1023. [This answer is correct. This is not one of the piecesof information that Reg. 601.201(n)(5) specifies organizations to include in a protest. However, theorganization would need to include the date and IRS identification symbols on the determinationletter or a copy of such letter.]

d. An outline of the law that the organization is relying on. [This answer is incorrect. A statement outlining thelaw or other authority that the organization is relying on is part of the information that Reg. 601.201(n)(5)indicates is necessary to include when protesting an adverse determination letter.]


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Lesson 2: Providing Information about theOrganization and Its Activities and OperationsIntroduction

Parts I through VIII of Form 1023 [Application for Recognition of Exemption Under Section 501(c)(3) of the InternalRevenue Code] provide the IRS with information concerning the organization, activities, and operation of the entityapplying for exempt status. This reporting focuses on several areas, including: the applicant’s organizationalstructure; whether provisions in the organizational document satisfy the statutory requirements for tax-exemptstatus; whether its activities (actual and/or proposed) are permissible; whether financial arrangements with certainpersons are reasonable and at arm’s-length; the nature of goods, services, or benefits the applicant provides tomembers or other persons; fundraising activities; and the extent of foreign activities, if any.

Form 1023-EZ [Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the InternalRevenue Code] is a 21/2 page exemption application form available for certain small organizations. Guidance forcompleting the form is provided in this lesson.


Completion of this lesson will enable you to:¯ Recognize the information required on Parts I, II, III, IV, and V of Form 1023.¯ Identify the necessary information for filling out Parts VI, VII, and VIII of Form 1023 and Parts I–VI of Form1023-EZ.

Part I of Form 1023

General Information

Part I of Form 1023 requests general information about the applicant organization. Line-by-line guidance oncompleting this section follows.

Line 1—Full Name of Organization. Enter the full name of the organization as it appears on the organizing/creatingdocument (including amendments). If the organization will operate under another name or an acronym, it shouldbe included in parentheses after the legal name.

Line 2—c/o Name. If the organization that has an “in care of” name, enter it on line 2.

Line 3—Mailing Address. Enter the address for mail delivery (e.g., if mail is not delivered to the applicant’s streetaddress and the applicant has a post office box, enter the box number, not the street address). A foreign organiza-tion enters a foreign address in the following order: city, province or state, and country (which should not beabbreviated). Follow the country’s practice in placing the postal code in the address.

Line 4—Employer Identification Number. Include the organization’s nine-digit employer identification number(EIN). If no identification number has been requested, an organization can request an EIN through a Web-basedsystem that instantly processes requests and generates EINs. The EIN application available at www.irs.gov(search “EIN”) is interactive and asks questions tailored to the type of entity being established. It also provides theoption to download, print, and save the confirmation notice, rather than waiting for it by mail. Third partiesauthorized by the organization can secure the EIN, but cannot download, print, or save the confirmation notice,which instead is mailed to the organization.

The IRS does not issue an EIN by telephone for domestic taxpayers. However, Form SS-4 can be mailed or faxedto the IRS.

Do not apply for an EIN more than once. An applicant that is uncertain whether it has an EIN, or whether it hasalready applied for an EIN, should call IRS Customer Service at (877) 829-5500 (a toll-free number) for assistance.


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Also if the organization has more than one EIN and has not been advised which to use, send an inquiry to:Department of the Treasury, Internal Revenue Service Center, Ogden, UT 84201–0027, explaining the EINs theorganization has, name and address associated with each EIN, and the organization’s principal office. The IRS willadvise about which EIN to use for Form 1023 purposes.

Line 5—Month the Annual Accounting Period Ends. Several factors should be considered in selecting the year-endfor a tax-exempt organization. Enter on line 5 the date the organization chooses as its tax year-end. The monthshould be shown numerically (e.g., if the annual accounting period ends December 31, enter “12” for the month).The year-end chosen may result in a short tax year (a year of less than 12 months) for the organization’s first yearof operations.

Line 6—Primary Contact. Enter on line 6a the name of someone the IRS can contact during business hours toobtain more information about the organization. This can be an officer, director, or trustee of the organization butwill usually be the attorney or accountant who completed Form 1023 while acting as an authorized agent of theorganization. Enter the contact person’s phone number on line 6b and fax number on line 6c. Although the faxnumber is optional, it should be included if there is one in order to expedite communication from the IRS to theapplicant.

Line 7—Authorized Representative. If the person listed on line 6a is an authorized representative (rather than anofficer, director trustee) or if the applicant desires to have an authorized representative, check the “Yes” box on line7 and attach a power of attorney on Form 2848 (Power of Attorney and Declaration of Representative) to Form1023. Form 2848 allows the authorized agent to receive confidential information and “to perform any and all acts”the organization’s directors or officers could perform concerning the tax matters specified on the power of attorney.The Form 2848 must specifically authorize an individual (not an organization or firm) to represent the organization.

An alternative to using Form 2848 is to attach Form 8821 (Tax Information Authorization) to the Form 1023application. However, Form 8821 only allows the representative to inspect and receive confidential information fromthe IRS, not to act on the taxpayer’s behalf. Thus, this authorization would not be sufficient to allow the representa-tive to be the primary contact” listed on Line 6 of Form 1023.

Line 8—Paid Consultant. Indicate whether anyone other than an officer, director, trustee, employee, or the autho-rized representative listed on line 7 has been (or will be) paid for advice on organizational, financial (includingfundraising), or tax matters. If the answer is “Yes,” such person’s name, the name and address of the person’s firm,compensation paid or promised, and services providedmust be detailed in an attachment. Among other things, theIRS uses this data to identify promoters who aremarketing exempt organizations as part of tax avoidance schemes.

Line 9—Website and Email Address. List the organization’s complete website address on line 9a (if it has one), orany website maintained on its behalf. The IRS is likely to visit the website to verify that information submitted as partof Form 1023 is consistent with the website contents. The IRS recently denied an organization’s exemptionapplication (Form 1023-EZ) noting conflicts between the application and information obtained from the organiza-tion’s website. An organization can elect whether to include its email address, if any, on line 9b. The IRS will use theemail address to send general educational information to the organization. It will not send or respond to confiden-tial information via email.

Line 10—Form 990 or Form 990-EZ Filing. This question asks if the applicant believes that it will not be required tofile Form 990 or Form 990-EZ, or Form 990-N (i.e., an annual return or notice). If the applicant is a privatefoundation, the question should be answered “NA” (since private foundations file Form 990-PF instead). If theapplicant is not required to file an annual return and is not a private foundation, answer this question “Yes” andattach a statement explaining why a Form 990, Form 990-EZ, or Form 990-N is not required.

The question on line 10 presumably serves two purposes. For an organization that answers the question “Yes”because it believes it is not required to file an annual return, the required statement allows the IRS to determine ifit agrees with the organization’s reason for nonfiling. Secondly, the question should alert the IRS not to send noticesconcerning failure to file an annual return when an organization has a valid reason for not filing one.

Line 11—Date Incorporated or Formed. Enter the date the organization became a legal entity. For a corporation,this is generally the date the articles of incorporation were approved by the proper state authorities. For a trust, the


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date of formation is the date the trust instrument was signed. For any other unincorporated organization, the dateof formation is the date the constitution, articles of organization, or articles of association were adopted.

Line 12—Foreign Organization. Line 12 asks whether the applicant was formed under the laws of a foreign countryand, if so, to state the country. For this purpose, an organization is considered formed under foreign law unlessformed under the laws of the U.S., its territories and possessions, federally recognized Indian tribal or Alaska Nativegovernments, or the District of Columbia. Form 1023 must be prepared in English, and an English translation mustbe provided for the articles of organization and/or bylaws. The IRS may ask for a translation of any other documentthat is in a foreign language and submitted with the Form 1023.

Part II of Form 1023

Organizations Eligible for Exempt Status

Only trusts, unincorporated associations, or corporations (including limited liability companies) are eligible fortax-exempt status under IRC Sec. 501(c)(3). Sole proprietorships, partnerships, or loosely affiliated groups ofindividuals are not eligible. Part II of Form 1023 is used by an applicant to inform the IRS of its legal structure.

Line 1—Corporation. If the applicant is a corporation, answer “Yes” in line 1 and attach a copy of its articles ofincorporation, including any amendments (or other organizing document under state law). The articles of incorpo-ration formed under a state statute must show evidence (“certification of filing”) that they were filed with, andapproved by, an appropriate state authority on a specified date. If articles of incorporation showing a certification offiling are unavailable, the applicant may submit a substitute copy of such document. This substitute copy may behandwritten, typed, printed, or otherwise reproduced. It must be accompanied by a declaration, signed by anofficer authorized to sign it, that it is a complete and correct copy of the articles of incorporation and that it containsall the powers, principles, purposes, functions, and other provisions by which the applicant currently governs itself.

Line 2—Limited Liability Company. If the applicant is a limited liability company (LLC), answer “Yes” on line 2 andattach a copy of its state-approved articles of organization. Evidence (certification of filing) that the articles werefiled with and approved by the appropriate state authority must be submitted. If an LLC has adopted an operatingagreement, such document is also part of its organizing document.

Generally, a single member LLC should not apply for its own tax exemption if its member desires to treat the LLC’sactivities as its own (i.e., to treat the LLC as a disregarded entity). An exempt organization that is the sole owner ofa disregarded LLC will not risk its tax-exempt status just because the organizational documents do not specificallylimit its purpose to an exempt purpose. However, the owner’s exempt status can be affected if the disregardedLLC’s organizational documents provide that the LLC will operate for purposes contrary to the owner’s exemptpurpose.

Line 3—Unincorporated Association. An unincorporated association should answer “Yes” on line 3 and attach acopy of its organizing document (e.g., articles of association or contribution) (including any signed and datedamendments) that is dated and signed by at least two individuals. The articles of organization must include itsname, its purpose, and the date the document was adopted. If a copy with the proper signatures and date ofadoption is unavailable, a written declaration stating that the copy is a complete and accurate copy of the signedand dated original may be submitted. Such declaration should indicate the original date of adoption.

Bylaws may be considered an organizing document only if they are properly structured (i.e., they include name,purpose, signatures, and intent to form an organization).

Line 4—Trust. If the applicant is a trust, answer line 4a “Yes” and attach a signed and dated copy of the trustdocument (including signed and dated amendments, if any). If the trust agreement copy does not contain theproper signatures, the applicant may submit a written declaration stating that the copy is a complete and accuratecopy of the signed and dated original. The declaration should indicate the original date that it was signed.

If the trust was created by a will, attach a copy of the death certificate (or a statement indicating the date of death)and a copy of the relevant portions of the will.


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Generally, a trust must be funded with property (which can be relatively nominal in value) to be created legally.Consequently, line 4b requires an explanation if the trust holds nothing of value.

Line 5—Bylaws. If the organization has adopted bylaws (the set of rules by which an organization governs itself), acurrent copy showing the date of adoption should be submitted as part of the application. If there are no bylaws, theapplicant must explain how its officers, directors or trustees are elected. (An organization will normally find itprudent to adopt bylaws, except perhaps in very limited or unusual circumstances.) Bylaws do not need to besigned unless they are the entity’s organizing document.

Part III of Form 2013To qualify for Section 501(c)(3) status, an organization must meet both an organizational test and an operationaltest. The organizational test must bemet by the creating document or state law. It cannot bemet by oral representa-tions or representations made in other documents.

The IRS has stringent requirements concerning the provisions and language that should be included in an entity’sorganizing document. The omission of a required provision in the organizing document or the inclusion of aninappropriate provision is the primary reason applications for exemption are initially denied. However, the applicantorganization typically is given an opportunity to correct the problem (e.g., to amend its articles of incorporation).The use of the sample boilerplate language provided in IRS Pub. 557 helps ensure that the document complies withIRS requirements.

Meeting the Organizational Test—Part III of Form 1023

To qualify for Section 501(c)(3) exempt status under the organizational test:

1. The organizing document must limit the organization’s purpose to one or more of the following exemptpurposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering nationalor international amateur sports competition, or preventionof cruelty to childrenor animals. Anorganizationis not organized exclusively for an exempt purpose unless it serves a public rather than a private interestand its assets are dedicated to an exempt purpose.

Line 1, Part III of Form1023 requires that an applicant specifically affirm that an exempt purpose(s) is statedin the organizing document and enter the location of such language in the document.

2. The organizing document must not expressly empower the organization to engage in activities not infurtherance of one or more exempt purposes (other than as an insubstantial part of its activities).

3. The organizing document must not expressly provide that the organization’s net earnings will inure to thebenefit of anyprivate shareholder or individual. A private shareholder or individual is definedas anypersonhaving a personal and private interest in the activities of the organization.

4. The organizing document must not expressly empower the organization to (a) devote more than aninsubstantial part of its activities to attempting to influence legislation, (b) directly or indirectly participatein a political campaign, or (c) have objectives or engage in activities that characterize it as an actionorganization.

5. The organizing document must—

a. require that the income for each tax year be distributed at such time and in such manner as to avoidthe tax on undistributed private foundation income; and

b. prohibit it from engaging in any act of self-dealing, retaining any excess business holdings, makingany taxable expenditures, or making any investments that would jeopardize its charitable purpose.

What Is an Exempt Purpose?

An exempt organization’s stated purpose can be as broad as those listed in IRC Sec. 501(c)(3)—for example, itsarticles of organization can read “for charitable purposes within the meaning of IRC Sec. 501(c)(3)”—or more


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specific than the purposes listed in IRC Sec. 501(c)(3)—for example, the articles can describe the purpose as being“to operate a nonprofit hospital providing services to indigent patients in the Chicago area.” Generally, the exemptpurpose as stated in the articles of organization should be as broad as possible since the operations of anorganization usually change to some extent over time. However, an organization will not pass the organizationaltest if its stated purpose is broader than those listed in IRC Sec. 501(c)(3)—for example, an organization would notqualify if its articles specified its purpose was “to fund charitable, benevolent, and philanthropic activities in thecommunity.”

Although the organizing document need not expressly refer to IRC Sec. 501(c)(3), it must specifically refer to oneof the permissible purposes using the terminology of either the statute or the applicable regulations. For example,stating that the organization’s purpose is to operate a school does not satisfy the purpose requirement because“school” is not a term found in IRC Sec. 501(c)(3) or the regulations; and, therefore, the mere operation of a schooldoes not necessarily further an exempt purpose. However, the operation of a school for educational purposessatisfies the purpose requirement because “educational” is a statutory term.

Example 2C-1 Organization formed to provide charitable assistance to a specified group.

The current graduating class of Big State University filed an application for exempt status under IRC Sec.501(c)(3) for a trust formed by its members. The trust is to provide funds for the relief of disabled or destitutemembers of the class and, if a surplus exists in the trust, to fund scholarships and fellowships to the university.Because the trust’s stated purpose is a charitable one, it appears to qualify for exemption under the Sec-tion 501(c)(3) rules. However, it fails to qualify because it is organized to benefit private rather than publicpurposes. Although the individuals who will ultimately benefit from the trust are not initially distinguishablefrom others in the group, every potential beneficiary is identifiable because of the closed nature of the group.

Example 2C-2 Organization formed to provide charitable assistance to the public.

Beta Omega Fraternity established a trust fund to provide scholarships to undergraduate members of thefraternity. The fund will foster intellectual excellence through scholarships and promote and encouragemoral,civic, and social responsibility. The trust will be funded by contributions from the alumni of the fraternity andwill annually award scholarships to current members of the fraternity based on scholarship, character, andservice to the fraternity. Even though the scholarships are limited to a particular group, the trust should qualifyfor exempt status since the membership of the group eligible for scholarships is not known and the trust’spurposes have the elements of public usefulness and benefit.

Dedication and Distribution of Assets upon Dissolution (the Dissolution Test)

An organization will not qualify for exemption unless its assets are permanently dedicated to an exempt purpose.An organization’s assets are dedicated to an exempt purpose if, upon the entity’s dissolution, the assets will,because of a provision in the organizing document or by operation of state law, be distributed for an exemptpurpose (or to federal, state, or local governments to be used exclusively for public purposes). The assets of theorganization are dedicated to an exempt purpose by operation of state law if, upon dissolution, the assets will bedistributed by a court order to another organization to be used in a manner that best accomplishes the generalpurposes for which the dissolved organization was formed.

Form 1023, Part III, line 2a requires that the applicant specifically affirm that its organizing document satisfies thedissolution test. Line 2b requires that the location of the dissolution language be entered.

Although including specific dissolution language in the organizing document is prudent, it is not always an absolutenecessity. Sometimes, the required language will be supplied by state law, as discussed later in this lesson. If theapplicant is relying on state law to supply the dissolution language, lines 2a and 2b should be left blank, the box online 2c should be checked, and the state entered in the space provided.

The instructions to Form 1023 state that foreign organizations may be able to rely upon the applicable laws of theirjurisdiction in a manner similar to domestic organizations’ reliance upon state law. When this is the case, a copy ofthe applicable law with an English translation must be attached to Form 1023.


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Satisfying the Dissolution Test Using an Acceptable Dissolution Provision

The dissolution test is most easily met by including an acceptable dissolution provision in the entity’s organizingdocument. The provision can either require the distribution of assets to a named beneficiary [which should beanother Section 501(c)(3) organization] or to a beneficiary class (rather than to a specific beneficiary)—e.g., “anyhospital exempt under IRCSec. 501(c)(3) providing care to indigent children.” The use of a specific beneficiarymaycreate problems since, at the time of dissolution, the beneficiary organization may not exist, may have lost itstax-exempt status (a dissolution clause naming a specific organization is acceptable only if the organizing docu-ment requires that such organization be a Section 501(c)(3) organization at the time of dissolution), or may beunwilling or unable to accept the distributed assets. As a general rule, any organizing document naming a specificbeneficiary upon dissolution of the organization should also provide at least one backup beneficiary—preferably anonspecific one.

The IRS recommends use of a clause such as the following (Form 1023 instructions):

“Upon the dissolution of this organization, assets shall be distributed for one or more exempt purposeswithin the meaning of section 501(c)(3) of the Internal Revenue Code, or corresponding section of anyfuture federal tax code, or shall be distributed to the federal government, or to a state or localgovernment, for a public purpose.”

Satisfying the Dissolution Test under State Law

Determining whether the dissolution test is satisfied by operation of state law is usually critical only when a properdissolution provision is lacking in an organizing document that cannot be amended (e.g., a testamentary charitabletrust). If state law operates to satisfy the dissolution test, the lack of a proper dissolution provision will not preventan entity from qualifying for tax-exempt status.

The distribution of exempt assets under state law usually is determined by whether the cy pres doctrine is appliedin that state. This doctrine of equitable approximation is a principle of law that courts use to save a charitableorganization from failing when a charitable objective is (or later becomes) impossible or impractical to fulfill. In suchcases, the court may substitute another charitable objective that approximates the original charitable purpose ofthe entity.

Example 2C-3 Application of the cy pres doctrine.

John bequeathed his residuary estate in trust to Children’s Hospital for the benefit of children suffering fromcancer. When John died, the hospital no longer existed. His heirs filed suit claiming the bequest had lapsed,and the residuary estate should pass to them under the state’s intestacy laws.

If the state in which John’s will is probated provides for the distribution of assets according to the cy presdoctrine, the court will require the distribution of the residuary estate to another charitable beneficiary. Forexample, the court might reason that the gift to Children’s Hospital was a charitable bequest because the giftwas not intended for a particular institution, but for the benefit of children with cancer as a class, with thehospital as trustee. Since the purpose and objective for which the trust was created (the treatment of childrenwith cancer) still exists, even though the hospital does not, the legacy should not lapse. Under the cy presdoctrine, the court could award the legacy to another local hospital as trustee for the benefit of children withcancer.

Part IV of Form 1023Operational Test

An organization must satisfy both an organizational and an operational test to qualify for exempt status. Theorganizational test was discussed previously, while the operational test is discussed below.

Information about an organization’s past, present, and planned activities and operations is included in Part IV ofForm 1023. The IRS determines if the organization will qualify for exemption from federal income tax under theoperational test. Therefore, it is important to be explicit in describing the organization’s activities and operations.


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All past, present, and planned organization activities should be described in order of importance, and eachdescription should include, at a minimum—

1. a detailed description of the activity, including its purpose;

2. the date the activity was or will be initiated;

3. where and by whom the activity will be conducted;

4. how the activity furthers the organization’s exempt purpose(s);

5. the percentage of total time allocated to the activity;

6. how the activity is funded; and

7. any alternate names under which the organization operates [e.g., also known as (aka) and doing businessas (dba)].

In addition to providing the IRS with information on evaluating whether the applicant is operating for one of theexempt purposes outlined in IRC Sec. 501(c)(3), these answers establish the framework within which the organiza-tion will be required to operate in the future. The organization should ensure that the operations described arebroad enough to encompass future activities the organization may choose to undertake.

An organization with unrelated trade or business income should draft the narrative of its activities carefully.Although an organization operating an unrelated trade or business can meet the requirements of IRC Sec.501(c)(3), carrying on such a trade or business cannot be the primary purpose of the organization. Separatelydescribe the unrelated trade or business and include an explicit statement that such activity is not the primarypurpose of the organization. The failure to disclose unrelated business activities in the narrative of the organiza-tion’s activities is not a sufficient reason for the IRS to revoke its exemption, provided such activities are insubstan-tial in relation to the organization’s overall activities.

Example 2D-1 Narrative description of an organization’s activities.

Kid’s Museum, Inc. (KMI), was formed to operate an art museum specifically for children. In addition tooperating the museum, KMI will sponsor an on-premises art school for children and run a gift shop sellingcards, educational toys, and other art-related merchandise. KMI’s narrative description of its activities in PartIV might be as follows:

KMI was formed on September 30 of the current year to introduce children to the visual arts. KMI will conductall of its activities in the Dallas-Fort Worth (DFW) metropolitan area. Its galleries, offices, and gift shop will beoperated in a permanent facility located at 599 DFW Street, Arlington, TX. This facility was purchased with agrant from the National Foundation for the Arts, a qualifying Section 501(c)(3) organization that is not a privatefoundation. The present and future activities of KMI are as follows:

Operation of Museum of Art for Kids. KMI plans to acquire a collection of art designed to educate children andappeal to their interests. The paintings and sculpture will be acquired by donation and purchase. In additionto exhibits of paintings and sculpture, KMI will have several rooms open to the public where children can havehands-on experience in working with paints and clay. To date, three paintings have been acquired bydonation from contributors and $800,000 has been earmarked to purchase additional paintings. The fundswere raised through a grant from the National Foundation for the Arts. Upon completion, KMI will have apermanent staff of six including an executive director, two clerical assistants, an accountant, an acquisitionsdirector, and an exhibits director. The rest of the staff will consist of volunteers from the community (estimatedto be 120 persons working part-time shifts). KMI will charge a nominal admission at the door ($1.00 forchildren and $2.50 for adults). Groups of school children will be admitted free when attending the museum ona class field trip. The operation of the museum will account for approximately 60% of KMI’s total activities.

Museum School. KMI will operate a school (staffed by volunteer teachers) to offer instruction in drawing,painting, art appreciation, 3-D design, and other creative arts topics. Students between the ages of 4 and 16


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will be accepted. The school will be advertised in all elementary schools, middle schools, and high schools inthe DFW metroplex—both public and private. Admission will be based on teacher recommendations, witheach school district having the option to nominate 20 children per semester. There will be no discriminationbased on race, religion, or income level in the selection of students. All students will be chosen by teachersbased on abilities and interest levels. Admission to the museum school will be free of charge. A samplecurriculum for the school is attached. The operation of the school will account for approximately 30% (basedon time) of KMI’s total activities.

Museum Gift Shop. A gift shop will be operated on the premises by a paid staff. The shop will offer art books,cards, and posters featuring reproductions of art works owned by KMI; educational toys; and other productsrelated to children and the visual arts. The inventory held for sale in the shop will be carefully selected to beeducational or related to KMI’s operations. Operation of the shop will not be KMI’s primary purpose. It is notanticipated that the gift shop will generate unrelated business income. The operation of the gift shop willaccount for approximately 10% of KMI’s activities.

Operating Hours. The museum and gift shops will be open year-round from 10:00 a.m. to 4:00 p.m., Tuesdaythrough Saturday, except on national holidays. The school will conduct classes year-round for 15 hours eachweek if there is sufficient demand.

Part V of Form 1023

Information about the compensation of, and other financial arrangements with, the officers, directors, trustees, andemployees of the organization, as well as with independent contractors is provided in Part V of Form 1023. Theprimary purpose of Part V is to give the IRS enough information to determine that there is no obvious privateinurement or private benefit to these parties and that no self-dealing will occur between the organization (if it is aprivate foundation) and disqualified persons. Either of these situations jeopardizes the exempt status of theorganization and subjects certain persons to excise taxes on any excess benefits.

The IRS looks for two types of private benefit in the operations of an exempt organization. The first encompassesany activities that benefit private interests rather than public interests. The recipient of this type of private benefittypically is an unrelated for-profit entity. Although the presence of private benefit can disqualify an organization forexemption under IRC Sec. 501(c)(3), the IRS may overlook an incidental benefit to private interests if the organiza-tion is truly benefiting the public. The second type of benefit (private inurement) includes any direct benefit providedto a person who has some control over the operations of the organization (e.g., an officer, director, trustee, orsubstantial contributor) or someone related to such person. If there is any direct benefit to a person in control of theorganization, the organization will fail to qualify for exempt status.

Common types of inurement that must be avoided are unreasonably high compensation, below-market interestrate loans from the organization, above-market interest rate loans to the organization, below-market rate rents paidto the organization, above-market rate rents paid by the organization, the purchase or sale of property for otherthan fair market value, and any retained interest (other than a life estate) in assets donated to the organization. Forexample, the court denied tax exemption to a special needs trust because the trust failed to provide support that thesalary of its founder/president was reasonable (i.e., no authoritative comparability data was included). Furthermore,because the president’s salary steadily increased as more funds were infused into the trust and the servicesprovided were expanded, the court considered this to be private inurement, which also prohibited the trust fromreceiving tax-exempt status.

For nonprivate foundations, the information in Part V also allows the IRS to determine if the organization’s govern-ing body has broad-based public representation. Such representation helps ensure a measure of public oversight,making it less likely that a few individuals control the organization.

Compensation

The IRS uses the information in Part V to determine if unreasonable compensation is being (or will be) paid, whichmight jeopardize the organization’s ability to qualify for exemption. If more space is needed to provide therequested information, attach a statement to the return.


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Form 1023, Part V, Line 1a—Names, Titles, Addresses, and Compensation of Officers, Directors, and Trustees. Listthe names, titles, mailing addresses, and compensation of all officers, directors, and trustees on line 1a, even thosewho receive no compensation. The organization’s addressmay be used. The amount of annual compensation paidor proposed to be paid to each individual listed includes salary or wages; deferred compensation; retirementbenefits, whether in the form of a qualified or non-qualified employee plan (pensions or annuities); fringe benefits(personal vehicles, meals, lodging, personal and family educational benefits, low interest loans, payments ofpersonal travel, entertainment, or other expenses, athletic or country club membership, and personal use of theorganization’s property); and bonuses for all services to the organization, whether as an officer, employee, or otherposition. The reimbursement of expenses under an accountable plan should not be considered compensation.

Example 2E-1 Determining the annual compensation of officers, directors, and trustees.

Drug-free Haven, Inc. (Haven), a nonprofit organization formed to build halfway houses for recovering drugaddicts, has two officers and three directors. Haven is not a private foundation. The president receives anannual salary of $50,000 and an expense account of $1,000 per month. He also is furnished a car, thepersonal use of which is valued at $5,000 per year. The vice president receives an annual salary of $30,000.The three members of the board of directors receive annual directors’ fees of $500 each. Their expenses forthe semiannual board of directors meetings are paid by Haven (the total cost including airfare, meals, andlodging is $2,200). One of the directors loaned Haven $50,000 in seed money. The loan is evidenced by awritten note with a 10-year term and bears interest at a 6% rate, which is a market interest rate.

Haven should include the information shown in the following table, either entering the information in the spaceprovided on the form or on an attached statement (with a notation on the form that a statement is attached).The loan from a director at a market rate of interest is not listed in the table because it has no compensatoryeffect. If the information is provided in a statement, it should be on an 81/2” × 11” sheet; include Haven’sname, address, and employer identification number; and indicate that it relates to Form 1023, Part V, line 1a.

Names, Titles, and Addresses, ofOfficers, Directors, and Trustees

AnnualCompensation

1. George Jones, President492 Dalton ParkwayDallas, TX 75111

Salary $ 50,000Expense account 12,000Car (value of personal use) 5,000

Total $ 67,000

2. Merle Nelson, Vice President7655 Athens Ave.Arlington, TX 75667 Salary $ 30,000

3. Tammy Tucker, Director4390 MelodyNashville, TN 11222 Directors’ fee $ 500

4. James Jones, Director8997 Freedom ParkwayWashington, D.C. 09887 Directors’ fee $ 500

5. Jonathan Jensen, Director984 Magnolia Dr.Los Angeles, CA 98776 Directors’ fee $ 500

Form 1023, Part V, Line 1b—Names, Titles, Addresses, and Compensation of Employees. Enter the names, titles,mailing addresses, and compensation of the applicant’s five highest compensated employees who receive, or willreceive, compensation of more than $50,000 annually. Enter “None” if there are not any. The organization’s mailingaddress can be used. Total compensation includes the same items as previously described for officers, directors,


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and trustees. The compensation of employees who are also officers, directors, or trustees should be listed in line1a rather than in line 1b.

Form 1023, Part V, Line 1c—Names, Addresses, and Compensation of Independent Contractors. Enter the individ-ual names, business names, mailing addresses, and compensation of the applicant’s five highest compensatedindependent contractors that receive, or will receive, compensation of more than $50,000 annually. If there are notany, enter “None.”

Several lines in the remainder of Part V request information concerning anyone listed in lines 1a, 1b, and 1c.Therefore, to facilitate further discussion, such persons will be collectively referred to as Related Persons.

Family or Business Relationships

Form 1023, Part V, Lines 2a through 2c—Family or Business Relationships. Indicate on lines 2a through 2c of PartV if:

1. There is a family or business relationship between any of the organization’s officers, directors, or trustees.For this purpose, family relationships include the individual’s spouse, ancestors, children, grandchildren,great grandchildren, siblings (whether bywhole or half blood), and the spousesof children, grandchildren,great grandchildren, and siblings. Business relationships include employment and contractual relation-ships and common ownership of a business where any officers, directors, or trustees, individually ortogether, possess more than a 35% ownership interest in common. Ownership means voting power in acorporation, profits interest in a partnership, or beneficial interest in a trust.

2. The organization has a business relationshipwith an officer, director, or trustee other than in such capacity.

3. An officer, director, or trustee has a family or business relationship with any of the employees orindependent contractors listed in line 1b or 1c, respectively.

A “Yes” answer to any of these three questions requires that the individuals be identified and the relationshipsexplained in an attachment to the return.

Qualifications, Hours, and Duties

Form 1023, Part V, Line 3a—Qualifications, Hours, and Duties. Attach a list to the return showing the qualifications,average hours worked, and duties for all related persons listed on lines 1a, 1b, or 1c.

Compensation from Related Entities

Form 1023, Part V, Line 3b—Compensation from Related Entities. Line 3b asks whether any of the related personsreceive compensation from any other organization, whether tax-exempt or taxable, that is related through commoncontrol. Common controlmeans that the applicant and one or more other organizations have (1) a majority of theirgoverning boards or officers appointed by the same organization(s); or (2) a majority of their governing boards orofficers consist of the same individuals. Common control also occurs when the applicant and one or morecommonly controlled organizations have a majority ownership in a corporation, partnership, or trust.

A “Yes” answer requires that the individual be identified, the relationship explained, and the compensation arrange-ment described in a statement attached to the return.

Recommended Compensation Practices

Form 1023, Part V, Lines 4a through 4g—Recommended Compensation Practices. The IRS recommends (but doesnot require as a condition for tax exemption) that an organization follow certain policies and practices in establish-ing compensation for related persons. Lines 4a through 4f ask questions that seek to determine if the applicant’scompensation arrangements adhere to these practices. If any of these questions is answered “No,” the applicantmust explain, as required by line 4g, why the compensation for the listed persons or firms is reasonable. If none arecompensated, enter “N/A” beside each line, with a notation (or attached statement) that there are no paid employ-ees.


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Compliance with five of the six recommended practices appears relatively simple and straightforward, but one ismore difficult to satisfy. Line 4e asks whether the organization approves compensation arrangements based on (1)compensation paid by other organizations (both taxable and nontaxable) of a comparable size, purpose, andresources for similar services; (2) current compensation surveys compiled by independent firms; or (3) actualwritten offers from similarly situated organizations. These methods are taken from Reg. 53.4958-6, which pre-scribes procedures to establish a rebuttable presumption that compensation is reasonable for purposes of theexcess benefit rules.

Conflict of Interest Policy

Form 1023, Part V, Lines 5a through 5c—Conflict of Interest Policy. The IRS recommends that an organization adopta conflict of interest policy, but does not require such policy as a condition for tax exemption. As a practical matter,most organizations will find it easier to adopt a conflict of interest policy than to satisfy the IRS that one isunnecessary.

Indicate on line 5a whether a conflict of interest policy has been adopted. If it has, attach a copy and an explanationregarding how it was adopted (e.g., by board resolution) to the return. If a policy has not been adopted, theapplicant must explain how it avoids conflicts of interest in compensation matters and business dealings withrelated persons. (Form 990, Part VI, Section B, Questions 12a–c specifically asks whether the organization has awritten conflict of interest policy and, if so, how it is monitored and enforced.)

Non-Fixed (Discretionary) Compensation

Form 1023, Part V, Lines 6a and 6b—Non-Fixed (Discretionary) Compensation. Most organizations compensatetheir officers, directors or trustees, and key employees on a fixed-payment basis. A fixed paymentmeans a paymentthat is either a set dollar amount or fixed through a specific formula where the amount is nondiscretionary. Forexample, a base salary of $200,000 that is adjusted annually based on the increase in the consumer price index isa fixed payment. However, some organizations (especially health care organizations) have compensation pack-ages that include incentives, or non-fixed payments. A non-fixed payment is defined for this purpose as anypayment that is discretionary, such as a performance bonus.

Indicate on lines 6a and 6b if the organization will compensate related persons through non-fixed payments. If so,it must explain, in a statement attached to the return, who is eligible for such payments, how the amounts aredetermined, whether there is a limitation on total compensation, and how the applicant will ensure that totalcompensation is reasonable for the services rendered.

Other Business Arrangements

Excessive compensation is only one of the ways that related persons can abuse an organization financially. Thus,the IRS wants to know whether other financial dealings between the applicant and related persons may not be atarm’s-length.

Form 1023, Part V, Lines 7a and 7b—Purchase/Sale of Goods, Services, or Assets. The organization must indicatewhether it purchases (or will purchase) from related persons (line 7a) or sells (or will sell) to related persons (line7b). If so, a statement must be attached that describes the transaction, identifies the related person, and explainswhy the terms of the deal were (or will be) arm’s length. If the transaction is a purchase by the applicant, thestatement must further explain how it was (or will be) determined that the consideration given does not exceed fairmarket value (FMV). Similarly, if the transaction is a sale by the applicant, the statement must explain how it was (orwill be) determined that the consideration received is at least FMV. Copies of any written agreements must also beattached.

Form 1023, Part V, Lines 8a through 8f—Leases, Contracts, Loans, and Other Arrangements. If the organization has(or will have) any leases, contracts, loans, and other agreements with a related person, answer “Yes” on line 8a. Ifso, lines 8b through 8f require that essentially the same information be provided as described previously for apurchase or sale transaction.


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Form 1023, Part V, Lines 9a through 9f—Agreements With Certain Entities. Line 9a asks whether the applicant has(or will have), any leases, contracts, loans or other agreements with the following:

1. Any organization [other than a Section 501(c)(3) organization] in which one of the applicant’s officers,directors, or trustees is also an officer, director, or trustee.

2. Any organization in which one of the applicant’s officers, directors, or trustees has more than a 35%ownership interest.

If the answer is “Yes,” lines 9b through 9f require that a copy of any agreement be attached and that the applicantprovide essentially the same information as described previously for a purchase or sale transaction.

All lease agreements should be disclosed, including, for example, an office copier lease or postage meter lease.The IRS may question boilerplate language in a lease (including a lease with an unrelated third party) if theexamining agent believes the provision may result in an abusive benefit to a private individual. The provisions of allleases entered into by an exempt organization should be reviewed to avoid situations that may require renegotia-tion of the lease or a delay in the application process.


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SELF-STUDY QUIZ


8. Young Readers would like to declare an authorized representative on Part I of its Form 1023. The organizationshould do which of the following?

a. Enter a director or officer’s name on line 6a.

b. Enter an appropriate phone number on line 6b.

c. Check “No” in the box on line 7.

d. Attach Form 2848 to Form 1023.

9. What should an organization enter on Line 11 of Part I of Form 1023?

a. Whether the applicant believes it is not required to file Form 990.

b. Whether the organization was formed in a foreign country.

c. The date that the organization became a legal entity.

d. The organization’s email address.

10. An unincorporated association should include a copy of which of the following with Part II of its Form 1023?

a. Its organizing document.

b. Its articles of incorporation.

c. Its state-approved articles of organization.

d. Its trust document.

11. Which of the following organizations has successfully prepared its narrative description of activities for theoperational test?

a. Clean Water provides information about its most important and time consuming activities.

b. Nourished Children creates a brief description that hits the highlights of its activities and operations.

c. Green Spaces provides specific information for each activity, including how it is funded and the dateinitiated.

d. Health Plus describes its operations as they are now, which may differ from future years.


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SELF-STUDY ANSWERS


8. Young Readers would like to declare an authorized representative on Part I of its Form 1023. The organizationshould do which of the following? (Page 163)

a. Enter a director or officer’s name on line 6a. [This answer is incorrect. Line 6a of Part I is for the name ofsomeone the IRS can contact during business hours to obtain more information about the organization.This canbeanofficer, director, or trusteeof theorganization,but itwill usuallybe theattorneyoraccountantwhocompletedForm1023while actingasanauthorizedagentof theorganization.So,while anauthorizedagent can be entered on this line, there are other steps for indicating an authorized agent. Also, theauthorized agent would typically not be a director or officer.]

b. Enter an appropriate phone number on line 6b. [This answer is incorrect. The contact’s primary phonenumber should be entered on line 6b and the fax number on line 6c; however, this step is separate fromthose used to indicate an authorized representative.]

c. Check “No” in the box on line 7. [This answer is incorrect. If the primary contact listed on line 6a is anauthorized representative or if the applicant desires to have an authorized representative, the “Yes” boxon line 7 (not the “No” box) should be checked.]

d. Attach Form 2848 to Form 1023. [This answer is correct. If an application desires to have anauthorized representative, a power of attorney on Form 2848 (Power of Attorney and Declaration ofRepresentative) shouldbeattached to Form1023. Form2848 allows the authorized agent to receiveconfidential information and “to perform any and all acts” the organization’s directors or officerscould perform concerning the tax matters specified on the power of attorney.]

9. What should an organization enter on Line 11 of Part I of Form 1023? (Page 163)

a. Whether the applicant believes it is not required to file Form 990. [This answer is incorrect. This is enteredon Line 10.]

b. Whether the organization was formed in a foreign country. [This answer is incorrect. Line 12 asks whetherthe applicant was formed under the laws of a foreign country and, if so, what country.]

c. The date that the organization became a legal entity. [This answer is correct. Line 11 is for the datethat the organization became a legal entity. For a corporation, this is generally the date the articlesof incorporation were approved by the proper state authorities. For a trust, the date of formation isthe date the trust instrument was signed. For any other unincorporated organization, the date offormation is the date the constitution, articles of organization, or other articles of association wereadopted.]

d. The organization’s email address. [This answer is incorrect. The organization’s completewebsite addressis listed on line 9a (if it has one). The IRS recently denied an organization’s exemption application (Form1023-EZ) noting conflicts between the application and information obtained from the organization’swebsite. An organization can elect whether to include its email address, if any, on line 9b.]


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10. An unincorporated association should include a copy of which of the following with Part II of its Form 1023?(Page 165)

a. Its organizing document. [This answer is correct. An unincorporated association should answer“Yes” on line 3 and attach a copy of its organizing document (e.g., articles of association orcontribution) (including any signed anddated amendments) that is dated and signed by at least twoindividuals. The articles of organization must include its name, its purpose, and the date thedocument was adopted.]

b. Its articles of incorporation. [This answer is incorrect. If the applicant is a corporation (not anunincorporated association), answer “Yes” in line 1 and attach a copy of its articles of incorporation,including any amendments (or other organizing document under state law).]

c. Its state-approved articles of organization. [This answer is incorrect. If the applicant is a limited liabilitycompany (LLC), it should answer “Yes” on line 2 and attached a copy of its state-approved articles oforganization.]

d. Its trust document. [This answer is incorrect. If the applicant is a trust, it should answer line 4a “yes” andinclude a signed and dated copy of the trust document (including signed and dated amendments, if any).An unincorporated association must include other information and indicate its status on a different line.]

11. Which of the following organizations has successfully prepared its narrative description of activities for theoperational test? (Page 168)

a. Clean Water provides information about its most important and time consuming activities. [This answeris incorrect. Information about an organization’s past, present, and planned activities and operations isincluded inPart IV of Form1023. All past, present, andplannedorganization activities should bedescribedin order of importance. Therefore, CleanWater needs to expand its description to cover all of its activitiesand operations, not just those that it considers most important or that take up the most of its time.]

b. Nourished Children creates a brief description that hits the highlights of its activities and operations. [Thisanswer is incorrect. The IRS determines if the organization will qualify for exemption from federal incometax under the operational test. Therefore, it is important to be explicit in describing the organization’sactivities and operations. If Nourished Child does not create an explicit, detailed narrative description, theIRS may not consider it to have passed the operational test.]

c. GreenSpacesprovides specific information for eachactivity, includinghow it is fundedand thedateinitiated. [This answer is correct. At a minimum, the narrative description should include thefollowing information about each activity: (1) a detailed description of the activity, including itspurpose; (2) the date the activity was or will be initiated; (3) where and by whom the activity will beconducted; (4) how the activity furthers the organization’s exempt purpose(s); (5) the percentageof total time allocated to the activity; (6) how the activity is funded; and (7) any alternate plans underwhich the organization operates.]

d. Health Plus describes its operations as they are now, which may differ from future years. [This answer isincorrect. In addition toproviding the IRSwith informationonevaluatingwhether the applicant is operatingfor one of the exempt purposes outlined in IRC Sec. 501(c)(3), these answers establish the frameworkwithin which the organization will be required to operate in the future. The organization should ensure thatthe operations described are broad enough to encompass future activities the organization may chooseto undertake.]


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Part VI of Form 1023

Goods, Services, or Funds

Lines 1a and 1b—Benefit Programs. If the applicant provides goods, services, or funds to individuals or otherorganizations, report this on Form 1023, Part VI, lines 1a and 1b. The instructions give the following examples ofsuch programs for individuals: providing food to the homeless, employment counseling to senior citizens, andgrants to victims of a disaster. Examples of programs provided to other organizations that would require anaffirmative answer are providing equipment, accounting assistance, or grants. Presumably, every charitable organi-zation provides goods, services, or funds. Thus, it is likely that either line 1a or 1b will be answered “Yes.”

A “Yes” answer requires that a statement describing each such program be attached to the return. The descriptionmust cover past, present, and planned activities.

Line 2—Limitations on Recipients of Goods, Services, or Funds. Report on line 2 any limitations that are placed onthe individuals or groups of individuals who will receive the goods, services, or funds offered.

A “Yes” answer requires attachment of a statement explaining the limitation and how recipients are selected foreach program. For programs that are available only for members, the applicant must attach a sample membershipapplication and a schedule of membership dues. If there is more than one membership level, any differences mustbe described along with the benefits available to each level.

Limitations that may jeopardize an organization’s application for exempt status include those based on age, race,religion, or other discriminatory restrictions. For example, a private school is required to document its antidiscrimi-natory admission policy to the IRS. This question also highlights any evidence of benefit to a class of individualsthat is too small or restricted to qualify as a charitable group. Any description of limitations placed on an organiza-tion’s membership that appears discriminatory or that narrows the pool of beneficiaries to a small private groupcould jeopardize recognition of the organization’s exempt status. (See Examples 2C-1 and 2C-2.)

Line 3—Benefits to Related Persons. Line 3 asks whether any individuals who receive goods, services, or fundshave a family or business relationship with any persons who are listed in line 1a, 1b, or 1c of Part V. If so, a statementexplaining how such individuals are eligible for benefits must be attached to Form 1023.

Part VII of Form 1023

Successor Organizations

Line 1—Successor to Another Organization. If the applicant is a successor to another organization, report this online 1. It is if it—

1. has taken over, or will take over, the activities of another organization;

2. has taken over 25% or more of the fair market value of the net assets of another organization;

3. was created upon the conversion of a for-profit entity to non-profit status or through the merger of otherorganizations; or

4. installed the same officers, directors, or trustees as another organization (regardless of whether taxable ortax-exempt) that no longer exists and that had purposes similar to the applicant’s purposes.

If the applicant is a successor, Schedule G must be completed.

When a for-profit organization with liabilities in excess of the fair market value (FMV) of its assets is converted to anonprofit organization, the new organization does not qualify for exempt status.


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Example 2G-1 Potential denial of exempt status when a for-profit organization is converted to anexempt organization.

Grady School, Inc. (Grady), a for-profit private school, has liabilities in excess of the FMV of its assets and hasconsidered closing. However, Grady’s shareholders are personally liable for its debt, so instead of allowingthe school to close, they decide to form a nonprofit private school and transfer all of the corporation’s assetsand liabilities to the new entity. The shareholders of the former corporation will be the directors of the school.

The school will not qualify for tax-exempt status because its directors have benefitted in their individualcapacities to the extent the school’s liabilities exceed the FMV of the transferred assets. Thus, the neworganization is not operated exclusively for educational and charitable purposes.

Late Filing of Form 1023

Line 2—Timely Filing of the Application. Indicate whether Form 1023 is being filed more than 27 months after theend of the month in which it was legally formed (i.e., is it being filed after the deadline for filing). If so, Schedule Emust be completed.

Part VIII of Form 1023

Political Campaign Participation

Line 1—Participation of the Applicant in Political Campaigns. Line 1 of Form 1023, Part VIII, asks whether theapplicant supports or opposes (through past, present, or planned activities) candidates in political campaigns; andif so, to explain those activities. The explanation should include representative copies of any political literature,brochures, or pamphlets. Certain types of activities are not considered to be participation in a political campaign(e.g., sponsoring candidate debates and conducting nonpartisan voter registration or education). An organizationexempt under IRC Sec. 501(c)(3) cannot intervene, to any extent, in a political campaign.

Attempts to Influence Legislation

Line 2 requests information about the organization’s lobbying activities. To qualify for exemption under IRC Sec.501(c)(3), no substantial part of an organization’s activities can consist of propaganda or otherwise attempt toinfluence legislation. Lines 2a and 2b seek to determine whether any attempts to influence legislation by theapplicant are permissible.

Line 2a—Attempts to Influence Legislation. Indicate on line 2a if the applicant has attempted (or will attempt) toinfluence legislation. (To qualify as a tax-exempt private foundation, the answer to this question must be “No.”) Fora public charity, if the answer is “Yes,” the applicant must explain the lobbying activity and estimate the percentageof its time and funds that are devoted (or planned to be devoted) to the activity. This question seeks to confirm thatthe lobbying activities are not more than an insubstantial part of its total activities. Attempts to influence legislationinclude direct lobbying (attempts to influence legislators) or indirect grass roots lobbying (i.e., attempts to influencethe electorate or general public). Determining whether the lobbying activity is “substantial” is a facts and circum-stances question. No general rule exists as to what is considered a “substantial portion” of an organization’sactivity, and the courts have held that a percentage test is not conclusive.

Example 2H-1 Lobbying activities.

Recycling Foundation of Fort Worth (d.b.a., Let’s Recycle) was formed to educate the public about thebenefits and methods of recycling. Let’s Recycle’s activities will consist primarily of holding educationalseminars at schools and club meetings and furnishing a free pamphlet on recycling. As an insubstantial partof its annual activities, Let’s Recycle plans to lobby local legislators to vote for laws to clean up the environ-ment. Let’s Recycle’s lobbying activities would be disclosed on lines 2a and 2b of its Form 1023.

Line 2b—The Lobbying Expenditure Election. A public charity, as defined in Lesson 3, normally can elect under IRCSec. 501(h) to apply a formula to determine if its lobbying expenditures are substantial. Public charities that do not


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(or cannot) make this election must rely on the less certain substantiality test based on all the facts and circum-stances. Organizations making this election must file Form 5768 [Election/Revocation of Election by an EligibleSection 501(c)(3) Organization To Make Expenditures To Influence Legislation] within the first tax year the electionwill apply.

Indicate whether the applicant has made (or is making) the election to have its legislative activities measured byexpenditures on line 2b. If “Yes,” Form 5768 must be attached (either a copy of Form 5768 that has already beenfiled or a completed form being filed initially). An organization that attempts (or will attempt) to influence legislationbut has not and is not making this election must explain whether attempts to influence legislation are (or will be) asubstantial part of its activities. The explanation should include a comparison of time andmoney spent on attemptsto influence legislation to the amount spent on all activities.

Gaming Activities

Report information concerning the applicant’s operation of bingo games or any other types of gaming activities onlines 3a through 3c. This information will help the IRS determine whether the gaming activity is an unrelated tradeor business for which Form 990-T should be filed.

Line 3a—Operation of Bingo or Gaming Activities. Indicate whether the applicant operates (or will operate) bingoor gaming activities on line 3a. Gaming activities include pull-tabs, raffles, keno, split-the-pot, and other games ofchance.

If the answer to line 3a is “Yes,” a supporting statement is required. This statement must describe the activities andinclude the following information:

1. How often the gaming activities are (or will be) conducted.

2. Where activities are conducted.

3. Who conducts the activities.

4. Whether the workers are compensated, and if so, how the compensation is determined.

5. All revenues received (or expected to be received).

6. Direct and indirect expenses paid (or expected to be paid), including the value of prizes.

Line 3b—Contracts for Gaming Activities. Indicate whether the applicant has entered into (or will enter into)contracts or arrangements with others to conduct the gaming activities on line 3b. If so, a supporting statementmust identify the persons with whom there are arrangements, describe the agreements, and explain how the termswere (or will be) negotiated at arm’s-length and how the applicant is (or will be) assured of receiving a fair share ofthe revenue. Copies of any agreements must also be attached.

Line 3c—Jurisdictions. If the applicant has (or will have) gaming activities, it must list the states and local jurisdic-tions (including cities, counties, towns, municipalities, and Indian Reservations) in which the activities are (or willbe) conducted.

Fundraising Activities

Exempt organizations frequently hire an outside party to conduct fundraising activities for their benefit. The IRS isconcerned that the fees charged by professional fundraisers may be private inurement, especially if they consumemost of the funds raised. The IRS is also focusing on donor advised funds maintained by Section 501(c)(3)organizations. Other issues can also arise as the result of fundraising activities. Consequently, a broad range ofinformation relating to fundraising activities is reported on lines 4a–4e.

These questions should be answered carefully so they agree with the financial data provided in Form 1023, Part IXand ensure that the fundraising activities described will not prevent the organization from qualifying for exempt


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status or require it to report unrelated business taxable income. Some examples of undesirable fundraisingactivities are “sales” of merchandise disguised as premiums awarded for donations (e.g., “donate $25 and we’llsend you a toaster”), donations received in return for services performed, and donations resulting in privateinurement to officers, trustees, substantial contributors, or fundraisers.

Line 4a—Nature of Fundraising Activities. If the applicant has undertaken (or will undertake) fundraising, indicatethat on line 4a. If so, it must also indicate and describe which of the listed fundraising programs it will conduct.

The description of fundraising activities should address both actual and planned activities and include bothfunctionally related activities and unrelated business activities. The description should include information about alltypes of fundraising being used or considered by the organization and the percentage of the organization’s fundsbeing raised by each type. Information about the personnel used to raise funds should also be included, particu-larly if professional fundraisers are being used. Sample copies of advertising and solicitation letters used forfundraising should be included with the application.

Example 2H-2 Describing the organization’s fundraising programs.

DeSoto Beautification Project, Inc. (DBP) was formed to beautify the parks and roadways of a small commu-nity. DBP expects to raise the majority of its funds through a telephone campaign by professional fundraiserstargeting the private citizens of the community. It will raise additional funds through solicitation letters sent toChamber of Commerce member businesses. DBP will also hold an annual “DeSoto Days Festival” in one ofthe area parks to raise money for park beautification. DBP’s fundraising activities could be described on Form1023 as follows:

Description of Fundraising Activities

DeSoto Beautification Project, Inc. (DBP), anticipates the following fundraising activities will beused to solicit donations for carrying out its exempt purpose of beautifying the parks androadways of the community:

Telephone Campaign. A telephone campaign targeting community residents is expected to raiseapproximately 60% of the contributions received by DBP. “X,” a professional fundraisingcorporation (not related to any officer or director of DBP) will conduct the campaign with itsemployees. X will be paid a flat rate of $10 per employee per hour of actual calling as evidencedby telephone logs. The hourly rate was negotiated after receiving proposals from five similarprofessional fundraising corporations that ranged from $8.90 to $17.25 per person per hour. Acopy of the proposed script for telephone solicitation is attached to this application.

Solicitation Letters to Businesses. DBP plans to conduct a mail campaign targeted at businesseswho aremembers of the DeSoto Chamber of Commerce. A sample solicitation letter is attached tothis application. It is anticipated that approximately 25% of DBP’s contributions will be raisedthrough this campaign.

DeSoto Days Festival. DBP expects to hold a carnival annually in one of the city parks to raisefunds for park beautification. Booths staffed by volunteers will sell food donated by localmerchants. Other boothswill sell raffle tickets for prizes contributed bymerchants, conduct a whiteelephant sale, and run games of chance. It is anticipated that carnival proceeds will account forapproximately 15% of DBP’s annual receipts. DBP believes these funds will not be unrelatedbusiness income since all festival activities will be conducted by volunteers.

Line 4b—Fundraising Agreements. If the applicant has an agreement with an outside party to conduct its fundrais-ing activity, it must identify such party, describe the activity, and show the revenue and expenses from the activity.Copies of all agreements must also be attached.

Line 4c—Fundraising for Other Organizations. Indicate on line 4c if the applicant has conducted (or will conduct)fundraising for other organizations. In addition, describe the organizations and the arrangements on attachedstatements. Copies of all agreements must also be attached.


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Line 4d—Fundraising Jurisdictions. An organization that engages in fundraising must list all state and localjurisdictions (including cities, counties, towns, municipalities, and Indian Reservations) in which it raises funds foritself or for others, or in which another party raises funds for the applicant.

Line 4e—Donor Advised Funds. Indicate whether the applicant has maintained (or will maintain) donor advisedfunds. A donor advised fund is a separate account maintained by a Section 501(c)(3) organization for a contributionby a donor whereby the donor may give nonbinding advice to the organization concerning the investment of fundassets and the recipients of distributions from the fund. If the applicant maintains such funds, the applicant mustdescribe its program and the nature of the advice that may be given by the donor. Copies of written materialsfurnished to donors must also be submitted.

Affiliation with Governmental Unit

Line 5 —Affiliation With Governmental Unit. Indicate whether the applicant is affiliated with a governmental unit onForm 1023, Part VIII, line 5. For this purpose, a governmental unit includes a state, a possession of the U.S., anypolitical subdivision of a state or possession of the U.S., the U.S. itself, and the District of Columbia. The applicantis affiliated with a governmental unit if it was created by, controlled by, or closely related to, a governmental unit. Ifthe answer is “Yes,” the applicant must identify the governmental unit, describe the relationship of the applicant toit, provide details of financial reports or audits required by the governmental unit, and describe any power orauthority it has given the applicant.

Economic Development Activities

Some organizations (e.g., economic development organizations) are created to combat community deteriorationin a specified economically depressed geographic area, eliminate prejudice and discrimination, or lessen thefinancial burdens of a governmental entity.

Lines 6a and 6b—Economic Development. Indicate whether the applicant does or will engage in economicdevelopment on Form 1023, Part VIII, line 6a. If “Yes,” it must describe the program (line 6a), fully describe who willbenefit (line 6b) and explain how the activities promote exempt purposes (line 6b). In addition, if the purpose is to“lessen the burdens of government,” the applicant must state whether the government has recognized its activitiesas those for which it would otherwise be responsible, and describe any involvement it has with governmentalentities that demonstrates it is actually lessening governmental burdens. See, for example, Ltr. Rul. 201408031 inwhich the IRS concluded that certain environmental activities lessened the burdens of a governmental subdivision,based on the relationship between the organization and the governmental entity, and therefore was not anunrelated business activity.

Facilities Development and Management

Line 7a—Facilities Developer. Indicate whether anyone other than the applicant’s employees or volunteers havedeveloped (or will develop) the applicant’s facilities on Form 1023, Part VIII, line 7a. Develop means the planning,financing, construction, or provision of similar services involved in the acquisition of real property. For example, aconsultant who arranges the acquisition of a nursing home through the issuance of tax-exempt bonds is adeveloper according to the instructions. If the answer is “Yes,” the applicant must describe the facility, the role of thedeveloper, and any business or family relationship between the developer and the applicant’s officers, directors, ortrustees.

Line 7b—Facilities Manager. Line 7b asks the same question as line 7a concerning any manager of the applicant’sfacilities. An example of a manager is an organization hired to administer an applicant’s gift shop. If the answer is“Yes,” the applicant must provide comparable information to that required by line 7a.

Line 7c—Additional Information. If there is (or will be) a facilities developer or manager, the applicant must identifysuch person, describe any relationship to the applicant’s officers, directors, or trustees, and explain how contractsare negotiated at arm’s-length. Copies of any contracts or agreements must also be attached.


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Joint Venture Participation

The IRS is concerned about Section 501(c)(3) organizations participating as general partners in a joint venture withfor-profit entities. The issue is that the Section 501(c)(3) organization will be compelled (by the terms of the jointventure agreement) to operate the joint venture at least partly for the benefit of the for-profit partners.

Line 8—Entering Into Joint Ventures. Indicate whether the applicant has entered (or will enter) into joint ventures,including partnerships or limited liability companies treated as partnerships, in which there are partners other thanSection 501(c)(3) organizations on line 8. If “Yes,” the applicant must attach a statement describing the activities ofsuch joint ventures.

Childcare Organizations

Exempt status is available to a childcare organization if substantially all of the care provided by the organization isto enable individuals to be gainfully employed, and the services are available to the general public. Substantially allgenerally means 85% or more. Gainfully employed includes enabling individuals to seek work.

Lines 9a through 9d—Qualifying as a Childcare Organization. Line 9a of Form 1023, Part VIII asks whether theapplicant is applying for exemption as a child care organization under IRC Sec. 501(k). If the answer is “No,” skipthe questions in lines 9b through 9d. If the answer is “Yes,” lines 9b through 9d are designed to show whether theapplicant satisfies the Section 501(k) requirements.

A “No” answer to any of the three questions in lines 9b through 9d requires an explanation of how the applicant canqualify under IRC Sec. 501(k). An organization failing the 85% test may still qualify, depending upon how close tothe 85% amount the applicant currently is and the efforts being taken to increase such percentage. These twopoints should be discussed if the answer to line 9c, which deals with the 85% test, is “No.”

Intellectual Property

The IRS is concerned that donors of intellectual property to charitable organizations have been claiming charitabledeductions in excess of its actual value because of retained ownership rights or other restrictions. A donor’s initialdeduction for the charitable contribution of intellectual property is limited to the lesser of (1) the donor’s basis in theproperty, or (2) the property’s fair market value. Additional deductions are available, based upon a 12-year slidingscale of percentages applied to the net income received by the donee charity, once the total of these deductionsexceeds the initial deduction. The intellectual property covered by these rules includes patents, copyrights,trademarks, trade names, trade secrets, know-how, and proprietary software.

Line 10—Ownership of Intellectual Property. Indicate whether the applicant has (or will have) ownership of, or rightsin, any intellectual property on Form 1023, Part VIII, line 10. For this question, the types of intellectual property arethe same ones discussed in the preceding paragraph.

Monitoring Charitable Contributions

The IRS is concerned that excessive charitable contribution deductions are being taken by donors of certain typesof property, including real property, conservation easements, closely held securities, all types of intellectualproperty, works of music or art, licenses, royalties, motor vehicles, and collectibles of any type.

Line 11—Acceptance of Contributions of Certain Property. In an effort by the IRS to monitor the contribution ofproperty that has been prone to valuation abuses, line 11 of Form 1023, Part VIII asks whether the applicant accepts(or will accept) the types of property contributions listed in the preceding paragraph. If the organization does notrefuse any contribution of demonstrable value, the answers will probably be “Yes.” If so, the applicant must attacha statement describing each type of contribution, the conditions imposed by the donor, and any agreements withthe donor regarding the contribution.

Foreign Activities

Because there is widespread concern that some U.S. charities may be helping to finance international terrorism,either directly or through other organizations, lines 12a through 12d and 14a through 14f require extensiveinformation from applicants with international activity.


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Lines 12a through 12d—Foreign Operations. Indicate whether the applicant operates (or will operate) in a foreigncountry on line 12a. (Territories and possessions of the U.S. are not foreign countries.) If so, the applicant mustattach a statement listing the country, as well as regions within the country, in which it operates. The applicant mustdescribe its activities by country and region and explain how operations in each area further its exempt purposes.

Lines 14a through 14f—Grants and Loans to Foreign Organizations. Indicate whether the applicant makes grants,loans, or other distributions (such as goods) to a foreign organization on Form 1023, Part VIII, line 14a. For thispurpose, a domestic organization is one that is formed under the laws of the U.S., its territories and possessions,certain Indian Tribal and Alaska Native governments, or the District of Columbia. A “foreign organization” is one thatis not a domestic organization.

If the answer to line 14a is “Yes,” attach a statement that provides the name of each foreign recipient, lists thecountry and regions within a country in which the recipient operates, and describes any relationship between theapplicant and the recipient (line 14b).

If a foreign recipient accepts contributions earmarked for a specific country or specific organizations, answer thequestion in line 14c “Yes,” and attach a statement that lists all earmarked countries or organizations.

Indicate whether the applicant’s contributors know that it has ultimate authority to use contributions for its exemptpurposes on line 14d. If “Yes,” the applicant must describe how contributors are so informed.

Indicate whether the applicant makes (or will make) pre-grant inquiries about the recipient on line 14e. Possibleexamples include inquiries about the recipient’s financial status, whether it is (or could be) tax-exempt under theInternal Revenue Code, and its ability to accomplish the purposes for which the resources are provided. If “Yes,”actual inquiries must be described.

Finally, line 14f asks whether the applicant uses (or will use) additional procedures (such as site visits or compli-ance checks) to ensure that distributions to foreign recipients are used in furtherance of the applicant’s exemptpurposes. An affirmative answer requires the attachment of a statement describing such procedures.

Grant Making Activities

A private foundation must generally maintain expenditure responsibility over its grants to other private foundations(unless they are operating foundations) and to certain other exempt entities. However, a public charity is not underany statutory obligation to monitor the use of funds that it distributes to other organizations. Nevertheless, theinformation requested on lines 13a through 13g of Form 1023, Part VIII suggests that the IRS expects there to besome oversight.

Lines 13a through 13g—Accountability for Grants and Loans. Indicate whether the applicant makes (or will make)grants, loans, or other distributions to organizations on line 13a. If so, the applicant must explain how the distribu-tions further its exempt purposes (line 13b), describe the recordsmaintained with respect to such distributions (line13e), and describe oversight procedures to ensure the distributions further the applicant’s exempt purposes (line13g). An example of an oversight procedure is the requirement of periodic and final reports on the use of thedistributions.

Indicate whether there are written contracts with the recipient organizations on line 13c. If so, a copy of eachcontract must be attached.

Information on how the applicant selects its grant or loan recipients is reported on line 13f. Specifically, theapplicant is asked whether it requires—

1. an application form. If “Yes,” a copy must be attached.

2. a grant proposal. If “Yes,” the applicant must indicate whether such grant proposal contains one or moreof the five oversight provisions enumerated in line 13f.

Finally, identify each recipient organization and explain whether it has a relationship with the recipient on line 13d.A relationship exists if, for example, the applicant controls the recipient (or vice versa) through common officers,


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directors, or trustees or through authority to approve budgets or expenditures; the applicant and recipient werecreated at approximately the same time by the same persons; the applicant and recipient operate in a coordinatedmanner (e.g., they share expenses); or the same persons exercise substantial influence over both the applicant andthe recipient.

Related Organizations

An applicant may have financial or other relationships with other organizations that could jeopardize its exemptpurpose(s).

Line 15—A Close Connection. Indicate whether there is a close connection between the applicant and any otherorganization, either taxable or tax-exempt, on line 15. Essentially the same factors and circumstances that deter-mine the relationship for line 13d also determine whether there is a “close connection” for line 15.

Other Section 501 Organizations

Indicate on lines 16, 17, and 18, respectively, whether the applicant is a Section 501(e) cooperative hospital serviceorganization (generally, an organization supplying nonmedical support services to two or more exempt hospitals);a Section 501(f) cooperative service organization of operating educational organizations (generally, an organiza-tion investing the funds of an exempt school in stocks and other securities); or a Section 501(n) charitable risk poolthat combines the insurance risks of its members (other than medical malpractice risks) and educates membersconcerning risk management. Each of these organizations must satisfy certain statutory requirements. A “Yes”answer to any of these three questions requires an explanation of how the applicant meets the requirements forexemption under the rules applicable to it.

Supplemental Schedules

Certain types of organizations must satisfy rules specifically applicable to them. The rules applicable to each suchorganization are addressed in supplemental schedules to Form 1023. An organization completes only the sched-ule pertaining to it.

If the applicant is the particular type of organization described in lines 19 through 22, a supplemental schedulemust be filed, as follows:

1. An applicant that operates (or will operate) a school (line 19), even if it is a secondary function, mustcomplete Schedule B.

2. An applicant whosemain function is (or will be) to provide hospital ormedical care (line 20)must completeSchedule C. A hospital includes a medical research organization if its principal purpose is the continuousactive conduct of medical research in conjunction with a hospital.

3. An applicant that provides (or will provide) low-income housing for the elderly or handicapped (line 21)must complete Schedule F.

4. An applicant that provides (or will provide) scholarships, fellowships, educational loans or othereducational grants to individuals for travel, study, or similar purposes (line 22) must complete Schedule H.However, an amount paid as compensation (e.g., a payment to a consultant to produce a report) is not aneducational grant. Similarly, educational grants do not include amounts paid to another organization thatuses such funds for scholarships to individuals if the applicant has no role in the selection process.

Form 1023-EZ

Prior to preparing Form 1023-EZ, the applicant must answer the 26 questions contained in the Form 1023-EZEligibility Worksheet to confirm that it is eligible to apply for exemption using Form 1023-EZ. According to thepreamble to the Worksheet, a “Yes” answer to any of these questions precludes the applicant’s use of Form1023-EZ. Instead, it must use Form 1023 (discussed previously in this lesson).


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Header. Check the box in the header to confirm eligibility and to confirm that the applicant has read and under-stands the requirements for Section 501(c)(3) exempt status.

Part I: Identification of Applicant

Line 1a—Full Name of Organization. Enter the organization’s full name as it appears on the organizing/creatingdocument (including amendments).

Line 1b–1e—Mailing Address. Enter the address for mail delivery (e.g., if mail is not delivered to the applicant’sstreet address and the applicant has a post office box, enter the box number, not the street address).

Line 2—Employer Identification Number (EIN). Include the organization’s nine-digit EIN. An EIN is required eventhough the organization has no employees. (If it does not have one, see the discussion for Form 1023, line 4, earlierin this lesson.)

Line 3—Month Tax Year Ends. Enter the date the organization has chosen to end its tax year. (See additionaldiscussion for Form 1023, line 5, earlier in this lesson.)

Lines 4–6—Person to Contact and Contact Information. Enter on line 4 the individual’s name the IRS can contact ifmore information is needed. The contact person can be an officer, director, or trustee of the organization, butusually should be the attorney or accountant who completed the Form 1023-EZwhile acting as an authorized agentof the applicant. Enter the contact person’s telephone number on line 5 and fax number on line 6. Although the faxnumber is optional, it should be included (if available) in order to expedite communication from the IRS to theapplicant. See discussion of Form 2848 earlier in this lesson.

Line 7—User Fee Submitted. Enter the user fee paid. The fee (at the time of publication) is $275.

Line 8—Names, Titles, and Mailing Addresses of Officers, Directors, and/or Trustees. Enter the full names, titles,and mailing addresses of the organization’s officers, directors, and/or trustees. The organization’s mailing addresscan be used in lieu of the individual’s addresses.

Only five persons should be listed on line 8. Consequently, if the applicant has more than five persons who couldbe listed, list only five in the following order:

1. President or chief executive officer or chief operating officer.

2. Treasurer or chief financial officer.

3. Chairperson of the governing body.

4. Any officers, directors, and trustees who are substantial contributors and not already listed previously.

5. Any other officers, directors, and trusteeswhoare related to a substantial contributor andnot already listedpreviously.

6. Voting members of the governing body not already listed previously.

7. Other officers not already listed previously.

If an individual serves in more than one office (e.g., both as an officer and director), list this person on only one lineand show all offices held. The officers of an organization are determined by reference to its organizing document,bylaws, or resolutions of its governing body, or otherwise designated consistent with state law.

Line 9a—Website. Enter the organization’s current website address as of the date Form 1023-EZ is filed. If none ismaintained, enter “N/A.”

Line 9b—Email Address. Enter an email address (optional) if the applicant wishes to receive educational informa-tion from the IRS.


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Part II: Organizational Structure

Only certain corporations, unincorporated associations, and trusts are eligible for Section 501(c)(3) status. Soleproprietorships, partnerships, and loosely affiliated groups do not qualify.

Line 1—Type of Organization. Check the box to indicate whether the applicant is a corporation, unincorporatedassociation, or a trust.

Line 2—Organizing Document. Check the box on line 2 to affirm that the applicant has the necessary organizingdocument for the type of organization indicated on line 1.

An applicant incorporated under a federal, state, or federally recognized Indian tribal or Alaska native governmentstatute has the necessary organizing document if its organizing document shows certification of filing (e.g.,evidence it was filed with, and approved by, an appropriate state authority on a specific date).

The articles of organization for an unincorporated association must include its name, purpose(s), the date thedocument was adopted, and the signatures of at least two individuals. Bylaws can be considered an organizingdocument only if they contain the preceding items and evidence of an intent to form an organization.

A trust agreement will be a necessary organizing document if it contains appropriate signatures and shows theexact date of formation.

Line 3—Date Incorporated or Formed. A corporation should enter the date the appropriate authority filed theorganizing document. An unincorporated association should enter the date the organizing document was signedby at least two persons. A trust should enter the date it was funded with property, provided the agreement does notprovide for distributions to non-charitable persons. If the document provides for distributions to non-charitablepersons, enter the date on which these interests expired. (A trust does not qualify for tax-exempt status if distribu-tions can currently be made to non-charitable persons.) A trust formed by a will should enter the testator’s date ofdeath or the date any non-charitable interests expired, whichever is later.

Line 4—State of Incorporation. Enter the jurisdiction under which the organization was incorporated or otherwiseformed. The state of incorporation may or may not be the place the applicant is physically located.

Line 5—Exempt Purpose. Check the box to attest that the applicant’s organizing document limits the purpose(s) tothose that are exempt pursuant to IRC Sec. 501(c)(3). This was discussed further under the topics “Meeting theOrganizational Test—Part III of Form 1023” and “What Is an Exempt Purpose” earlier in this lesson.

Line 6—Limitation of Activities. Check the box to attest that the applicant’s organizing document does not expresslyempower it to engage in activities that do not further one or more exempt purposes unless such non-exemptpurpose activities are insubstantial. A discussion of this limitation appears under the topic “Meeting the Organiza-tional Test—Part III of Form 1023” earlier in this lesson.

Line 7—Dissolution Provision. Check the box to attest that the applicant’s organizing document provides that upondissolution, any remaining assets will be used exclusively for IRC Sec. 501(c)(3) purposes. A discussion of thisrequirement appears earlier in this lesson under the topic “Dedication and Distribution of Assets upon Dissolution(the Dissolution Test)” earlier in this lesson.

Part III: Specific Activities

Line 1—Describe Specific Activities. Use this space to describe the organization’s mission or the most significantactivities. This should include either actual or planned mission or activities , but it should not describe anyspeculative future programs.

Example 2I-1 Actual or planned mission qualifies for exemption.

Pet Organization’s mission is to prevent animal cruelty. In accomplishing this mission, the organization willsubsidize spaying and neutering animals for pet owners who otherwise could not afford the services. Theorganization should describe its mission in line 1. Pet Organization qualifies for exemption under IRC Sec.501(c)(3) as an organization formed and operating exclusively for the prevention of cruelty to animals.


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Example 2I-2 Potential future programs should not be described.

An organization plans to further educational purposes by operating an after school homework club. Thisshould be described in line 1. The same organization is contemplating offering scholarships in the future.However, the organization does not currently offer scholarships and has no immediate or definitive plans to doso. Because this activity is speculative, it should not be described in line 1.

Line 2—NTEE Code. Enter the three-character National Taxonomy of Exempt Entities (NTEE) Code. The NTEEcodes can be found at the end of the instructions to Form 1023-EZ.

Line 3—Exempt Purpose(s). Check each box that describes an exempt purpose of the applicant.

Line 4—Prohibited or Restricted Activities. Check the box to attest that the organization has not conducted (and will notconduct) activities that are prohibited or restricted for Section 501(c)(3) organizations. These include the following:

1. Participating or intervening in a political campaign.

2. Conducting activities that result in the inurement of net earnings to the benefit of organization insiders orrelated persons.

3. Conductingactivities thatdonot further, other than insubstantially,non-exemptpurposes (suchasactivitiesthat benefit private interests).

4. Conducting as its primary purpose a trade or business that is unrelated to the applicant’s exemptpurpose(s).

5. Attempting to influence legislation (except as an insubstantial part of its activities) or if the lobbyingelectionhas been made, normally not making expenditures in excess of the expenditure limitation amounts.

6. Providing commercial-type insurance as a substantial part of its activities. Certain types of insuranceactivities are not considered commercial-type insurance, such as insurance provided at substantiallybelow cost to a class of charitable recipients.

Line 5—Attempting to Influence Legislation. Attempting to influence legislation (i.e., lobbying) was briefly discussedearlier in this lesson. An organization that has or will engage in lobbying should consider making a lobbyingelection on Form 5768 [Election/Revocation of Election By an Eligible Section 501(c)(3) Organization to MakeExpenditures To Influence Legislation].

Line 6—Compensation of Officers, Directors, or Trustees. Check “Yes” if such individuals will be compensated.Otherwise, check “No.” Compensation includes not only salary or wages, bonuses, and deferred compensation,but also retirement benefits (whether under a qualified or nonqualified plan) and fringe benefits (e.g., use of vehicleor other personal property, meals, lodging, personal and family educational benefits, low interest loans, athletic orcountry club memberships, personal travel, entertainment, or other expenses).

Line 7—Donations or Payments of Expenses to Individuals. Check “Yes” if the applicant has or will donate funds toindividual(s) or paid expenses for individual(s) (other than paying for or reimbursing employees’ businessexpenses). Otherwise, check “No.”

Line 8—Foreign Activities and Grants. Check “Yes” if the organization has conducted or will conduct activitiesoutside the U.S. or has or will provide grants or other assistance to individual(s) or organization(s). Outside the U.S.means those locations other than the U.S., its territories, and possessions.

Line 9—Financial Transactions With Related Persons. Answer “Yes” if the applicant has engaged or plans toengage in loans, grants, payments for goods or services, rentals, or other financial transactions with officers,directors, or trustees or any entities they own or control.

Line 10—Unrelated Business Income. Answer “Yes” if the applicant has received or expects to receive grossunrelated business income of $1,000 or more during a tax year.


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Line 11—Gaming Activities. Answer “Yes” if the applicant has or will conduct bingo or other gaming activities.

Line 12—Disaster Relief. Answer “Yes” if the organization has or will provide disaster relief.

Part IV: Foundation Classification

Organizations that are described in IRC Sec. 501(c)(3) are classified as either public charities or private founda-tions. This classification is important because different tax rules apply to the operations of each entity type. Part IVis designed to classify the applicant as a public charity or private foundation. Generally, every Section 501(c)(3)organization is a private foundation unless if qualifies for one of the public charity exceptions.

Certain organizations cannot use Form 1023-EZ to apply for exemption as described in Part IV, line 1.

Lines 2a–2b—Support. Organizations with broad financial support from the general public generally qualify aspublic charities. Select item 2a if the organization either normally (1) receives at least one-third of its support frompublic sources, or (2) receives at least 10% of its support from public sources and satisfies certain other require-ments. Select item 2b if the organization normally receives more than one-third of its support for a combination ofgifts, grants, contributions, membership fees, and certain gross receipts from activities related to its exemptfunction and normally does not receive more than one-third of its support from investment income and unrelatedbusiness taxable income. A detailed discussion of these rules appears in Lesson 3.

Line 2c—Operated for Benefit of a Government School. Select this item if the applicant both (1) is organized andoperated exclusively to receive, hold, invest, and administer property for, and make expenditures to or for thebenefit of, a state or municipal college or university; and (2) normally receives a substantial part of its support froma governmental unit or from direct or indirect contributions from the general public, or from a combination of thesesources. For this purpose, an organization’s support does not include income received in the exercise or perfor-mance of its charitable, education, or other exempt purpose.

Line 3—Private Foundation Status. An applicant that selected an item on lines 2a–2c should not complete line 3.However, an applicant that is not described in lines 2a, 2b, or 2c is a private foundation. It must check the box online 3 to attest that its organizing document contains the provisions required by IRC Sec. 508(e). Alternatively, theapplicant can select item 3 if it relies on the operation of the law of the state in which it was organized to satisfy therequirements of IRC Sec. 508(e).

Part V: Reinstatement After Automatic Revocation

An applicant should complete Part V only if it (1) had its exempt status automatically revoked for failure to filerequired annual returns or notices for three consecutive years, and (2) is applying for reinstatement under Section4 or 7 of Rev. Proc. 2014-11. See also Rev. Proc. 2018–5 2018–1 IRB 233, Section 6.05.

Line 1—Section 4 Reinstatement. Check this box if—

1. the applicant was eligible to file either Form 990-EZ or Form 990-N for each of the three consecutive yearsthat it failed to file,

2. this is the first time its exempt status was automatically revoked for failure to file, and

3. Form 1023-EZ is being submitted not later than 15 months after the later of the date of the applicant’sRevocation Letter or the date on which the IRS posted its name on the Revocation List at www.irs.gov(search for “Select Check”).

By checking the box on line 1, the applicant is also attesting that its failure to file was not intentional and that it hasimplemented procedures to file future required returns or notices.

Line 2—Section 7 Reinstatement. Check the box if the applicant is agreeing to accept an effective date ofreinstatement as of the date Form 1023-EZ is filed.


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Part VI: Signature

An officer, director, or trustee listed in Part I, line 8, who is authorized to sign for the applicant, must electronicallysign Form 1023-EZ. To do so, the signer must check the “penalties of perjury” box and type his or her name on theline provided. The signature must be accompanied by the title or authority of the signer and the date.


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SELF-STUDY QUIZ


12. Reaching Out Together is a nonprofit organization that provides food, clothing, and basic toiletries to thehomeless. Where should it report these goods on its Form 1023?

a. Line 3a of Part V.

b. Lines 1a and 1b of Part VI.

c. Line 1 of Part VII.

d. Line 1 of Part VIII.

13. Which of the following statements correctly describes an issue related to Part VIII of Form 1023?

a. When determining whether an organization attempts to influence legislation, direct lobbying is taken intoaccount but grass roots activities are not.

b. If an organization mentions in Part VIII that it operates any gaming activities, such as bingo, it will need tofile Form 990-T.

c. For a childcare organization to qualify as tax exempt, 100% of their services must be for individuals whoare currently employed.

d. If an organization indicates that it is affiliated with a state or a U.S. possession, it will need to provideadditional information on Form 1023.

14. The Cancer Corps, a nonprofit organization, answers “yes” to three of the 26 questions on the Form 1023-EZEligibility Worksheet. It will have to do which of the following?

a. Include extra signatures in Part IV.

b. Include a National Taxonomy of Exempt Entities (NTEE) Code.

c. Use Form 1023 instead of Form 1023-EZ.

d. Send an explanatory document with its Form 1023-EZ.


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SELF-STUDY ANSWERS


12. Reaching Out Together is a nonprofit organization that provides food, clothing, and basic toiletries to thehomeless. Where should it report these goods on its Form 1023? (Page 178)

a. Line 3a of Part V. [This answer is incorrect. Line 3a of Part V is used to record qualifications, hours, andduties. Theorganization should attach a list to its return showing the qualifications, average hoursworked,and duties for all related persons listed on lines 1a, 1b, or 1c.]

b. Lines1aand1bofPart VI. [This answer is correct. If theapplicant providesgoods, services, or fundsto individuals or other organizations, this should be reported on Form 1023, lines 1a and 1b. Theinstructions give the following examples of such programs for individuals: providing food to thehomeless, employment counseling to senior citizens, and grants to victims of a disaster.]

c. Line 1 of Part VII. [This answer is incorrect. Line 1 of Part VII is used to report whether the applicant is asuccessor to another organization.]

d. Line 1 of Part VIII. [This answer is incorrect. Line 1 of Form 1023, Part VII, asks whether the applicantsupports or opposes (through past, present, or planned activities) candidates in political campaigns; andif so, to explain those activities.]

13. Which of the following statements correctly describes an issue related to Part VIII of Form 1023? (Page 179)

a. When determining whether an organization attempts to influence legislation, direct lobbying is taken intoaccount but grass roots activities are not. [This answer is incorrect. When filling out Part VIII of Form 1023,indicate on line 2a if the applicant has attempted (or will attempt) to influence legislation. (To qualify as atax-exempt organization, the answer to this question must be “no.”) For a public charity, if the answer is“yes,” the applicant must explain the lobbying activity and estimate the percentage of its time and fundsthat are devoted (or planned to be devoted) to the activity. The question seeks to confirm that the lobbyingactivities are not more than an insubstantial part of its total activities. Attempts to influence legislationinclude direct lobbying (attempts to influence legislators) or indirect grass roots lobbying (i.e., attemptsto influence the electorate or general public).]

b. If an organization mentions in Part VIII that it operates any gaming activities, such as bingo, it will need tofile Form990-T. [This answer is incorrect. Applicants report informationconcerning their operationofbingogames or any other types of gaming activities on lines 3a through 3c of Part II. This information will helpthe IRS determine whether the gaming activity is an unrelated trade or business for which Form 990-Tshould be filed. Therefore, Form 990-T is not always required when such gaming activities exist.]

c. For a childcare organization to qualify as tax exempt, 100% of their services must be for individuals whoare currently employed. [This answer is incorrect. According to IRCSec. 501(k), exempt status is availableto a childcare organization if substantially all of the care provided by the organization is to enableindividuals to be gainfully employed, and the services are available to the general public. Substantially allmeans 85% or more (so not necessarily 100%).Gainfully employed includes enabling individuals to seekwork; therefore, not limited to individuals who are already employed.]

d. If an organization indicates that it is affiliatedwith a state or aU.S. possession, it will need toprovideadditional information on Form 1023. [This answer is correct. Line 5 of Part VIII is used to indicatewhether the applicant is affiliated with a governmental unit. For this purpose, a governmental unitincludes a state, a possession of the U.S., any political subdivision of a state or possession of theU.S., the U.S. itself, and the District of Columbia. If such an affiliation exists, the applicant mustidentify the governmental unit, describe the relationship of the applicant to it, provide details offinancial reports or audits required by the governmental unit, and describe any power or authorityit has given the applicant.]


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14. The Cancer Corps, a nonprofit organization, answers “yes” to three of the 26 questions on the Form 1023-EZEligibility Worksheet. It will have to do which of the following? (Page 185)

a. Include extra signatures in Part IV. [This answer is incorrect. An officer, director, or trustee listed in Part I,line 8, who is authorized to sign for the applicant, must electronically sign Form 1023-EZ. To do so, thesigner must check the “penalties of perjury” box and type his or her name on the line provided. Thesignaturemustbeaccompaniedby the titleorauthorityof thesignerand thedate.However,havinganextrasigner added to the form is not an appropriate response to answering “yes” to questions in the eligibilityworksheet; therefore, the Cancer Corps should not do this.]

b. Include a National Taxonomy of Exempt Entities (NTEE) Code. [This answer is incorrect. Any organizationfiling Form 1023-EZ needs to enter the three-character NTEE Code on line 1 of Part III. The NTEE codescan be found at the end of the instructions to Form 1023-EZ. Therefore, use of this code by the CancerCorps has no bearing on whether or not it answered “yes” to questions in the eligibility worksheet.]

c. Use Form 1023 instead of Form 1023-EZ. [This answer is correct. Prior to preparing Form 1023-EZ,the applicant must answer the 26 questions contained in the Form 1023-EZ Eligibility Worksheet toconfirm that it is eligible to apply for the exemption using Form 1023-EZ. According to the preambleto the worksheet, a “yes” answer to any of these questions precludes the applicant’s use of Form1023-EZ. Instead, it must use Form 1023, which is what the Cancer Corps will have to do in thisscenario.]

d. Send an explanatory document with its Form 1023-EZ. [This answer is incorrect. According to thepreamble of the worksheet, this would not be an acceptable response to “yes” answers related to any ofthese 26 questions.]


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Lesson 3: Determination of Public Charity versusPrivate Foundation StatusIntroduction

Part X of Form 1023 (Public Charity Status) must be completed to assist the IRS in determining—

1. theorganization’s statusasaprivate foundationor apublic charity (lines1–5). If theorganization is aprivatefoundation, Part X is designed to determine whether it is a private operating foundation, and

2. the organization’s public charity status if it has existed for five or more tax years.

Schedules A–D of Form 1023, referenced in lines 5a–d of Part X, give the IRS detailed information on types oforganizations that only qualify for exemption if they comply with rules unique to that type of organization. Theinformation requested on Schedules A–D is closely interrelated with the information provided by the organizationon Form 1023, Part IV (Narrative Description of Your Activities).


Completion of this lesson will enable you to:¯ Recognize thedifferencesbetweenqualifying as a public charity and aprivate foundation, aswell as the 331/3%test, facts and circumstances,more than one-third, and one-third or less tests for qualifying as a public charity.

¯ Determinehow toqualifyasapubliccharityunder the rules thatgovernsupportingorganizations,how toqualifyas a private operating foundation, what makes a grant unusual, how to provide information about contributingsources, whenSchedules A–Hof Form1023 are needed, andwhen safe harbors for organizations that providelow-income housing come into effect.

Qualifying as a Public Charity Instead of a Private Foundation

An organization must indicate whether it is claiming nonprivate foundation (i.e., public charity) status whencompleting Form 1023, otherwise, the organization is presumed to be a private foundation. Lines 1 and 2 ofForm 1023, Part X ask whether the organization is a private foundation or a private operating foundation. If theorganization is neither, line 5 asks for the public charity classification the organization is claiming. This discussionfocuses on how to determine an organization’s correct classification (as a private foundation, private operatingfoundation, or public charity) and the advantages of classification as a public charity.

Advantages of Public Charity Status

A Section 501(c)(3) organization classified as a public charity enjoys several benefits that a private foundation doesnot, including the following:

1. Public charities are not subject to the private foundation excise taxes.

2. Charitable contributions to public charities are governed by less restrictive rules than contributions toprivate foundations. (Public charities are “50%” charities under the rules of IRC Sec. 170, while privatefoundations are generally “20%” or “30%” charities.)

3. Public charities may engage in limited lobbying activities while private foundations cannot.

4. All private foundations, regardless of size, must file Form 990-PF annually, whereas small public charitiesare eligible to file Form 990-EZ, which is a simplified version of Form 990, or, if annual gross receipts arenormally less than $50,000, they need only file Form 990-N [Electronic Notice (e-Postcard) for Tax ExemptOrganizations Not Required to File Form 990 or 990-EZ].


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Because of the advantages of public charity status, qualifying organizations should claim such status on Form 1023by correctly completing line 5 of Part X.

Definition of a Private Foundation

All Section 501(c)(3) organizations are presumed to be private foundations unless they qualify for nonprivatefoundation status under one of the following exceptions:

1. A church or a convention or association of churches.

2. An educational organization that normally maintains a regular faculty and curriculum and has a regularlyenrolled student body in attendance where its educational activities are regularly carried on (i.e., a schoolor college).

3. An organization whose principal purpose or function is providing medical or hospital care or medicaleducation or research.

4. An organization that receives a substantial part of its support (exclusive of income received in theperformanceof its exempt function) from theUnitedStatesor anystateorpolitical subdivisionor fromdirector indirect contributions from the general public, and organized and operated exclusively to receive, hold,invest, and administer property and tomake expenditures to or for a public college or university. This typeof organization is commonly known as an educational endowment fund.

5. A state or possession of the United States (or any political subdivision of these), the United States, or theDistrict of Columbia.

6. An organization that normally receives a substantial part of its support (exclusive of income received in theperformanceof its exempt function) fromagovernmental unit (described in item 5)or fromdirector indirectcontributions from the general public. Community trusts are normally included in this exception.

7. An organization that usually receives more than one-third of its support from any combination of gifts,grants, contributions, membership fees, and gross receipts from activities related to its exempt purpose,but receives one-third or less of its support from gross investment income and unrelated business income(net of any unrelated business income tax).

8. An entity that is (a) organized and operated exclusively for the benefit of, to perform the functions of, or tocarry out the purposes of one or more organizations described in items 1–7; (b) operated, supervised, orcontrolled by or in connection with an organization described in items 1–7; and (c) not controlled directlyor indirectly by disqualified persons other than the foundation manager or an organization described initems 1–7.

9. An agricultural research organization directly engaged in continuous research in conjunction with a landgrant college or university or a non-land grant college of agriculture.

10. An organization organized and operated exclusively for testing of public safety.

In this lesson, the tests for public charity status described in items 1–5 and 9–10 are referred to as functional tests;the tests for public charity status described in item 6 or 7 are public support tests; and the test for public charitystatus in item 8 is the supporting organization test.

The Functional Tests for Qualifying as a Public Charity

Qualification as a public charity (nonprivate foundation) under the functional tests (i.e., as a church, school,hospital, medical research organization, governmental unit, university endowment fund, or an organization testingfor public safety) is governed by the rules in Reg. 1.170A-9 rather than by the definitions of these types oforganizations under IRC Sec. 501(c)(3). The definitions of certain qualifying organizations under the Section 170regulations are summarized in the following paragraphs.


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Qualifying as a Church

The IRS is hesitant to issue regulations on whether an organization qualifies as a church or a convention orassociation of churches because of freedom of religion issues. However, previously the IRS used the 14 criteria todetermine if a specific organization is a church. The criteria are not of equal importance and not all 14 must be metfor an entity to be a church. An organization was held to not qualify as a church because it did not meet the 14criteria. In recent years, the IRS appears to be relying more heavily on three of the 14 factors that have emerged ascore factors. Several private letter rulings illustrate that regular worship services must be conducted at a regularlocation with a regular congregation to qualify as a church.

There is no statutory definition of the term convention or association of churches. The Code provides that anorganization will not be precluded from being a convention or association of churches merely because theorganization includes individuals or because individuals have voting rights in the organization. The IRS has alsoprivately ruled that an electronic ministry failed to be a church because it did not meet the association test.

Qualifying as an Educational Organization

The definition of an educational organization includes primary, secondary, preparatory, or high schools; andcolleges and universities. However, it does not include an organization providing both educational and noneduca-tional activities unless the noneducational activities are incidental to the educational activities. A private schoolcannot be exempt unless it has a racial nondiscriminatory policy for its students. Such organizations should reviewRev. Proc. 75-50 before completing Schedule B of Form 1023. Public schools are not subject to the nondiscrimina-tion rules of Rev. Proc. 75-50.

Qualifying as a Hospital or Medical Research Organization

An organization qualifies as a hospital if its principal purpose is to provide medical or hospital care. (An entity canalso qualify as a hospital when its principal purpose is to provide medical education or medical research. However,such an entity must also be actively engaged in providing medical or hospital care as an integral part of satisfyingits principal purpose.) Medical care includes treatment of any physical or mental disability or condition on either aninpatient or outpatient basis, provided the cost of the treatment qualifies as a deductible medical expense forfederal income tax purposes. The term hospital does not include convalescent homes, homes for children or theaged, or institutions whose principal purpose is to provide job training for handicapped individuals.

An entity qualifies as a medical research organization if its principal purpose is medical research, and it is directlyengaged in the continuous active conduct of medical research for a hospital that qualifies as a public charity.Medical research is “the conduct of investigations, experiments, and studies to discover, develop, or verify knowl-edge relating to the causes, diagnosis, treatment, prevention, or control of physical or mental diseases.” Medicalresearch encompasses associated disciplines spanning the biological, social, and behavioral sciences (e.g.,chemistry, psychiatry, biomedical engineering, immunology, and pharmacology).

Donations to a medical research organization do not qualify for the maximum 50% charitable contribution limitunless the organization is committed to spend the donations for medical research before the start of the fifthcalendar year that begins after the date a donation is received. This rule does not apply for determining if theorganization qualifies for nonprivate foundation status.

An organization is not engaged in medical research if its activities consist solely of contributing funds towardmedical research or extending grants or scholarships to others.

Qualifying as an Educational Endowment Fund

An educational endowment fund normally must receive a substantial part (331/3% or more) of its support from theUnited States or any state or political subdivision thereof or from direct or indirect contributions from the public (orfrom a combination of two or more such sources). Direct or indirect contributions from the public include cash andthe fair market value of property received as donations. An example of an indirect contribution from the public is thereceipt of funds from the United Way or some other clearing house type of charitable organization. Support doesnot include income received in the performance of the organization’s exempt purpose. Although the instructions


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are silent on how support should be calculated, this course suggests that an educational endowment fund’ssupport is calculated the same as entities qualifying as public charities under the 331/3% test of IRC Sec.170(b)(1)(A)(vi). According to the instructions for line 5f, Part X of Form 1023, an organization that qualifies as aneducational endowment fund would also qualify as a supporting organization described on line 5d of Part X.

The funds received by an educational endowment fund must be given to or spent for the benefit of a public collegeor university. Qualifying expenditures include payments for the acquisition and maintenance of real propertycomprising the campus area; the construction of campus buildings; the acquisition andmaintenance of equipmentand furnishings used for normal functions of the school; and payments made for scholarships, libraries, andstudent loans.

Qualifying as an Agricultural Research Organization

Since the 2015 PATH Act was enacted, qualifying agricultural research organizations are treated as public charitiesregardless of their sources of support. Donations to an agricultural research organization do not qualify for themaximum 50% charitable contribution limit unless the organization is committed to spend the donations foragricultural research before the start of the fifth calendar year that begins after the date a donation is received.

The Section 509(a)(1) 331/3% Test for Qualifying as a Publicly SupportedCharity

A Section 501(c)(3) organization qualifies for nonprivate foundation (public charity) status under IRCSec. 170(b)(1)(A)(vi) if it normally receives 331/3% or more of its support from a governmental unit or from direct orindirect contributions from the public.

Definition of a Governmental Unit

For the 331/3% test, a governmental unit includes a state or a U.S. possession (and any political subdivision of eitherof these), the United States, and the District of Columbia. It is unclear whether a governmental unit includes theforeign equivalents of U.S. political subdivisions in all instances. In Rev. Rul. 75-435, the IRS ruled that an exemptorganization organized in a foreign country and receiving a substantial portion of its support from a foreigngovernment was not a private foundation. However, the IRS subsequently concluded that this revenue ruling didnot apply to a domestic U.S. exempt organization receiving most of its support from a foreign government. Therationale for the distinction between foreign and domestic organizations was that a foreign government is less likelyto be interested in supervising the activities of an organization operating outside of its jurisdiction than inmonitoringthe activities of its own organization.

In GCM 38327, the IRS reconsidered the case of the organization involved in GCM 37001 and its suggestedrevision of Rev. Rul. 75-435, but did not reach a conclusion.

Test Period

To qualify under the 331/3% test, an organization must normally receive its support from public sources. The test isperformed on an aggregate basis using information from the current tax year and the four preceding years. If theorganization satisfies the support test for this five-year period, it is deemed to meet the test not only for the currenttax year but also for the immediately succeeding tax year. Since the five-year support test is performed on anaggregate basis, the qualification of the organization for the current year and the next tax year gives the organiza-tion an opportunity to preserve its nonprivate foundation status even if its sources of support change unexpectedly.

A new organization cannot comply with the five-year support test when it has existed for less than four years beforethe current tax year. However, if an organization has existed for at least one tax year consisting of at least eightmonths but for fewer than five tax years, the number of years the organization has existed plus the current tax yearis substituted for the five-year test period.


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Example 3C-1 Determining the test period for a new organization.

The Oklahoma City Assistance League adopted a calendar tax year when it was formed on March 1, 2017.The League has applied for tax exemption as a Section 501(c)(3) organization and is seeking nonprivatefoundation status as a publicly supported organization under the 331/3% test.

Its status as a public charity for 2018 is based on the initial short tax year from March 1–December 31, 2017.(See Example 3C-2 for a discussion of the test period used to make an initial determination of nonprivatefoundation status.) Satisfying the test for public charity status in 2019 can be based either on having passedthe test in 2018 or on the aggregate support of the organization from March 1, 2017–December 31, 2018.Meeting the test in 2020 can be based either on having passed the test in 2019 or on the aggregate supportfrom March 1, 2017–December 31, 2019. The five-year period generally provided for performing the publicsupport test will apply to all succeeding years.

Computing the Percentage of Public Support

The 331/3% test requires that an organization receive at least 331/3% of its total support from governmental units orfrom direct or indirect contributions from the general public. The percentage is calculated using public support asthe numerator and total support as the denominator. Therefore, both the total support and the public support mustbe determined for the test period. Once the total support has been calculated, the public support can be calculatedas a subset of that number.

Calculation of Total Support (Denominator of Equation)

The following items are included in the calculation of total support:

1. Gifts, grants (not including unusual grants), contributions, and membership fees. Membership fees areincluded only if the payment is to provide support for the organization, rather than to purchase admissions,merchandise, services, or the use of facilities.

2. Amounts received fromagovernmental unit (as defined previously in this lesson), including donations andrevenue received in connection with a research grant or a contract for the performance of services thatbenefit the public directly (rather than the needs of the governmental entity).

3. Net income from unrelated business activities, even if not regularly carried on. Note that membership feesare included here to the extent they are payments to purchase admissions, merchandise, services, or theuseof facilities inanunrelatedbusinessactivity.Net income fromspecial eventsmayalsobe includedwhenthe special event would be considered an unrelated business, if it were regularly carried on.

4. Gross investment income from interest, dividends, rents, royalties, and from loaning the organization’ssecurities to the extent the income is not unrelated business income (UBI).

5. Tax revenues levied for the benefit of the organization and either paid to, or expended for, the organization.

6. The value of services or facilities furnished by a governmental unit without charge (unless such servicesor facilities normally are furnished to the public without charge).

7. Qualified sponsorship payments (money or property, but not services), without reduction for disregardedbenefits.

8. Other income (if not excluded from total support, as discussed in the following paragraph).

The definition of total support does not include the following:

1. Amounts received from theperformance of the organization’s exempt function.However, payments receivedfrom a governmental unit that enable the organization to provide a service to, or maintain a facility for, thedirect benefit of the public, rather than to serve the direct and immediate needs of the payor, are counted as


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support revenue. Examples of such payments include amounts paid for the maintenance of library facilitiesopen to the public, amounts paid to nursing homes or homes for the aged to provide health care or housing,and amounts paid to child placement or guidance organizations for services rendered to children.

2. The value of services contributed to the organization for which a charitable contribution deduction is notallowed.

3. Unusual grants (the definition of an unusual grant is provided later in this lesson).

4. Capital gains, loan repayments, and the value of the organization’s tax-exempt status.

Calculation of Public Support (Numerator of Equation)

Items included in calculating public support are as follows:

1. Any amount received from a governmental unit (as defined earlier in this lesson), including donations andamounts received in connection with a contract for the performance of services or a research grant.However, amounts received for the performance of services for the direct benefit of a governmental unit(rather than the general public) are excluded.

2. Contributions from other Section 170(b)(1)(A)(vi) organizations or from other Section 170(b)(1)(A)organizations that could qualify under IRCSec. 170(b)(1)(A)(vi). For example,most churches could qualifyunder the public support tests of IRC Sec. 170(b)(1)(A)(vi), but since they qualify for exemption andnonprivate foundation status under a functional test, they are not required to qualify under the publicsupport tests. Therefore, donations from churches are included in the calculation of public support, eventhough they are not Section 170(b)(1)(A)(vi) organizations.

3. Gifts,grants, andcontributions,excludingunusualgrants.The IRShas ruled that thecontributions receivedfrom a donor advised fund operated on its website by a charity were from the general public for purposesof the public support test. Membership fees are also included but only if the payment is to provide supportfor the organization and not to purchase admissions, merchandise, services, or the use of facilities. Inaddition, qualified sponsorship payments received in the form of money or other property are consideredpublic support in full without reduction for the amount of any disregarded benefits. However, none of theseitemsare included inpublic support to theextent theamountcontributedbyanydonor [orperson(s) relatedto that donor] during the computation period exceeds 2%of the organization’s total support for that period(i.e., the 2% limit).

Example 3C-2 Calculating an organization’s percentage of public support.

Public Charities of New York (PC) was formed on April 1, 2017, and adopted a calendar year-end. It appliedfor recognition of its exempt status under IRC Sec. 501(c)(3) on June 1, 2018. PC filed a Form 990-EZ for itsfirst tax year, covering the period from April 1–December 31, 2017. PC received financial support for 2017 asfollows:

Investment income $ 25,000Contributions 50,000Grant from United Fund [a Section 170(b)(1)(A)(vi) organization] 100,000Capital gains on the sale of donated securities 5,000

Total financial support $ 180,000

None of the contributions are from donors contributing more than 2% of PC’s total support. PC’s total supportis $175,000 (i.e., total financial support less the $5,000 capital gains). Its public support is $150,000 (contribu-tions plus the grant received from the United Fund). PC’s percentage of public support is calculated asfollows:

Public supportTotal support

= $150, 000$175, 000

= 85.7%


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Because PC’s first tax year is longer than eight months, the organization’s initial test period is its current yearof operations, 2017. Since public support for 2017 is 331/3% or more of total support, PC is a publiclysupported organization qualifying for nonprivate foundation status.

Example 3C-3 Applying the 2% limit to gifts, grants, and contributions.

Assume PC’s (see Example 3C-2) operations in 2017, 2018, and 2019 includes the following:

2017 2018 2019 Total

Investment income $ 25,000 $ 35,000 $ 50,000 $ 110,000Contributions 50,000 50,000 200,000 300,000Grant from United Fund[a Section 170(b)(1)(A)(vi) organization] 100,000 75,000 50,000 225,000Contract services for city — 10,000 10,000 20,000Capital gains 5,000 — — 5,000

Total financial support $ 180,000 $ 170,000 $ 310,000 $ 660,000

Of the contributions received in 2018 and 2019, $25,000 and $125,000, respectively, were received from oneindividual, Percy Smith. Since these contributions are not unusual grants, the 331/3% test for public support for2019 must be calculated.

Since PC has existed for fewer than five tax years, the applicable test period is 2017 through 2019. The 331/3%test percentage is calculated on an aggregate basis. Therefore, total support for the test period is $655,000($660,000 of total financial support less the capital gains of $5,000 recognized in 2017). Public support for thetest period is computed as follows:

Grant from United Fund $ 225,000Contributions 300,000Contract services for city 20,000Less: Amount by which contributions from Percy Smith exceed 2%of total support [($125,000 + $25,000) − $13,100a] (136,900 )

Public support $ 408,100

Note:

a 2% of total support = 2% × $655,000 = $13,100.

PC’s percentage of public support is 62.3% ($408,100 ÷ $655,000). Since public support is 331/3% or moreof PC’s total support for the test period, the organization qualifies as a publicly supported organization underIRC Sec. 170(b)(1)(A)(vi) for 2019 and for 2020 (the year after satisfying the public support test).

Example 3C-4 Applying the 2% limit to contributions from governmental units and Section170(b)(1)(A)(vi) organizations.

Patti wants to make a contribution of $100,000 to Save the Whales Fund (SWF) in 2018. She is a disqualifiedperson with respect to SWF. Because of this, Patti makes her contribution to Montfort Charities (Montfort), apublicly supported organization qualifying for nonprivate foundation status under IRC Sec. 170(b)(1)(A)(vi),with the requirement that Montfort make a contribution of $100,000 to SWF.

Because the Montfort contribution is from funds earmarked by the donor for SWF, the contribution to SWFfromMontfort (funded by Patti’s contribution) is subject to the 2% limit under Reg. 1.170A-9(f)(6)(v). Thus, the2% limit is applied to the contribution in determining whether SWF satisfies the 331/3% test for public supportunder IRC Sec. 170(b)(1)(A)(vi). If Patti had made the contribution to Montfort with a requirement only that thefunds be contributed to organizations advancing animal rights, the 2% limit would not have applied becauseMontfort would have been free to select the ultimate recipients of the donated funds.


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Community Trusts

Community trusts are established to attract large endowment contributions for the benefit of a particular commu-nity. Such contributions are often received and maintained in separate trusts or funds subject to varying degrees ofcontrol by the community trust’s governing body.

A community trust must meet either the 331/3% test or the facts and circumstances test to qualify as a publiclysupported organization. It can be treated as a single entity instead of a combination of separate funds if it meets thefollowing requirements:

1. The organization is commonly known as a community trust or similar name.

2. All of its funds are subject to a common governing instrument.

3. All of its funds have a common governing body that monitors distributions from the funds exclusively forcharitable purposes and has certain other powers to modify or restrict the terms of each trust or fund.

4. The organization prepares its periodic financial reports treating all the funds in the aggregate as a singleentity (as opposed to separate entities).

To be treated as part of a community trust rather than a separate trust or not-for-profit corporation, a trust or fund (1)must be created by a transfer to a community trust that is treated as a single entity and (2) may not be directly orindirectly subjected by the transferor to any material restriction with respect to the transferred assets.

The Facts and Circumstances Test for Qualifying as a Publicly SupportedCharity

A Section 501(c)(3) organization that normally receives a “substantial” part of its support (under a facts andcircumstances test) from a governmental unit or from direct or indirect contributions from the public qualifies as apublic charity under IRC Sec. 170(b)(1)(A)(vi). (See line 5h of Form 1023, Part X.) This test is applied to organiza-tions that fail to meet the 331/3% test. “Governmental unit” was defined earlier in this lesson.

Mechanics of the Test

An organization must satisfy all of the following requirements to qualify as a public charity (i.e., nonprivatefoundation) under the facts and circumstances test.

1. The governmental and public support “normally” received by the organization must equal at least 10% ofthe total support “normally” received by the organization. This 10% test uses the same five-year test period(or shorter test period for new organizations) and definition of total support and public support used incalculating the 331/3% test for public support (including the 2% limit, as discussed previously—see item3 in “Calculation of Public Support”).

2. The organization must be organized and operated to attract new and additional public or governmentalsupport on a continuous basis. Organizations satisfy this requirement by maintaining a continuous andbona fide program for soliciting funds. The scope of the organization’s fundraising activities should bereasonable in light of its charitable activities.

3. All pertinent facts and circumstances must indicate the organization is publicly supported.

The regulations provide various factors to determine whether an organization is publicly supported. An organiza-tion need not satisfy all of these factors to be considered publicly supported.

Example 3D-1 Applying the facts and circumstances test under IRC Sec. 170(b)(1)(A)(vi).

TheCity Zoo (Zoo) was organized several years ago and is tax-exempt under IRCSec. 501(c)(3). Zoo receivesits support from donations made by the general public, contributions from United Fund [a Section


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170(b)(1)(A)(vi) organization], and admission fees. Zoo also admits groups of schoolchildren and others freeof charge. Currently, Zoo is instituting a program to solicit donations from the public through an adopt-an-ani-mal program and a “Zoo friends” program. Zoo has interest and dividend income on investments totalling$20,000 and unrelated business income totalling $100,000 from the sale of items (not related to its exemptpurpose) in the gift shop. Zoo’s governing body includes four individuals—a well-known zoologist from thelocal university, a prominent local banker and civic leader, the superintendent of the local school board, andthe president of the local veterinary society. Zoo’s sources of support for the previous four years are:

Net income from unrelated business activities $ 100,000aInterest and dividends 20,000Donation from the United Fund 200,000Contributions (two unrelated donors gave $100,000 and $300,000,respectively, during the test period)—not unusual grants 400,000

Total support $ 720,000

Note:

a Receipts from admissions are not included in total support under Section 170(b)(1)(A)(vi).

For qualification as a public charity under the facts and circumstances test, Zoo’s public support is computedas follows:

United Fund donation $ 200,000Contributions 400,000Contributions in excess of 2% of total supporta[($300,000 − $14,400) + ($100,000 − $14,400)] (371,200 )

Public support $ 228,800

Note:

a 2% of total support = 2% × $720,000 = $14,400.

Because Zoo’s percentage of public support is only 31.8% ($228,800÷ $720,000), it is not publicly supportedunder the 331/3% test. However, Zoo should qualify for public charity status under the facts and circumstancestest because its public support is 10% or more of its total support; it has a solicitation plan for attracting publicsupport and a broad, representative governing body; it receives a large percentage of its support (includingthe United Fund donation) from the general public; and its facilities are available to the general public.

The Section 501(a)(2) Test for Qualifying as a Publicly Supported Charity

The Section 509(a)(2) test has two requirements. First, a Section 501(c)(3) organization must normally receivemore than one-third of its support (i.e., qualifying support) from gifts, grants, contributions, membership fees, orfrom gross receipts from admissions, sales, services, or the furnishing of facilities in an activity that is not anunrelated trade or business, to qualify for nonprivate foundation (i.e., public charity) status as a publicly supportedorganization. Second, the organization must receive one-third or less of its support from a combination of grossinvestment income and unrelated business income (UBI) (net of any unrelated business income tax imposed onsuch income) from business acquired by the organization after June 30, 1975. Qualifying support must be receivedfrom permitted sources as defined later in this lesson. The box on line 5i of Part X, Form 1023, should be checkedto indicate exemption from private foundation status under IRC Sec. 509(a)(2).

Test Period

The test period for determining if an organization normally satisfies the more than one-third and one-third or less testsof IRC Sec. 509(a)(2) is the same five-year period described in relation to the 331/3% test. Therefore, an organizationnormally satisfies the Section 509(a)(2) tests for both the current and immediately succeeding tax years if it satisfiesthe tests on an aggregate basis for the current and four preceding years. The rules discussed in relation to the 331/3%


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test also apply for (1) a new organization, (2) an organization’s initial determination of nonprivate foundation status,and (3) an organization experiencing a substantial or material change in sources of support.

Computing the Percentage of Public Support—the More Than One-third Test

To meet the requirements of the more than one-third test under IRC Sec. 509(a)(2), more than one-third of anorganization’s total support must be qualifying support from permitted sources. The percentage of qualifyingsupport is calculated using public support as the numerator and total support as the denominator. Therefore, boththe amount of total support and the amount of public support must be determined for the test period.

Calculation of Total Support (Denominator of Equation)

The definition of total support includes all of the items included in the calculation of total support for the 331/3% test,plus the following additional items:

1. Membership fees to the extent they are paid to purchase admissions, merchandise, services, or the useof the organization’s facilities in an activity that is related to the organization’s exempt function.(Membership fees thatmerely provide support to the organization but no significant benefit to thememberare already included for the 331/3% test.)

2. Gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities,in an activity that is not an unrelated trade or business.

The definition of total support does not include the following:

1. Unusual grants. (Unusual grants are defined later in this lesson.)

2. Capital gains, loan repayments, and the value of the organization’s tax-exempt status.

Calculation of Public Support (Numerator of Equation)

The calculation of public support includes the following:

1. Gifts, grants, contributions, andmembership fees from permitted sources. Membership fees are includedonly if they are actually donations or represent a payment for a product or service resulting from theorganization’s performance of its exempt purpose.

2. Gross receipts (from permitted sources) generated from admissions, sales of merchandise, performanceof services or furnishing of facilities in an activity that is not an unrelated trade or business, either becausesuch activity is substantially related to the organization’s exempt purpose or because it is statutorilyexcluded by IRC Sec. 513 from the definition of unrelated trade or business.

Permitted sources include governmental units, Section 501(c)(3) organizations that are public charities under IRCSec. 509(a)(1) (see the first six entities earlier in this lesson under the subheading “Definition of a Private Founda-tion”), and persons (other than disqualified persons of the organization). Contributions or membership feesreceived from a private foundation, another Section 509(a)(2) organization, or an organization described in IRCSec. 509(a)(3) are not from permitted sources and, thus, are not included in the numerator.

Limitation on Gross Receipts

Gross receipts received from any one person or from a single bureau or agency of a governmental unit are includedin the public support calculation only to the extent such receipts do not exceed the greater of $5,000 or 1% of theorganization’s total support for the tax year. For this purpose, a bureau or agency of a governmental unit includeseach separate operating unit of a government department.

Because of the limitation imposed on gross receipts, it is important to distinguish gross receipts from gifts, grants,contributions, and membership fees. Gross receipts are amounts received from an activity (not an unrelated tradeor business) if a specific service, facility, or product is provided to serve the direct and immediate needs of the payor


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rather than primarily to confer a direct benefit on the public. In contrast, gifts and contributions include amounts forwhich the donor is allowed a charitable contribution deduction. Therefore, payments of money or transfers ofproperty without adequate consideration are gifts or contributions. Also included in the definition of gifts andcontributions are bequests, legacies, devises, and transfers [within the meaning of IRC Sec. 2055 or 2106(a)(2)]. Agrant is a payment made to encourage the grantee organization to carry on certain programs or activities infurtherance of its exempt purpose. Payments are membership fees (and not gross receipts) if their intent is toprovide support for the organization rather than to purchase admissions, merchandise, services, or facility use.

To determine the dollar amount of total support and public support, the amount of a gift, grant, or contribution is theFMV or rental value of the property transferred at the date of the gift or contribution.

Example 3E-1 Distinguishing between membership fees and gross receipts.

The Beethoven Symphony receives all of its financial support from ticket sales to its summer and winterconcert series and the collection of membership fees from the symphony society. It has three classes ofmemberships available: patron level (donations of up to $500), friend level (donations of $501–$5,000), andangel level (donations of more than $5,000). Membership in the society at any level entitles a member to buyseason tickets before they are made available to the general public. The member’s price for season tickets isthe same as that for the general public.

The society’s membership fees must be carefully reviewed to determine if they are membership fees or grossreceipts. Since symphony members receive no substantial benefit from being a member, presumably theypay their membership fees to support the organization. Thus, the payments are treated as membership feesrather than gross receipts when calculating the symphony’s public support. If its membership fee included thecost of a season ticket or a substantial discount on season tickets, all or part of the membership fee would bereclassified as gross receipts rather than membership fees.

Example 3E-2 Calculating public support when the gross receipts limitation applies.

The Montgomery Fund (Fund) was formed on June 1, 2016, and received a determination letter recognizingits tax-exempt status under IRC Sec. 501(c)(3). The Fund is a public charity under the rules of IRCSec. 509(a)(2). In applying the more than one-third and one-third or less tests to determine qualification forthe 2018 tax year, its support for the three prior tax years must be examined. The Fund’s financial support forthis period was from the following sources:

2016 2017 2018 Total

Gross investment income $ 30,000 $ 70,000 $ 80,000 $ 180,000Contributions from substantial contribu-tors 20,000 30,000 30,000 80,000Other contributions from the public 50,000 200,000 225,000 475,000UBI 12,000 30,000 35,000 77,000Contract with Corporation A 8,000 15,000 15,000 38,000Gross receipts from admissions (noreceipts from single individual in excessof $5,000 or 1% of total support) 50,000 100,000 110,000 260,000

Total support $ 170,000 $ 445,000 $ 495,000 $ 1,110,000

Since the Fund has been in existence less than five years, its public support for 2018 is determined by lookingat the three prior tax years and is calculated as follows:

Contributions from the public $ 475,000Revenue from contract with Corporation A 15,000Gross receipts from admissions 260,000

Total public support $ 750,000


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The investment income and UBI are excluded from public support in total. The contributions from substantialcontributors are excluded because they are receipts from disqualified persons. The gross receipts from thecontract are subject to the gross receipts limitation and are only included up to the greater of $5,000 or 1% oftotal support in each of the three years. Since $5,000 is greater than 1% of $170,000, $445,000, and $495,000for the respective three years, contract revenue of $5,000 each year is considered public support. The fundmeets the more than one-third test for 2018 because its public support is more than one-third of its totalsupport ($750,000 ÷ $1,110,000 = 68%).

The One-third or Less Test

Organizations that meet the more than one-third test for public support must also meet the one-third or less test toqualify as a public charity under IRC Sec. 509(a)(2). An organization satisfies this test if it normally receivesone-third or less of its total support from the sum of its gross investment income and the excess, if any, of its UBIover the tax imposed on such income. Gross investment income includes gross income from interest, dividends,payments on securities loans, rents, and royalties (to the extent such amounts are not included in the computationof UBI).

Example 3E-3 Applying the one-third or less test.

Assume the same facts as in Example 3E-2. Assume the Fund paid unrelated business income tax (UBIT) for2016 through 2018 of $11,100.

The one-third or less test for 2018 is determined as follows:

Gross investment income $ 180,000UBI less UBIT paid ($77,000 − $11,100) 65,900

Total $ 245,900

Because the sum of the Fund’s gross investment income and UBI (net of tax) is not more than one-third of itstotal support for the test period ($245,900÷ $1,110,000= 22%), it satisfies the one-third or less test. Since theFund satisfies both the more than one-third and one-third or less tests for the applicable test period (2016through 2018), the fund qualifies as publicly supported.

Special Investment Income Attribution Rule

To determine an organization’s investment income under the one-third or less test, a flow-through concept isapplied to donations from certain entities to recharacterize those donations as gross investment income. Thisattribution rule applies to amounts received from—

1. an entity qualifying as a supporting organization under IRC Sec. 509(a)(3) because of its support of thedonee organization (see the discussion of supporting organizations later in this lesson); and

2. any charitable trust, corporation, fund, association, or similar entity that is required by its governinginstrument or otherwise to distribute, or that normally distributes, at least 25% of its adjusted net incometo the organization, and such distribution normally equals at least 5% of the organization’s adjusted netincome.

Amounts received from such entities are classified as gross investment income to the extent such amounts arecharacterized as gross investment income by the distributing entity. All gross investment income of a distributingentity is deemed distributed first (before other types of income) and retains its character in the hands of thedistributee organization. If the distributing entity makes distributions to more than one organization, the grossinvestment income deemed distributed is prorated among the organizations receiving distributions.

An organization attempting to qualify (or that has qualified) as a public charity under the more than one-third andone-third or less tests must complete and attach Schedule A, Part III to its annual information return (Form 990 or990-EZ) each year listing all amounts received from such distributing entities.


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Relationships Created for Tax Avoidance

If an organization seeking to qualify under the more than one-third and one-third or less tests enters into anarrangement with an organization that purports to be its supporting organization to avoid private foundation status,the character and amount of support received by the supporting organization will be attributed to the beneficiaryorganization.

If the beneficiary loses its status as a public charity because of this provision (or the investment income attributionrule discussed earlier in this lesson), the supporting organization will also lose its status as a public charity pursuantto IRC Sec. 509(a)(3).


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SELF-STUDY QUIZ


15. The Horowitz Group is classified as a public charity instead of as a private foundation. Which of the followingis an advantage the Horowitz Group will enjoy as part of this classification?

a. Exemption from excise taxes.

b. Being considered a “30%” charity.

c. The ability to focus its exempt purpose on lobbying activities.

d. The option to file Form 990-PF.

16. Which of the followingmust occur for an educational endowment fund to be considered a public charity underthe functional tests?

a. Less than one-third of its support can come from the United States government and/or publiccontributions.

b. It cannot accept a donation from any source if it includes property.

c. The funds received must be spent for the benefit of a public college or university or be given to such aninstitution.

d. Funds from this type of endowment can be used for scholarship payments, room and board, andtextbooks.

17. Memorial Services is seeking recognitionasapublic charityusing the331/3%rule.WhencalculatingMemorial’stotal support under this rule, which of the following would be excluded?

a. Amounts received while performing its exempt function.

b. Gifts and contributions.

c. Net unrelated business income (UBI).

d. Tax revenues that were levied for the organization.

18. Which of the following must be true for an organization to pass the one-third or less test?

a. No more than one-third of its donations qualify to be recharacterized under the flow-through concept.

b. One-third or less of its support comes from the excess of UBI over related tax and its gross investmentincome.

c. One-third or less of its support comes from governmental unit or public support.

d. The organization meets all the qualifications to be considered a community trust.


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SELF-STUDY ANSWERS


15. The Horowitz Group is classified as a public charity instead of as a private foundation. Which of the followingis an advantage the Horowitz Group will enjoy as part of this classification? (Page 195)

a. Exemption from excise taxes. [This answer is correct. A Section 501(c)(3) organization classifiedas a public charity enjoys several benefits that private foundations do not. One of these advantagesis that public charities arenot subject to theprivate foundationexcise taxes. Therefore, theHorowitzGroup will not have to pay such excise taxes since it has this classification.]

b. Beingconsidereda “30%”charity. [This answer is incorrect.Charitable contributions topublic charitiesaregoverned by less restrictive rules than contributions to private foundations. Public charities are “50%”charities under the rules of IRCSec. 170, while private foundations are generally “20%” or “30%” charities.Therefore, the Horowitz Group will be considered a “50%” charity because of its classification as a publiccharity.]

c. The ability to focus its exempt purpose on lobbying activities. [This answer is incorrect. Public charities,like the Horowitz Group,may engage in limited lobbying activities; however, those activities still cannot be“substantial,” per IRCSec. 501(c)(3). Private foundations are not allowed even limited lobbying activities.]

d. The option to file Form 990-PF. [This answer is incorrect. One of the benefits of being classified a publiccharity is that all private foundations, regardless of size, must file Form 990-PF annually, whereas smallpublic charities are eligible to file Form990-EZ, which is a simplified version of Form990, or if annual grossreceipts are normally less than $50,000, they need only file Form 990-N. Therefore, depending on annualgross receipts, the Horowitz Group will file either Form 990-EZ or Form 990-N.]

16. Which of the followingmust occur for an educational endowment fund to be considered a public charity underthe functional tests? (Page 196)

a. Less than one-third of its support can come from the United States government and/or publiccontributions. [This answer is incorrect. An educational endowment fund normally must receive asubstantial part (331/3% or more) of its support from the United States or any state or political subdivisionthereof or from direct or indirect contributions from the public (or from a combination of two or more suchsources).]

b. It cannot accept a donation from any source if it includes property. [This answer is incorrect. A qualifyingeducational endowment fund can have direct or indirect contributions from the public that include cashand the fair market value of property received as donations.]

c. The funds receivedmust be spent for the benefit of a public college or university or be given to suchan institution. [This answer is correct. According to Reg. 1.170A-9(c)(2)(i), the funds received by aneducational endowment fund must be given to or spent for the benefit of a public college oruniversity.]

d. Funds from this type of endowment can be used for scholarship payments, room and board, andtextbooks. [This answer is incorrect. According to Reg. 1.170A-9(c)(2)(i), qualifying expenditures includepayments for the acquisition and maintenance of real property comprising the campus area; theconstruction of campus buildings; the acquisition and maintenance of equipment and furnishings usedfor normal functions of the school; and payments made for scholarships, libraries, and student loans.Room, board, and textbooks are not included in this list of qualifying expenditures.]


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17. Memorial Services is seeking recognitionasapublic charityusing the331/3%rule.WhencalculatingMemorial’stotal support under this rule, which of the following would be excluded? (Page 198)

a. Amounts received while performing its exempt function. [This answer is correct. According to Reg.1.170A-9(f)(7)(i), amounts received from the performance of the organization’s exempt function arenot included in thedefinitionof total support. However, payments received fromagovernmental unitthat enable the organization to provide a service to, ormaintain a facility for, the direct benefit of thepublic, rather than to serve the direct and immediate needs of the payor, are counted as supportrevenue.]

b. Gifts and contributions. [This answer is incorrect. According to Reg. 1.170A-9(f)(7)(iv), gifts, grants (notincluding unusual grants), contributions, and certain membership fees are included in the calculation oftotal support.]

c. Net unrelated business income (UBI). [This answer is incorrect. According to Reg. 1.170A-9(f)(7), netincome from unrelated business activities, even if not regularly carried on, is factored into the calculationof an organization’s total support.]

d. Tax revenues that were levied for the organization. [This answer is incorrect. Part of an organization’s totalsupport, as calculated under Reg. 1.170A-9(f)(7), are any tax revenues levied for the benefit of theorganization and either paid to, or expended for, the organization.]

18. Which of the following must be true for an organization to pass the one-third or less test? (Page 203)

a. Nomore thanone-third of its donationsqualify tobe recharacterizedunder the flow-through concept. [Thisanswer is incorrect. According to Reg. 1.509(a)-5, to determine if an organization’s investment incomeunder the one-third or less test, a flow-through concept is applied to donations from certain entities torecharacterize thosedonationsasgross investment income.However, theamountofdonations thatqualifyfor this treatment is not a requirement for passing the test.]

b. One-third or less of its support comes from the excess of UBI over related tax and its grossinvestment income. [This answer is correct. Organizations that meet the more than one-third testfor public support must also meet the one-third or less test to qualify as a public charity under IRCSec. 509(a)(2). According to Reg. 1.509(a)-3(a)(3), an organization satisfies this test if it normallyreceives one-third or less of its total support from the sum of its gross investment income and theexcess, if any, of its UBI over the tax imposed on such income.]

c. One-third or less of its support comes from governmental unit or public support. [This answer is incorrect.According to Reg. 1.170A-9(f)(3), when using the fact and circumstances test (not the one-third or lesstest), thegovernmental andpublicsupport “normally” receivedby theorganizationmustequalat least10%of the total support “normally” received by the organization.]

d. Theorganizationmeets all thequalifications tobe considereda community trust. [This answer is incorrect.Community trusts are established to attract large endowment contributions for the benefit of a particularcommunity. A community trust must meet either the 331/3% test or the facts and circumstances test toqualify as a publicly supported organization. Passing the one-third or less test would be the same for thistype of entity as any other—being a community trust does not affect the one-third or less test.]


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Qualifying as a Public Charity According to the Rules GoverningSupporting Organizations

An organization can qualify for nonprivate foundation status if it is organized and operated to provide support toanother exempt organization (i.e., the beneficiary organization) that is not a private foundation. To qualify under thisprovision, the supporting organization must be organized (organizational test) and operated (operational test)exclusively for the benefit of, to perform the functions of, or to carry out the purposes of an organization qualifyingfor nonprivate foundation status under IRC Sec. 509(a)(1) or (a)(2). The supporting organizationmust be operated,supervised, controlled by, or in connection with the beneficiary organization (or another public charity) (relationshiptest), and must not be controlled directly or indirectly by a disqualified person (other than a foundation manager ora public charity.)

The beneficiary organization must be organized in the United States.

Meeting the Organizational Test

An organization seeking exemption as a supporting organization under IRC Sec. 509(a)(3) [and checking the boxon line 5d, Part X of Form 1023] must satisfy both an organizational and an operational test. To satisfy theorganizational test, a supporting organization must comply with the following requirements in its articles of organi-zation (i.e., the written instrument by which it is created):

1. The organization must be limited to operating exclusively for the benefit of, performing the functions of, orcarrying out the purposes of, one or more public charities.

2. Theorganizational documentmust not expressly empower the organization to engage in any activities thatdo not further its stated purposes.

3. The organizational document must specify the publicly supported (beneficiary) organization(s) on whosebehalf the supporting organizationwill be operated. Thedegree towhich thebeneficiary organizationmustbe specified is determined by the relationship between the supporting organization and the beneficiaryorganization. The beneficiary organization(s) normally must be identified by name if the supportingorganization is operated in connection with the beneficiary organization. However, the beneficiaryorganization need not be identified by name if the supporting organization is supervised or controlled inconnection with or is operated, supervised, or controlled by the beneficiary organization(s). (These termsare defined later in this lesson.) If the beneficiary organization is not specified by name, the articles oforganizationof the supporting organizationmust require it to beoperated to support or benefit oneormorebeneficiary organizations that are designated by class or purpose. [See Reg. 1.509(a)-4(d) for moreinformation on the requirement to specify a beneficiary organization.]

4. The organizational document must not expressly empower the organization to pay any part of its incometo, or performany services for, anybeneficiary organizationother than those specified in the organizationaldocument. Even if the actual operations of the supporting organization have been exclusively forbeneficiary organizations specified in the organizational document, it will not satisfy this portion of theorganizational test.

Example 3F-1 Qualifying as a supporting organization when no beneficiary organization is named.

Eldercare was formed in the current year by members of Zion Church to operate a home for the aged. Themembers and officers of Zion Church appoint the Eldercare board of directors and control its operation.Eldercare’s organizational document requires it to provide no-cost housing for the elderly, but does notrequire that such services specifically be provided to church members.

Since caring for the aged is a longstanding function and purpose of organized religion, Eldercare isconsidered to be carrying out the purposes of Zion Church. Because it is also controlled by Zion Church[within the meaning of Reg. 1.509(a)-4(g)], Eldercare qualifies as a supporting organization for Zion Churcheven though it is not specifically named in Eldercare’s organizational document. (The “control” of a


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supporting organization by a beneficiary organization is discussed later in this lesson under the subheading“Meeting the Relationship Test.”)

Meeting the Operational Test

In addition to satisfying the organizational test, a supporting organization must satisfy an operational test byoperating exclusively for the benefit of, to perform the function of, or to carry out the purposes of, one ormore publiccharities. A supporting organization operates exclusively to support a public charity only if it engages solely inactivities that support or benefit the organization. These activities can include making payments to or for the use of,or providing services or facilities for, individual members of the charitable class benefitted by the beneficiaryorganization (payments do not have to be made directly to the beneficiary organization). An organization willgenerally fail to qualify as a supporting organization if any of its activities are not for the support or benefit of a publiccharity described in IRC Sec. 509(a)(1) or (2) (i.e., the beneficiary organization).

Example 3F-2 Failing to qualify as a supporting organization when operations are not exclusively forthe beneficiary organization.

The Patton Fund (Patton) is a Section 501(c)(3) organization formed to provide financial assistance toCentralAid, a Section 509(a)(1) publicly supported organization active in providing relief to Central America.Patton is required by its organizational documents to provide funds principally to CentralAid. However, it alsomakes a small grant annually to the Gomez Foundation (Gomez), a private foundation that also funds reliefefforts in Central America. Even though Patton is operated principally for the benefit of CentralAid, a permissi-ble beneficiary organization, it is not deemed to be operated exclusively for the benefit of that organization.The grant to Gomez prevents Patton from satisfying the operational test under IRC Sec. 509(a)(3); thus, itdoes not qualify as a supporting organization.

Meeting the Relationship Test

One of three different relationships must exist between a supporting organization and its beneficiary (supported)organization(s) for the supporting organization to qualify for public charity status under IRC Sec. 509(a)(3).Requiring one of these relationships helps ensure that the supporting organization is responsive to the needs anddemands of the beneficiary and is an integral part of, or maintains a significant involvement in, its operations. Asupporting organization can be:

1. Operated, Supervised, or Controlled by a Beneficiary Organization (Type I). This relationship exists whenthe governing body, members of the governing body, officers acting in their official capacity, or themembership of one or more publicly supported organizations elect or appoint a majority of the officers,directors, or trustees of the supporting organization. (See Example 3F-3.) Such a relationship ensures thatthe supporting organization is under the direction of, and accountable or responsible to, the beneficiaryorganization. The IRS views this relationship as a parent-subsidiary relationship with the beneficiaryorganization as the parent and the supporting organization as the subsidiary. The IRS is comfortable withthis type of relationship.

2. Supervised or Controlled in Connection with a Beneficiary Organization (Type II). This relationship existswhen the control ormanagement of the supporting organization is vested in the samepersonswhocontrolor manage the beneficiary organization. (See Example 3F-4.) A supporting organization is not consideredto be supervised or controlled in connection with a beneficiary organization merely because it makesmandatory or discretionary payments to the beneficiary organization. The IRS views this relationship as abrother-sister relationship between the beneficiary and supporting organizations. The IRS is alsocomfortable with this type of relationship.

3. Operated in Connection with One or More Beneficiary Organizations (Type III). (See Example 3F-5.) Tosatisfy this relationship, the beneficiary organization normally must be specified by name in theorganization’s articles of incorporation or trust instrument unless a historic and continuing relationshipexists between the organizations. No particular language is necessary to specify the beneficiaryorganization. The IRS is not comfortable with this relationship and prefers either the “parent-subsidiary” or“brother-sister” relationships described previously. One reason is that Type III supporting organizations


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have been promoted as a vehicle for securing a charitable contribution deductionwithout the donor givingup control over, or beneficial enjoyment of, the property used to fund the entity. These abuses led to theadoption ofmore stringent rules. The regulations interpreting these rules are discussed later in this lesson.

Prohibited person. An organization cannot qualify as either a Type I or Type III supporting organization if it acceptsany gift or contribution from a prohibited person. Accepting such a contribution will cause the organization to betreated as a private foundation until it can demonstrate to the IRS’s satisfaction that it qualifies as a public charityrather than as a supporting organization. A prohibited person is as follows:

1. A person other than a public charity described in IRC Sec. 509(a)(1), (a)(2), or (a)(4) who controls thegoverning body of the beneficiary organization. Control can be direct or indirect and either alone ortogether with persons who are family members or controlled entities.

2. A familymember of an individual described in item 1. Familymembers include a spouse, siblings (whetherbywholeorhalf blood)and their spouses,ancestors,directdescendants throughgreat-grandchildren,andspouses of such descendants.

3. A 35% controlled entity, which is defined as a corporation, partnership, trust, or estate more than 35% ofwhich is actually or constructively controlled by persons described in items 1 and 2.

Example 3F-3 Determining if a supporting organization is operated, supervised, or controlled by abeneficiary organization (i.e., a Type I supporting organization).

MedPress is a nonprofit entity organized and operated to provide publishing services exclusively to theUniversity of St. James Medical School, an organization qualifying as a Section 509(a)(1) public charity. Theofficers and directors of MedPress are appointed by the Board of Regents of the medical school. Conse-quently, MedPress is considered to be operated, supervised, or controlled by the medical school.

Example 3F-4 Determining if a supporting organization is supervised or controlled by a beneficiaryorganization (i.e., a Type II supporting organization).

John Dough, a longtime member of Zion Church (Church), died in the current year, leaving a portion of hisestate in trust for Church. The trust instrument provides that the pastor and deacons are to act as trustees anduse trust funds to accomplish Church’s charitable purposes. Since the trustees are Church members influen-tial in the management of Church, the trust is deemed to be supervised or controlled by Church.

Requirements for a Type III Supporting Organization

A Type III supporting organization must satisfy a notification requirement, a responsiveness test, and an integralpart test. The organization demonstrates that it is an integral part of a beneficiary organization by satisfying therequirements of either a functionally integrated Type III supporting organization or a non-functionally integratedType III supporting organization, as defined later in this lesson. Each of these requirements is discussed in thefollowing paragraphs.

Notification Requirement. Each taxable year, a Type III supporting organization must provide to each of its benefi-ciary organizations: (a) a written notice addressed to a principal officer of the beneficiary organization identifyingthe supporting organization and describing the amount and type of support it provided to the beneficiary organiza-tion during the supporting organization’s taxable year immediately preceding the taxable year when the notice isprovided; (b) a copy of the supporting organization’s most recently filed Form 990 or other annual informationreturn required to be filed under IRC Sec. 6033 (as of the date the notification is provided); and (c) a copy of thesupporting organization’s governing documents, including any amendments. (Copies of governing documentsneed only be provided once.) The required notice and documents must be postmarked or electronically transmit-ted by the last day of the fifth month after the close of the supporting organization’s tax year. Organizations shouldretain proof of delivery in their records.

Responsiveness Test. The responsiveness test is structured to give the beneficiary organization the ability toinfluence the supporting organization, thereby ensuring that it will be responsive to the needs of the beneficiary


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organization. A supporting organization (including a charitable trust) satisfies this test if it meets both the relation-ship and significant voice requirements.

The relationship requirement can be met if—

1. oneormoreofficers, directors, or trusteesof thesupportingorganizationareelectedor appointed (whetherornotduring the taxyear)by theofficers, directors, trustees,ormembershipof thebeneficiaryorganization;

2. one or more members of the beneficiary organization’s governing body are also officers, directors, ortrustees of, or hold other important offices in, the supporting organization; or

3. the supporting organization’s officers, directors, or trustees maintain a close and continuous workingrelationship with the beneficiary organization’s officers, directors, or trustees.

Because of the relationship described in these items, the beneficiary organization must have a significant voice inthe (1) investment policies, (2) timing of grants, (3) manner of making grants, (4) selection of grant recipients by thesupporting organization, and (5) directing the use of its income or assets. This test is quite subjective; it does notmean that the beneficiary organization must have control, but simply that it must be likely to have influence.

Integral Part Test—Functionally Integrated. A Type III supporting organization is functionally integrated if it satisfiesa but-for test, is the parent of each of its beneficiary organizations, or supports a governmental supported organiza-tion.

1. But-for Test. The activities performed by the supporting organization for or on behalf of the beneficiaryorganization carry out the purposes of the beneficiary organization and, but for the involvement of thesupporting organization, would be activities performed by it.

The regulations require that substantially all of the Type III supporting organization’s activities directlyfurther the exempt purpose of the beneficiary organization. All facts and circumstances will be consideredin determining whether substantially all of the supporting organization’s activities directly further theexempt purpose of a beneficiary organization. The activities must be conducted by the supportingorganization, rather than the beneficiary organization. A supporting organization will be considered todirectly further the exempt purposes of its beneficiary organization by holding or managing exempt-useassets.

However, unless they fall under an exception, fundraising, grantmaking, and investing and managingnonexempt-use assets are types of activities that will not be deemed to directly further exempt purposes.

Grants, scholarships, or other payments to individuals who aremembers of a charitable class who benefitby thebeneficiary organizationwill beanactivity that directly furthers theexemptpurposeof thebeneficiaryorganization if—

a. beneficiaries are selected on an objective and nondiscriminatory basis;

b. the officers, directors, or trustees of the beneficiary organization have a significant voice in when andhow payments are made, as well as selecting the recipients; and

c. makingsuchpayments ispartof anactiveprogramof thesupportingorganization thatdirectly furthersthe exempt purposes of the beneficiary organization and in which the supporting organizationmaintains significant involvement.

2. Parent of Beneficiary Organization. An organization is considered a parent if (a) it exercises a substantialdegree of direction over the supported organization’s policies, programs, and activities; and (b) it appointsor elects, directly or indirectly, the majority of the officers, directors, or trustees of the supportedorganization. Consequently, a supporting organization can qualify as a parent of a second tier, or lower,subsidiary.


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3. Governmental Supported Organization. A Type III supporting organization will be deemed to support agovernmental supported organization if it—

a. supports at least one supported organization that is a governmental entity to which the supportingorganization is responsive within the meaning of Reg. 1.509(a)-4(i)(3); and

b. engages in activities for or on behalf of the governmental supported organization that perform thefunctions of, or carry out the purposes of, that governmental supported organization and that, but forthe involvement of the supporting, would normally be engaged in by the governmental supportedorganization itself.

Generally, a GSO is a supported (beneficiary) organization that is (1) a governmental unit described in IRC Sec.170(c)(1) (including all agencies, departments, and divisions of the governmental unit) , or (2) an organizationdescribed in IRC Sec. 170(c)(2) and 170(b)(1)(A) (other than private foundations and publicly supported organiza-tions) that is an instrumentality of one or more governmental units described in IRC Sec. 170(c)(1). To qualify asfunctionally integrated, the new test requires the following:

1. The supporting organization must support only GSOs. In addition, if more than one GSO is supported, allof the GSOs must either—

¯ operate with the same geographic region (e.g., a city, county, or metropolitan area) or

¯ work in close coordination or collaboration with one another to conduct a service, program, or activitythat the supporting organization supports.

2. A substantial part of the supporting organization’s total activities are activities that directly further theexempt purposes of its GSOs.

Special Rule. A Type III supporting organization in existence on or before February 19, 2017, that supports nomorethan one additional beneficiary organization will be treated as functionally integrated if certain requirements aremet.

Transitional Rules Have Expired. The proposed further extended the transition relief provided in Notice 2014–4. AType III supporting organization in existence on or before February 19, 2016, could continue to rely on therequirements of Notice 2014–4 until the earlier of the first day of the organization’s first tax year beginning after thedate the final regulations are issued, or the first day of the organization’s second tax year beginning after February19, 2016. The regulations have not been finalized as of the date of this publication.

Integral Part Test—Non-functionally Integrated. To qualify as a non-functionally integrated Type III supportingorganization, the organization must satisfy both an annual distribution requirement and an attentiveness test.

1. Distribution Requirement. To meet the distribution requirement, an organization must distribute eachtaxable year, to or for the use of its beneficiary organization(s), the greater of 85% of the organization’sadjusted net income or its minimum asset amount. (Carryovers of excess distributions from certain prioryears may be used for this purpose.) Adjusted net income is determined under the rules for privatefoundations [in IRC Sec. 4942(f) and Reg. 53.4942(a)-2(d)]. Theminimum asset amount is 3.5% of the fairmarket value of the organization’s nonexempt-use assets, reduced by related acquisition indebtedness(regardless of when incurred), and increased by certain recoveries of amounts previously treated asdistributions. Fair market value is based upon asset values as of the end of the organization’s prior taxableyear. No distribution is required during an organization’s first year of existence.

The following distributions (calculated as the amount of cash or fair market value of property on the dateof distribution, using the cash method) count toward fulfilling the distribution requirement:

a. Direct Payments. Any amount paid to a beneficiary organization to accomplish its exempt purposes.

b. Indirect Support. Amounts expended on activities that directly further the exempt purposes of abeneficiary organization. However, the supporting organization can only count expenditures of an


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activity towards itsdistribution requirement to theextent theexpendituresexceedany revenuederivedfrom the activity. For example, if a supporting organization spends $1 million in a taxable yearoperating a museum for a beneficiary organization and the museum admissions generate $800,000in receipts for the supporting organization during the same year, the supporting organization canonlycount $200,000 towards its distribution requirement.

c. Administrative Expenses.Any reasonable andnecessary administrative expensespaid to accomplishthe exempt purposes of the beneficiary organization(s). Such expenses do not include expensesincurred to produce investment income.

d. Exempt-use Assets.Any amount paid to acquire an exempt-use asset. The assetmay be used or heldby either the supporting organization or a beneficiary organization. If held by the supportingorganization, the supporting organization must make it available to the beneficiary organization freeof charge or for nominal rent.

e. Set Asides. An amount set aside for a specific project that accomplishes the exempt purposes of abeneficiaryorganization tobecountedasadistribution in theyear setaside (butnot in theyearactuallypaid). The organization must request IRS approval of the set aside before the end of the taxable yearin which the amount is set aside. Among other things, the request must establish that the amount setasidewill be expended for the specific project within 60months after it is set aside and that the projectcan be better accomplished by the set aside than by the immediate payment of funds.

The supporting organizationmust also obtain awritten statement from the supported organization, signedby one of its principal officers under penalty of perjury (a) confirming the specific project accomplishes theexempt purposes of the beneficiary organization; and (b) approving the supporting organization’sdetermination that the project can be better accomplished through the set aside than by the immediatepayment of funds or distribution of assets.

An organization that fails to meet the distribution requirement will not be classified as a private foundationin the taxable year for which it fails to meet such distribution requirement if it can show the failure was dueto reasonable cause.

2. Attentiveness Test. The regulations provide that an organization must distribute one-third or more of itsannual distributable amount to one or more beneficiary organizations that are attentive to the supportingorganization’s operations and for which the supporting organization meets the responsiveness test.Carryovers of excess distributions from prior years do not count toward the attentiveness requirement. Todemonstrate that a beneficiary organization is attentive, a supporting organization must—

a. distribute to the beneficiary organization an amount equal to 10%ormore of its total support receivedduring the beneficiary organization’s last taxable year ending before the beginning of the supportingorganization’s taxable year;

b. providesupport that isnecessary toavoid the interruptionofcarryingonaparticular functionoractivityof the beneficiary organization; or

c. provide an amount of support that is a sufficient part of a beneficiary organization’s total support toensure attentiveness, based on all pertinent facts, including the number of supported organizations,the length and nature of the relationship between the supporting organization and beneficiaryorganization, and the purpose to which the funds are put.

The attentiveness of a beneficiary organization is normally influenced by the amounts received from thesupporting organization, but evidence of actual attentiveness to the operations is of almost equalimportance. Amounts received from a supporting organization that are held in a donor advised fund of thesupported organization are disregarded in determining attentiveness.

Example 3F-5 Determining if a supporting organization is operated in connection with a beneficiaryorganization (i.e., a Type III supporting organization).

John Dough’s estate funded a trust upon his death to provide an endowment in memory of his wife for OatsUniversity, United Methodist Hospital, and the Cancer Research Fund. The trustees are John’s two brothers,


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who are not related to the beneficiary organizations. Under the terms of the trust instrument, all of its incomeis distributed annually in equal shares among the three beneficiaries. The amounts distributed each yearcomprise less than 1% of each organization’s total support. Under state law, the beneficiary organizationshave enforceable rights and can require a trust accounting. The trustees have no dealings with the beneficiaryorganizations.

The beneficiary organizations exercise no control over the trust. Thus, the only permissible relationshipbetween the trust and the beneficiary organizations that would qualify it as a supporting organization is theoperated in connection with definition of Reg. 1.509(a)-4(i). To satisfy this definition, the relationship betweena supporting and beneficiary organization must pass the responsiveness and integral part tests. The respon-siveness test is satisfied because the beneficiary organizations are specifically named in the trust instrumentand have enforceable rights against the trust. However, the relationship between the trust and beneficiariesdoes not satisfy the integral part test. The distributions from the trust do not meet at least one of the attentiveto the operations requirements. If the trust had provided a larger portion (i.e., at least 10%) of the beneficiaries’income or the distributed funds had been earmarked for a program or activity that the beneficiary organiza-tions would not otherwise have been able to carry on, the integral part test probably would have been met.

Example 3F-6 Determining if a supporting organization meets the distribution requirements.

Section 501(c)(3) organization (O) supports five Section 509(a)(1) private universities (V, W, X, Y, and Z). Omeets the responsiveness test for each of the five beneficiary organizations. Each year O distributes an equalamount to each university. The combined amount equals the required distribution under Reg.1.509(a)-4(i)(5)(ii)(B). O’s annual distributions to each V andW equal more than 10% of each university’s totalannual support. Based on these facts, O meets the requirements of the attentiveness test because it distrib-utes two-fifths (more than the required one-third) of its distributable amount to beneficiary organizations thatare attentive to O.

Advantages of Functionally Integrated Type III Supporting Organizations

Functionally integrated Type III supporting organizations have the following advantages over those that are notfunctionally integrated:

1. They are not subject to the excess business holding rules of IRC Sec. 4943 (see discussion later in thislesson under “Excess Business Holdings Rules”).

2. They are not subject to annual payout requirements.

3. Private foundations may treat grants to them as qualifying distributions under IRC Sec. 4942.

Failure to Qualify as a Type III Entity

A Type III supporting organization that fails to meet the requirements of the regulations will be classified as a privatefoundation. Once classified as a private foundation, the rules regarding termination of private foundation statusunder IRC Sec. 507 will apply.

Relief for Pre-November 1970 Trusts

The regulations provide special relief for pre-November 1970 trusts.

Responsiveness Test. The regulations provide that additional facts and circumstances, such as a historic andcontinuing relationship with a beneficiary organization, can be considered in determining compliance with theresponsiveness test for organizations in existence prior to November 20, 1970.

Determination Letters for Supporting Organizations

An organization can request an initial determination of the type of supporting organization it is (or requests adetermination of a change in type) by filing Form 8940 (Request for Miscellaneous Determination) and attaching the


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information required in the instructions to the form. A user fee is required to be attached to the form. Current userfees are available at www.irs.gov (search “exempt organization user fee”).

Excess Business Holdings Rules

The excess business holdings rules applicable to private foundations also apply to supporting organizations in twoinstances:

1. A Type II supporting organization that accepts any gift or contribution from a person who is considered aprohibited person (as defined later in this lesson).

2. A Type III supporting organization that is not functionally integrated with a beneficiary organization.

However, Regs. 53.4943-11(f) and (g) provide limited transitional relief from the excess business holdings rules forprivate foundations that qualified as Type III supporting organizations before August 17, 2006, and Type III support-ing organizations created as trusts before November 20, 1970.

Prohibited Person. A prohibited person is generally a (1) person who controls the governing body of a beneficiaryorganization of the supporting organization, either directly or indirectly, or alone or together with other disqualifiedpersons; (2) member of a control person’s family; or (3) 35% controlled entity. However, a public charity, other thana supporting organization, will not be considered a control person.

For this purpose, a disqualified person is—

1. any person who was in a position to exercise substantial influence over the organization’s affairs in thefive-year period ending on the last day of the tax year;

2. any family member of an individual in 1 (e.g., a spouse, siblings and their spouses, ancestors, anddescendants through great grandchildren and their spouses); and

3. any corporation, partnership, trust or estate, more than 35% of which is owned by persons in 1 and 2.

Qualifying to Be Considered a Private Operating FoundationCertain organizations qualify as private operating foundations under IRC Sec. 4942(j)(3) or (j)(5). A private operat-ing foundation is a hybrid organization that for certain purposes is treated as a public charity and for others as aprivate foundation.

Definition of Unusual GrantsUnusual grants are excluded from the public support and total support definitions in the following calculations:

1. The 331/3% test.

2. The 10% requirement of the facts and circumstances test.

3. The more than one-third and one-third or less tests.

The exclusion of unusual grants from the five-year test period that normally applies when determining if anorganization is publicly supported provides a high degree of flexibility in dealing with unexpected or unusualdonations that might otherwise cause it to be reclassified as a private foundation.

Determining When a Grant Is Unusual

The criteria for determining when a grant is unusual are the same for each of the three support tests. Generally, agrant is deemed unusual if it—

1. is a substantial contribution or bequest from a disinterested party;

2. was attracted by reason of the publicly supported nature of the organization;


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3. is unusual or unexpected with respect to amount; and

4. would, by reason of its amount, result in the organization not meeting the applicable public support test.

Whether a particular contribution satisfies these criteria depends on all the facts and circumstances.

Example 3H-1 Excluding an unusual grant under the 331/3% test of IRC Sec. 170(b)(1)(A)(vi).

The Benson Fund (Benson), a Section 501(c)(3) exempt organization, was formed several years ago andadopted a calendar year-end. Benson has received a definitive ruling on its status as a public charity underIRC Sec. 170(b)(1)(A)(vi). It received the following financial support for the five years ending December of thecurrent year.

Net investment income $ 150,000Government contracts (enabling the organization to provide a service forthe direct benefit of the general public) 150,000Unrelated business income 300,000Contributions from the public (none in excess of 2% of total support) 250,000Bequest from John J. Smitt 500,000

Total support $ 1,350,000

The calculation of Benson’s current-year percentage of public support, assuming the Smitt bequest is not anunusual grant (therefore, not excluded), is as follows:

Public support—Government contracts $ 150,000Contributions from the public 250,000Bequest subject to 2% limit (2% × $1,350,000) 27,000

Total public support $ 427,000

Benson fails the 331/3% test because its percentage of public support is 32% ($427,000 ÷ $1,350,000).However, it might still qualify as publicly supported for the current year if it passed the test in the prior year orif it satisfies the facts and circumstances test.

If the Smitt bequest qualifies as an unusual grant, the calculation of Benson’s total support, public support,and percentage of public support is:

Public support ($427, 000 − $27, 000)Total support ($1, 350, 000 − $500, 000)

= $400, 000$850, 000

= 47% public support

Thus, by excluding the unusual grant, Benson passes the 331/3% public support test for the current year (andfor the next year).

Advance Ruling Available on Unusual Grant Status

If an organization believes a donation it is about to receive will qualify as an unusual grant, it can request anadvance ruling from the IRS to preapprove the donation as an unusual grant by submitting Form 8940 (Request forMiscellaneous Determination) and attaching the information required in the instructions to the form. A user fee isrequired to be attached to the form. Current user fees are available at www.irs.gov (search “exempt organizationuser fee”).

Some of the gifts approved to be unusual grants include the following:

¯ Gifts of estate-owned assets to be sold to establish designated fund benefitting other public charities.

¯ Bank’s grant to program developing and testing technology-enabled solution to improve financial healthof under-served consumers.


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¯ Grant to community foundation for operatingexpensesandconstructinga science, technology, andhealthcenter for at-risk youths.

¯ Grant to organization to expend and enhance preschool programs for low-income working and militaryfamilies and establish new after-school and summer programs for teens.

¯ Grant to organization to enrich the lives of at-risk youth and foster children through programs that restoreand increase self-esteem, self-worth, and self-sufficiency.

Reporting Information Regarding Contribution Sources

Significant Contributions Require Analysis

Report additional information about the sources of contributions to organizations seeking public charity statusunder the public support tests [i.e., an organization that checked box h, i, or j on line 5 of Part X] on Form 1023, PartX, lines 6 and 7.

Line 6a—Information about Contributions Subject to the 2% Limit under IRC Sec. 170(b)(1)(A)(vi). Only organiza-tions seeking public charity status under IRC Sec. 170(b)(1)(A)(vi) must complete line 6a (e.g., entities thatchecked box h or j on line 5 of Part X). Line 6a(i) requires the organization to calculate 2% of its total support basedon the financial information provided in Part IX-A. Line 6a(ii) requires an attached statement showing the name andamount contributed by each person (other than a governmental unit or another publicly supported organization)whose total gifts, grants, and contributions were more than the amount entered on line 6a(i). If the answer is“None,” state this. (Part IX-A is discussed in Lesson 4.)

Line 6b(i)—Information about Contributions to a Section 509(a)(2) Organization. Only organizations seeking publiccharity status under IRC Sec. 509(a)(2) must complete line 6b (e.g., entities that checked box i or j on line 5 of PartXb). Line 6b(i) asks the applicant to attach a statement, for each year covered by the financial data presented inPart IX-A, showing the name and amount received from any disqualified persons. If the answer is “None,” state this.Amounts received from disqualified persons are not included in the calculation of public support. Line 6b(ii) asksthe applicant to attach a statement, for each year covered by the financial data presented in Part IX-A, showing thename and amount received from each payor (other than a disqualified person) whose payments to the organizationduring any year were more than the larger of 1% of Form 1023, Part IX-A, line 10, or $5,000. The list should includeany such payments received from other public charities or from government agencies.

Line 7—Description of Unusual Grants. This line requests a description of any unusual grants received during theperiod covered by the financial information provided in Part IX-A of Form 1023. Attach a statement for each yearlisting the date and amount of the grant, the name of the contributor, and a brief description of the circumstancessurrounding the grant supporting the organization’s contention that it is unusual. (Guidance on determining if agrant qualifies as an unusual grant was provided earlier in this lesson.)

Additional Reporting Requirements That May Affect Certain Organizations(Schedules A–H of Form 1023)

Schedules A–H of Form 1023 request additional information from certain types of organizations. The requirementto attach Schedule A (church), Schedule B (school), Schedule C (hospital), or Schedule D (supporting organiza-tion) arises if the applicant asserts (in Part X, line 5) that it is a public charity because it qualifies as one of theseentities. The requirement to attach Schedule E (if not filing within 27 months of formation), Schedule F (homes forthe elderly or handicapped and low-income housing), Schedule G (successors to other organizations) and Sched-ule H (organizations providing scholarships, fellowships, education loans, etc.) must be attached when the appli-cant responds affirmatively to certain questions in Parts VII and VIII. Complete these schedules carefully to makesure the answers do not conflict with other information provided on Form 1023 or erroneously indicate the applicantorganization is involved in any activities that might jeopardize its exempt status.


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Safe Harbors for Organizations That Provide Low-income Housing

The IRS has provided safe harbor guidelines for organizations providing low-income housing. The guidelines areintended to significantly reduce the average processing time for exemption applications of these organizations. Anorganization must meet the following requirements to be considered charitable:

1. In eachproject, at least 75%of the unitsmust beoccupiedby low-income residents andeither 20%ormoremustbeoccupiedbyvery low-incomeresidents,orat least40%mustbeoccupiedby residentswith incomenot exceeding 120% of the area’s very low-income limit. (However, 25% of the units can be provided topersons with incomes in excess of the low-income limit.)

2. The project must actually be occupied by poor and distressed residents. A reasonable transition periodis allowed for projects requiring construction or rehabilitation.

3. The housing must be affordable to charitable beneficiaries.

4. A project with multiple buildings, where each building does not separately meet the safe harborrequirements, must share the same grounds.

The safe harbor rules are still met even if the organization retains the right to evict tenants for failure to pay rent orother misconduct, or to foreclose for loan default. In addition, the organization may still qualify without meeting thesafe harbor rules under the facts and circumstances test (e.g., a substantially greater percentage of residents thanrequired under the safe harbor with income up to 120% of the area’s very low-income limit). Also, it may qualifywithout meeting the safe harbor requirements if the purposes include combating community deterioration, lessen-ing the burdens of government and neighborhood tensions, and elimination of discrimination and prejudice.


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SELF-STUDY QUIZ


19. The Welles Fund (WF) is a nonprofit organization seeking exemption as a supporting organization under IRCSec. 509(a)(3). WF’s organizational document (1) limits it to operating exclusively for the benefit of a publiccharity, (2) does not empower the organization to engage in activities unrelated to its stated purpose, (3)specifies the public charity for which WF is operated, and (4) does not empower the organization to provideincome or services to any entities other than those specified in the document. Which of the following tests hasWF met?

a. The operational test.

b. The organizational test.

c. The relationship test.

d. The responsiveness test.

20. Under which of the following circumstances would a grant be considered unusual?

a. The amount comes from a disinterested party.

b. The amount helps the organization meet the public support test.

c. The amount matches that of most contributions to the organization.

d. It was attracted due to the publicly supported nature of the organization.

21. The following entities all provide low-income housing. Assuming all other qualifications are met, which onewould be considered charitable?

a. Rachel Arms Apartments rents 50% of its units to low-income families and an additional 5% to verylow-income residents.

b. Glendale Residences charges fair market value to rent the majority of the units on its property.

c. HampsteadHomes is a projectwithmultiplebuildingson the samegrounds, thoughnot all of thebuildingsmeet the safe harbor requirements.

d. Downtown Apartments planned to serve poor and distressed residents, but has not been able to fulfill thisgoal over five years.


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SELF-STUDY ANSWERS


19. The Welles Fund (WF) is a nonprofit organization seeking exemption as a supporting organization under IRCSec. 509(a)(3). WF’s organizational document (1) limits it to operating exclusively for the benefit of a publiccharity, (2) does not empower the organization to engage in activities unrelated to its stated purpose, (3)specifies the public charity for which WF is operated, and (4) does not empower the organization to provideincome or services to any entities other than those specified in the document. Which of the following tests hasWF met? (Page 212)

a. The operational test. [This answer is incorrect. A supporting organization must satisfy an operational testby operating exclusively for the benefit of, to perform the function of, or to carry out the purposes of, oneor more public charities. According to Reg. 1.509(a)-4(e), a supporting organization operates exclusivelyto support a public charity only if it engages solely in activities that support or benefit the organization. Thecharacteristics of WF’s organizational document seem to further that goal, but it does not pass theoperational test based on its organizational document.WF’s actual activitieswould need to be consideredfor the operational test.]

b. The organizational test. [This answer is correct. An organization seeing exemption as a supportingorganization under IRC Sec. 509(a)(3), like WF, must satisfy both an organizational and anoperational test. To satisfy the organizational test, a supporting organization must comply withcertain requirements in its articles of organization. As described above, WF meets thesequalifications, as listed in Reg. 1.509(a)-4(c). Therefore, WF has passed the organizational test.]

c. The relationship test. [This answer is incorrect. According toReg. 1.509(a)-4(f)(2), tomeet the relationshiptest, a supporting organization can be (1) operated, supervised, or controlled by a beneficiaryorganization; (2) supervised or controlled in connection with a beneficiary organization or (3) operated inconnectionwith one ormore beneficiary organization. This is different than the considerations listed in theabove scenario, so it is unknown at this time whether WF passes the relationship test.]

d. The responsiveness test. [This answer is incorrect. The responsiveness test is structured to give thebeneficiary organization the ability to influence the supporting organization, thereby ensuring it will beresponsive to the needs of the beneficiary organization. A supporting organization satisfies this test if itmeets both the relationship and significant voice requirements. However, this situation is different than theone described above, so it is unknown if WF would meet the responsiveness test.]

20. Under which of the following circumstances would a grant be considered unusual? (Page 219)

a. The amount comes from a disinterested party. [This answer is incorrect. According to the regulations,generally, a grant is deemedunusual if it is a substantial contribution or bequest fromadisinterested party.Therefore,while beingadisinterestedparty is important, that fact on its own is not enough to label thegrantunusual. The amount would have to be substantial, as well.]

b. The amount helps the organization meet the public support test. [This answer is incorrect. Per theregulations, a grant would be considered unusual if, by reason of its amount, it results in the organizationnot meeting the applicable public support test.]

c. Theamountmatches thatofmostcontributions to theorganization. [Thisanswer is incorrect.Agrantwouldbe considered unusual if it is unusual or unexpected with respect to amount, per the regulations.]

d. It was attracted due to the publicly supported nature of the organization. [This answer is correct.According to Regs. 1.170A-(9)(f)(6)(ii) and 1.509(a)-3(c)(3), one of the circumstances under whicha grant could be deemed unusual is if it was attracted by reason of the publicly supported natureof the organization.]


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21. The following entities all provide low-income housing. Assuming all other qualifications are met, which onewould be considered charitable? (Page 222)

a. Rachel Arms Apartments rents 50% of its units to low-income families and an additional 5% to verylow-income residents. [This answer is incorrect. To be considered charitable, Rachel Arms would need tohave at least 75%of its units occupiedby low-income residences andeither 20%ormoreoccupiedby verylow-income residences. Alternatively, at least 40% of the unitsmust be occupied by residents with incomenot exceeding 120% of the area’s very low-income limit.]

b. GlendaleResidencescharges fairmarket value to rent themajority of theunits on itsproperty. [This answeris incorrect. To be considered charitable, Glendale Residences would need to provide housing that isaffordable to charitable beneficiaries, which will likely be less than fair market value for the property.]

c. Hampstead Homes is a project with multiple buildings on the same grounds, though not all of thebuildingsmeet thesafeharbor requirements. [This answer is correct. According toRev. Proc. 96-32,one of the safe harbor guidelines providedby the IRS is that a project withmultiple buildings,whereeach building does not separately meet the safe harbor requirements, must share the samegrounds. Therefore, sinceHampsteadHomesmeets this qualification, assuming it met all the otherrequirements, it would be considered charitable.]

d. Downtown Apartments planned to serve poor and distressed residents, but has not been able to fulfill thisgoal over five years. [This answer is incorrect. While a reasonable transition period is allowed for projectsrequiring construction or rehabilitation (which is not mentioned in this scenario), to be consideredcharitable, the project must actually be occupied by poor and distressed residents. Since this is not thecase here, Downtown Apartments would not be considered charitable.]


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Lesson 4: Providing Financial DataIntroductionPart IX of Form 1023 [Application for Recognition of Exemption Under Section 501(c)(3) of the Internal RevenueCode] requests financial data concerning the organization’s actual or proposed operations.


Completion of this lesson will enable you to:¯ Identify thepurposeofPart IXofForm1023,applicable reportingperiods, theaccountingmethod,how to reportrevenues and expenses, how to list assets, how to classify liabilities, and how to report fund balances, netassets, and substantial balance sheet changes.

Part IX of Form 1023Part IX (Financial Data) of Form 1023must be completed by all organizations requesting recognition of their exemptstatus under IRC Sec. 501(c)(3). When completing the statement of revenue and expenses and balance sheet inthis section, it is important to consider how the IRS will use the information.

The primary purpose for the details of an organization’s sources of revenue is to provide backup for the IRS’scalculation of public support (for any organization claiming nonprivate foundation status as a publicly supportedorganization). The financial data should report contributions, gross receipts, and other income in the samecategories these amounts are reported for calculating public support. (Lesson 3 includes a discussion of the publicsupport tests.)

The IRS analyzes information provided about an organization’s expenditures and its balance sheet to ensure it isnot making disbursements that might preclude exempt status. Therefore, it is important that the details regardinguse of the organization’s financial resources support the description of its activities as stated in Part IV of Form 1023and that no disbursements are made for the benefit of a private individual. The IRS will also review the financialinformation to determine if an unrelated trade or business is being conducted by the organization.

Reporting PeriodsPart IX of Form 1023 requires the organization to provide a (1) statement of revenue and expenses and (2) balancesheet. The period covered by this financial information depends on the length of time the organization has existed.

Period Covered by Statement of Revenue and Expenses

The IRS uses Part IX, Section A (Statement of Revenue and Expenses), to analyze whether an organizationrequesting status as a publicly supported organization satisfies one of the public support tests (as discussed inLesson 3). For this reason, the information requested in Section Amust be completed for the current year and eachof the four immediately preceding tax years (public support is calculated based on a five-year test period). Theinformation should be provided on the basis of tax years, not 12-month periods. (Most organizations will have a firsttax year of less than 12 months.)

Existence of Less Than Five Years. An organization that has completed at least one but less than five tax years whenits application is filed must provide its actual income and expenses for each completed year (or years) andprojections of its likely income and expenses (based on a reasonable and good faith estimate) for the entire currentyear and two future years, if necessary, to show four years of financial information. If an organization has existed forless than one tax year, it must provide projections for the entire current year and the next two years, for a total ofthree years. Financial information for the year of filing should always be entered in column (a), the heading of whichis Current Tax Year.

Existence of Five or More Years. An organization that has completed five or more taxable years when its applicationis filed must provide income and expenses for the most recent five years. A separate schedule must be attachedbecause the data table in Part IX has not been updated for a fifth year.


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Example 4B-1 Period covered by Section A of Part IX, Form 1023, when an organization has not yetcompleted one tax year.

The Dakota Fund (Dakota) is an organization applying for exempt status as a Section 501(c)(3) organizationand claiming nonprivate foundation status under IRC Sec. 170(b)(1)(A)(vi). Dakota was formed on Janu-ary 18, 2018, and adopted a calendar year-end. Form 1023 for Dakota will be filed on December 16, 2018.Since Dakota will not have completed a full tax year, projected information must be provided for the currentyear from January 18 through December 31, and proposed budgets must be provided for the next two taxyears (calendar years 2019 and 2020). Revenues and expenses for the current year are included in column(a). Proposed budgets for 2019 and 2020 are included in columns (b) and (c), respectively. Each columnheading should designate, in the space provided, the period covered by the financial information in thatcolumn. If the information provided is a proposed budget, indicate “Projected” beneath the designated yearin the column heading.

Example 4B-2 Period covered by Section A when an organization has completed at least one taxyear but less than five years.

Assume the same facts as Example 4B-1 except that Dakota was formed on June 1, 2017, and Form 1023 isbeing filed on June 28, 2018. Dakota has been in existence for more than one tax year but less than five years.Therefore, Dakota must provide its actual income and expenses for the completed tax year (June 1–Decem-ber 31, 2017) and projections of its likely income and expenses for calendar years 2018, 2019, and 2020.

Period Covered by Balance Sheet

The instructions to Part IX indicate the balance sheet presented in Section B of Part IX should be prepared for theorganization’s most recently completed tax year. If the organization has not completed a full tax year, it must “usethe most current information available.” Presumably the most current information is used to project year-end data,since the instructions specify that the year-end date, rather than the date the form is prepared, must be entered inthe space provided.

Example 4B-3 Period covered by Section B of Part IX, Form 1023.

Assume the same facts as in Example 4B-2. Since Dakota’s last (and only completed) tax year ended onDecember 31, 2017, the balance sheet date should be December 31, 2017.

Accounting Method

The financial information presented in Part IX of Form 1023 should reflect the method of accounting the organiza-tion uses for keeping its books and records. However, if the organization uses a method other than the cashreceipts and disbursements method, a statement should be attached to Form 1023 explaining the method used.

Reporting Revenues

The accuracy of the revenue information provided in Part IX of Form 1023 is important for all exempt organizations,but particularly for an organization claiming status as a publicly supported organization. The IRS uses this informa-tion to determine if the organization satisfies at least one of the public support tests. (Lesson 3 included adiscussion of the public support tests.)

Line-by-line Analysis

This discussion provides a line-by-line analysis of the revenue portion of Form 1023, Part IX, Section A (Statementof Revenue and Expenses).

Line 1—Gifts, Grants, and Contributions Received. Report money and property transferred to the organizationwithout adequate consideration. (Unusual grants are included on line 12 rather than line 1. See Lesson 3 for adiscussion of what is considered a gift, grant, or contribution and for the definition of an unusual grant.) Property isincluded on line 1 at its fair market value (FMV) or rental value on the date of contribution.


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Amounts received from the general public (such as receipts from admission to a facility operated by the organiza-tion or fees for services) or a governmental unit for the exercise or performance of the organization’s exemptfunction are not included on line 1. Instead, these amounts are included on line 9 as gross receipts. [Such amountsare included in the definition of public support under IRC Sec. 509(a)(2), but not under IRC Sec. 170(b)(1)(A)(vi).]

The value of services or facilities donated to the organization is not reported on line 1. However, if the items weredonated by a governmental unit, their value may be reported on line 6.

Example 4D-1 Reporting contributions, gifts, and grants.

Benevolent Charities, Inc. (BCI), is applying for exempt status recognition as a Section 501(c)(3) organization.BCI has elected a calendar year-end and maintains its books and records using the cash method of account-ing. The financial data provided in BCI’s Form 1023, Part IX covers the current period from March 2, 2017(date of incorporation) through December 31, 2017, and projected amounts for tax years 2018, 2019, and2020. BCI has recorded on its books the following amounts received for the period March 2–December 31,2017:

Description Amount

Contributions from the general public $ 125,000Proceeds of fundraising symphony concert 10,000Proceeds of television solicitation 15,000Contribution of residential property (FMV) 150,000Contribution from United Fund (a public charity) 250,000

Total amount received $ 550,000

The fundraising concert sold 200 tickets at $50 each. Tickets for a regular (nonfundraising) symphony concertsell for $30 each. The television solicitation resulted in 500 donations of various dollar amounts. Threehundred contributors made a contribution of $40 or more and received a T-shirt bearing the BCI logo with aFMV of $8 and a cost to BCI of $4.

BCI expects to hold the fundraising concert annually with approximately 200 tickets sold each year. Contribu-tions from the general public and television solicitations are expected to increase 10% each year (based onannualized 2017 amounts). BCI has received a commitment from the United Fund for a contribution of$125,000 in 2018, 2019, and 2020, and it received a personal residence from a supporter who died in 2017.A report of BCI’s actual and projected contributions, gifts, and grants on Part IX, Section A, are as follows:

DescriptionCurrentYear

Projected2018

Projected2019

Projected2020

Contributions from the general public $ 125,000 $ 165,000a $ 181,500 $ 199,650Proceeds of fundraising concertb 4,000 4,000 4,000 4,000Proceeds of television solicitation 15,000 19,800 21,780c 23,960Contribution from United Fund 250,000 125,000 125,000 125,000

Total gifts, grants, and contributions (PartIX, line 1) $ 394,000 $ 313,800 $ 332,280 $ 352,610

Notes:

a $125,000 × 12/10 × 110% = $165,000.

b The proceeds of the fundraising concert are partially included as contributions on line 1 and asgross receipts on line 9. The portion of each ticket sale treated as a contribution is the amount bywhich the cost of a ticket ($50) exceeds the value of the benefit received ($30), or $20 per ticket.Thus, in each of years 2017, 2018, 2019, and 2020 BCI should include $4,000 of the proceedsfrom the fundraising concert as contributions.


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c ($15,000 × 12/10 × 110%) × 110% = $21,780.

The bequest of the personal residence received by BCI in 2017 is not included as a contribution. Instead, itqualifies as an unusual grant reportable on line 12. (See the discussion of unusual grants in Lesson 3.)

Part IX has not not been revised to reflect the requirement for four total years when the organization has beenin existence for less than five years.

Line 2—Membership Fees Received. Report amounts received from the organization’s members paid to providesupport for the organization. Amounts paid to purchase admissions, merchandise, or services provided by theorganization (rather than merely to provide support) are included on line 9 as gross receipts. [Such amounts areincluded in the definition of public support for IRC Sec. 509(a)(2), but not IRC Sec. 170(b)(1)(A)(vi).] (See Lesson3 for a discussion of the difference between membership fees and payments by members that are treated as grossreceipts.)

Example 4D-2 Reporting membership fees treated as contributions.

The Bluff City Symphony solicits funds by accepting members into the symphony society in return for annualdues of $150. Society members can purchase season tickets and select the location of their seats beforeseason tickets are sold to the general public. Society members do not receive any discount on season ticketsor any other benefits. Since the members receive no significant benefits from their memberships, the totalamount received is treated as membership fees (not contributions) and is reported on line 2.

Line 3—Gross Investment Income. Include income received from dividends, interest, rents, royalties, and loaningsecurities to the extent such revenue is not included in the calculation of unrelated business income (UBI).

Line 4—Net Unrelated Business Income. Report net amounts received by the organization from an unrelated tradeor business activity. This amount should match Form 990-T, if one is filed.

Line 5—Taxes Levied for the Benefit of the Organization. Report amounts collected by local taxing authorities fromthe general public and allocated for the organization’s use. Include amounts paid to or spent on behalf of theorganization. An example of this type of revenue is a hospital’s allocated portion of county hospital taxes. Taxrevenues collected for the benefit of an organization are included in the definitions of total support and publicsupport under each of the support tests as discussed in Lesson 3.

Line 6—Services or Facilities Furnished by a Governmental Unit. Include the FMV (at date furnished) of services orfacilities furnished by a governmental unit directly for the organization without charge. Do not include the value ofpolice or fire protection or other government services or facilities that are normally available to the general publicwithout charge. The value of services or facilities reported on this line is included in the definitions of total supportand public support under each of the support tests.

Line 7—Other Revenue. Any revenue not reported on lines 1–6 or line 9, 11, or 12 should be included on line 7.Attach a statement to Form 1023 listing each type of revenue included on this line and the amount and source ofsuch revenue. An example is interest received on loans to officers, directors, trustees, or employees.

Line 9—Gross Receipts from Exempt Function Activities. Include any revenue generated by the organization’sexempt function activities (such as admission fees, sales of merchandise, and fees for services) and nontaxablefundraising events (excluding any contributions received), such as raffles, bingo, and income-producing activitiesthat are not regularly carried on. Also include revenue from activities that are unrelated to the organization’s exemptfunction but that are not treated as an unrelated business activity because of a statutory exclusion. Thus, revenuefrom an unrelated activity in which substantially all (generally 85% or more) of the work in the activity is conductedby volunteers is included on line 9. Also included on line 9 is revenue from an unrelated activity involving the saleof merchandise, substantially all of which was received by the organization as a donation and revenue from anactivity conducted primarily for the convenience of the organization’s members, students, patients, officers, oremployees. A “grant” from a governmental unit should also be included on line 9 if the grant was actually thepayment for a service or facility for the use of the governmental payer, rather than for the direct benefit of the public.


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Amounts included on line 9 will be the same as amounts treated as “gross receipts” for calculating public supportunder IRC Sec. 509(a)(2). [Gross receipts are not treated as public support under the support test of IRC Sec.170(b)(1)(A)(vi).]

Example 4D-3 Reporting gross receipts from exempt function activities.

Assume the same facts as in Example 4D-1. BCI also operates a small factory to provide job training fordisabled citizens of the community. BCI manufactures brooms and mops that are sold through area mer-chants. The factory operation had gross receipts of $10,000 for the period fromMarch 2–December 31, 2017.BCI expects the gross receipts from the factory to remain constant in future years.

Assuming the operation of the factory is related to the performance of BCI’s charitable purposes, the grossreceipts from the manufacturing operation are reported on line 9 rather than as unrelated trade or businessincome. BCI will also report the proceeds of ticket sales for the fundraising concert (see Example 4D-1) on thisline to the extent of the FMV of the benefit provided (200 tickets× $30/ticket = $6,000). Form 1023 for BCI willreflect gross receipts of $16,000 for the current period and gross receipts of $18,000 [($10,000 × 12/10) +$6,000] in 2018, 2019, and 2020.

Line 11—Net Gain or Loss on Sale of Capital Assets. This line includes any gain or loss realized from the sale of acapital asset. Such amounts are not included in total support or public support under any of the support testcalculations described in Lesson 3. Organizations recognizing gains or losses on the sale of capital assets mustattach a schedule to the application.

Total amounts should be entered for each category, rather than the amount for each individual transaction.

When determining gain or loss from the sale of a capital asset, the organization’s basis in the asset and anyexpenses of sale (e.g., broker commissions) are deducted from the gross proceeds.

Line 12—Unusual Grants. Unusual grants generally are substantial contributions or bequests from disinterested orunrelated persons that are unexpected and unusual in amount. Unusual grants must be fully described in Part X,line 7. (See Lesson 3 for a discussion of unusual grants.)

Reporting Expenses

Expenses

The expense information provided on Form 1023, Part IX gives the IRS insight into whether amounts are being, orwill be, expended for a purpose that jeopardizes the organization’s exemption application. This discussion pro-vides a line-by-line discussion of expenses reported in Part IX, Section A.

Line 14—Fundraising Expenses. Report all expenses incurred in soliciting contributions, gifts, and grants includedon line 1. Report expenses on this line consistent with the information provided on Form 1023, Part VIII, line 4,where the organization describes its fundraising activities. Examples of items reported on line 14 include (1)amounts paid to professional fundraisers, (2) solicitation campaign expenses conducted by mail or telephone(such as printing, postage, and telephone costs), (3) amounts spent for fundraising events such as parties orspecial concerts (including publicity and catering expenses), (4) professional fees paid for planning events oradvertising to solicit support, (5) the costs of collecting pledged amounts, and (6) any other amounts expended toraise funds for the organization, including joint costs allocated to fundraising from a combined educationalcampaign and fundraising solicitation. If the organization allocates a portion of other expenses to fundraising, anitemized list describing the amounts allocated must be attached.

Example 4E-1 Reporting fundraising expenses.

Assume the same facts as in Example 4D-1. As part of its television solicitation campaign, BCI incurs the costof providing T-shirts to individuals making contributions of $40 or more (300 are given away at a cost of $4each). The $1,200 (300× $4) spent on the T-shirt giveaway is reported as a fundraising expense on line 14 of


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Section A, Part IX, for the current period. Projected 2018, 2019, and 2020 fundraising expenses are $1,584($1,200 × 12/10 × 110%), $1,742 ($1,584 × 110%), and $1,916 ($1,742 × 110%), respectively.

Line 15—Contributions, Gifts, and Grants Paid. Include any contributions, gifts, or grants paid to individuals,for-profit entities, or nonprofit organizations. Attach a detailed schedule showing the name of each recipient; a briefdescription of the purposes or conditions of payment; and the amount paid to each recipient. The IRS may reviewamounts paid to disqualified persons or payments for any purpose other than the organization’s exempt purposes.

Colleges and universities, and other educational institutions and agencies subject to the Family Educational Rightsand Privacy Act need not list the names of individuals who were provided scholarships or other financial assistanceif such disclosure would violate the privacy provisions of the law. Instead, such organizations should group eachtype of financial aid provided, indicate the number of individuals who received the aid, and specify the aggregatedollar amount.

Example 4E-2 Reporting contributions, gifts, and grants paid.

BCI (see Example 4D-1) paid $40,000 in contributions, gifts, and grants during its first 10 months of opera-tions. BCI reports the total amount paid on line 15, column (a) of Part IX, Section A. BCI also must attach aschedule to the application describing the recipients, purpose, and amount of the payment. Since theamounts listed on line 15, columns (b), (c), and (d) of Part IX, Section A, represent estimated amounts forwhich the recipients have not yet been identified, the detail schedule does not provide any information for thethree tax years with proposed budgets.

Line 16—Disbursements to or for the Benefit of Members. Include any amounts paid to or for the benefit ofmembers. Attach a detailed schedule showing the name of each member receiving benefits, a brief description ofthe benefits received, and the amount paid to or on behalf of each member. This information:

1. permits the IRS to determine if the payments are for the direct benefit of themembers rather than for publicbenefit, and

2. indicates whether the organization provides goods or services to members in return for their membershipfees. [Doing so would result in the “membership fees” being excluded from the calculation of publicsupport for organizations seeking nonprivate foundation status under IRC Sec. 170(b)(1)(A)(vi).]

Provide information on line 16 consistent with the information concerning member benefits included in Part VI ofForm 1023.

Line 17—Compensation of Officers, Directors, and Trustees. Report the total amount of compensation paid toofficers, directors, and trustees. Report amounts in column (a) consistent with the amounts shown on Form 1023,Part V, lines 1a, 1b, and 1c.

Example 4E-3 Reporting officers’ and directors’ compensation.

During its current calendar tax year, Drug-Free Haven (DFH) paid the following compensation to its officersand directors (who started at different times during the year) between March 1 (date of incorporation) andDecember 31:

Name TitleWages orDirector Fees

TaxableAuto

AllowanceTotal

Compensation

Compensationon an

Annual Basis

George Jones President $ 50,000 $ 4,000 $ 54,000 $ 67,000Merle Nelson Vice Pres. 22,000 500 22,500 30,000Tammy Tucker Director 850 — 850 1,310James Jones Director 935 — 935 1,403Jonathan Jensen Director 740 — 740 987

$ 74,525 $ 4,500 $ 79,025 $ 100,700


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DFH reports $79,025 ($74,525 + $4,500) on line 17, column (a), which is the amount paid or incurred duringthe current 10-month period.

Line 18—Other Salaries andWages. Include salaries that are not reported on line 17. The instructions to Form 1023do not indicate whether employee benefits should also be included on this line. However, if the inclusion of benefitsis intended, presumably the line caption would be “other compensation,” rather than “other salaries and wages.”Therefore, this course recommends reporting the costs of benefits on line 23 rather than line 18. If, however, anorganization includes benefits on line 18, a footnote to this line should indicate what portion of the amount is salaryversus other benefits.

Line 19—Interest Expense. Include all interest paid for the year, except for mortgage interest treated as occupancyexpense on line 20. To avoid unnecessary IRS inquiries when the amount reported as interest expense on this lineis substantial, consider including a schedule detailing the interest paid.

Line 20—Occupancy Expenses. Include any amounts paid by the organization for its facilities, such as paymentsfor rent, utilities, outside janitorial services, repairs, landscaping, real estate taxes, mortgage interest, and any otherexpenses related to occupancy.

Line 21—Depreciation and Depletion. Report any depreciation or depletion recorded by the organization on itsbooks.

Line 22—Professional Fees. Report fees paid to individuals and entities that are not the organization’s employees(e.g., fees for accounting services, legal counsel, consulting services, and contract management).

Line 23—Other Expenses. The instructions to Form 1023 indicate that a statement should be attached to theapplication detailing the type and amount of each significant expense for which a separate line is not provided inthe statement of revenue and expense. All expenses that are not significant can be reported on the statement as asingle total. Determining which “other expense” categories are significant involves choosing a dollar amount that,based on the total amount of expenses incurred, seems significant. For example, an organization with normalannual expenses of $100,000 may determine that all expense categories with annual totals in excess of $1,000 aresignificant and should be separately listed. However, an organization with normal annual expenses of $5,000 maydetermine that all expense categories with annual totals in excess of $250 are significant.

Example 4E-4 Reporting expenses incurred from the organization’s exempt function.

Assume the same facts as in Example 4D-1. The expenses associated with BCI’s operation of the broom andmop factory during the period March 2–December 31, 2017, are as follows:

Description Amount

Director’s salary $ 12,000Salaries to disabled workers 30,000Utilities 10,000Materials and supplies 8,000

Total expenses $ 60,000

Since BCI’s gross income from activities carried on in furtherance of its exempt purpose (operation of thefactory) is reported on line 9, the costs of conducting those activities are reported on lines 17–23 of Section A.

Assets

Balance Sheet

Section B of Form 1023, Part IX, is a balance sheet detailing the organization’s assets, liabilities, and fund balancesor net assets. The balances provided are as of the last day of the most recently completed tax year. If theorganization has not completed a full tax year, the most current information available should be used. This


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information is generally used by the IRS to determine whether an unrelated trade or business is being carried onthat is not being reported, and to help determine if the organization has any loans receivable that might jeopardizeits exempt status (or result in the assessment of an excise tax on a private foundation).

Example 4F-1 IRS use of Part IX to identify assets used in an unrelated trade or business.

Charitable Hospital is applying for exempt status. It reports ownership of land and four apartment buildingswith a basis of $10 million and mortgages of $5 million on line 7 (Other investments) of Section B of Part IX ofForm 1023. (Completion of line 7 is discussed later in this lesson.) Because the buildings are debt-financed,the IRS may conclude that the hospital is engaged in an unrelated trade or business and thus subject to thetax on unrelated trade or business income and required to file a Form 990-T.

Line-by-line Analysis

The remainder of this discussion provides a line-by-line discussion of the assets section of the balance sheet.

Line 1—Cash. The instructions to Section B indicate that line 1 includes the balances in checking and savingsaccounts, money market funds, certificates of deposit (CDs), treasury bills, other obligations that mature in lessthan one year, and petty cash funds.

Line 2—Accounts Receivable. Report accounts receivable arising from the sale of goods or the performance ofservices (less any reserve for bad debts). Report receivables arising from other sources on line 4 as bonds andnotes receivable or on line 10 as other assets. Related discussion of accounts payable appears later in this lesson.

Line 3—Inventories. Include the amount of materials, goods, and supplies donated to, purchased by, or manufac-tured by the organization and held to be sold or used in a future period. Report the dollar value of inventorycomputed based on the valuation method used for book purposes on this line. Examples of items that might beincluded in inventory are items held for sale in a gift shop operated by a museum or medical supplies held for useby a clinic or hospital. The definition of used for this purpose implies that items will be “consumed” in carrying outthe organization’s exempt purpose. Thus, for example, artworks owned by a museum and held for public viewingare not inventory since they are not consumed in carrying out the museum’s exempt purpose. Instead, report theartwork as “Other assets” on line 10 of the balance sheet.

Line 4—Bonds and Notes Receivable. Include bonds and notes receivable held by the organization. Notesreceivable should be evidenced by a written note between the organization and the borrower. Attach a scheduledetailing the amount reported on this line. The schedule should include the name of the borrower, a brief descrip-tion of the obligation, including its interest rate, due date, and the amount due. Best practices suggest that anyrelationship between the borrower and the applicant organization, as well as the reason for the related party loan,be disclosed on this schedule.

Line 5—Corporate Stocks. Report the dollar value of the organization’s stock holdings on line 5. Attach a scheduledetailing the organization’s holdings, as follows:

1. The name of the corporation.

2. For an investment in a closely held corporation (i.e., a corporation whose stock is held by a small numberof shareholders and is not traded on an established market), a brief summary of the corporation’s capitalstructure.

3. For an investment in stocks that are traded on an organized exchange or in substantial quantities in theover-the-counter market, a description of the stock and the principal exchange on which it is traded.

4. The number of shares held.

5. The value of the stock as reflected on the books of the organization. If this value does not reflect currentmarket value, the fair market value (FMV) of the stock should also be included.


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Example 4F-2 Reporting investments in corporate stocks.

Assume the same facts as in Example 4D-1. BCI’s assets include investments in the stock of several corpora-tions. The investments in corporate stocks are carried on the books at FMV. As of December 31, 2017, BCI’sstock holdings included the following:

1. 50 shares of Smith Corp., a corporation that is not traded on an established market and whose stock isowned almost entirely by members of the Smith family. (BCI acquired its shares from a Smith familymember upon his death.) The stock has a FMV of $20 per share.

2. 150 shares of BBM Corp. common stock traded on the New York Stock Exchange. The stock has a FMVof $52 per share.

3. 100 shares of ZedcoCorp. common stock traded on the NASDAQ. The stock has a FMV of $35 per share.

All of BCI’s holdings are summarized on line 5 of Section B of Part IX and reported on an attachment to Form1023.

Line 6—Loans Receivable. Include any loans (personal and mortgage) made by the organization. For each loan,attach a schedule indicating the borrower’s name, the purpose of the loan, the repayment terms, the interest rate,the original amount of the loan, and the balance due at year end. This line is typically completed by organizationsproviding low-income housing loans. (See Lesson 3 for a discussion on the guidelines for low-income housingorganizations.)

Line 7—Other Investments. Report any investments that are not included on line 1, 4, 5, or 6. Typically, this lineincludes investments in federal, state, or municipal bonds; mutual funds; real estate; and personal property (suchas coins or art) held for investment. Attach a schedule identifying each asset included on this line and its bookvalue.

Line 8—Depreciable and Depletable Assets. Report the book value of buildings and equipment used by theorganization for its exempt purposes or in an unrelated trade or business. (Buildings and equipment held asinvestments are reported on line 7.) Attach a schedule listing each depreciable asset, its original cost or other basis,accumulated depreciation, and net book value at the close of the current tax year/period.

The net book value of certain depletable assets (e.g., the leasehold costs of an oil and gas working interest) is alsoreported on line 8 if the organization uses those assets in an unrelated trade or business. (The book value of oil andgas royalty interests is reported as investments on line 7.)

Example 4F-3 Reporting investments in buildings and equipment.

Assume the same facts as in Example 4D-1. BCI owns the following buildings and equipment:

1. An office building carried on the books at a cost of $100,000 and used to house the offices of BCI.Accumulated depreciation of $2,085 has been recorded through December 31, 2017.

2. An office/warehouse building carried on the books at a cost of $75,000 that houses BCI’s manufacturingoperations. Accumulated depreciation of $1,560 has been recorded through December 31, 2017.

3. Equipment used in the manufacturing operation carried on the books at a cost of $40,000. Accumulateddepreciation of $4,285 has been recorded through December 31, 2017.

4. A residential property acquired by BCI as a bequest, which is currently being held as an investment andcarried on the books at a value of $150,000.

The residential property (item 4) held by BCI is not included in the amount reported on line 8. Instead, it isreported on line 7 of Section B as an investment. Since the office building, office/warehouse building, andequipment (items 1, 2, and 3) are all used to accomplish BCI’s exempt purpose, they are reported on line 8 attheir net book value (i.e., cost less accumulated depreciation).


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Line 9—Land. Report the book value of land that is not held for investment by the organization. For example, reportthe land owned by a museum on which the museum facilities are located on this line. Report land held forinvestment on line 7.

Line 10—Other Assets. Include any category of assets not reported in lines 1 through 9 on line 10. Attach aschedule detailing the book value of each category of other assets. Examples of assets that might be reported onthis line are receivables from employees, other loans not evidenced by a note, assets other than land or deprecia-ble assets used for the organization’s exempt purpose (such as artwork exhibited in a museum), intangible assets(such as patents and copyrights), and claims against vendors.

Liabilities

Liabilities

Lines 12–15 of Form 1023, Part IX, Section B, provide information about the organization’s liabilities. The balancesentered are those at the end of the most recently completed tax year. If the organization has not completed a full taxyear, the most current information available should be used. The following discussion provides a line-by-linedescription of the liability section of the balance sheet reported in Part IX, Section B.

Line 12—Accounts Payable. For organizations using the accrual method of accounting, include all payables tosuppliers and others, as well as any accrued expenses. Also include accrued salaries, payroll taxes, and interestexpense. Normally, entities using the cash method of accounting will not have an entry on this line. (However,payroll taxes withheld from employees’ pay are an accrued payable for cash-basis taxpayers.)

Line 13—Contributions, Gifts, Grants, etc., Payable. Include any contributions or grants the organization is obli-gated to make in future years. An example of this type of liability would be the last three years of a four-yearscholarship awarded to a college student whose freshman year is the organization’s current year. Although anorganization using the cash method of accounting will normally not have an entry on this line, consider attaching aschedule to the application describing any commitments to provide future grants or contributions.

Line 14—Mortgages and Notes Payable. Report the dollar amount of all mortgages and notes payable owed by theorganization. Each of these liabilities should be evidenced by a written document. For each mortgage or notepayable, attach a separate schedule to the application detailing the lender’s name, the purpose of the loan, therepayment terms of the loan, the rate of interest, the original amount of the loan, and the balance at year-end. It isa best practice to also disclose any relationship between the organization and a lender (and the reason for therelated party loan) on this schedule.

Line 15—Other Liabilities. Include on this line any liability not reported on lines 12–14. Examples of such liabilitiesinclude (1) loans from officers, directors, and other employees and (2) contributions received but designated foruse in future periods by the grantor. Submit an itemized list of these liabilities, including the amounts owed.

Fund Balances and Net Assets

Organizations Using Fund Accounting

Fund accounting is a method of maintaining an organization’s books and records in which its assets, liabilities, andequity are segregated into several different funds. Each fund has its own assets, liabilities, revenues, expenses, andequity (or fund balance). An applicant organization using fund accounting reports the total of all fund balances online 17 of Part IX, Section B, Form 1023.

Organizations Not Using Fund Accounting

An organization that does not use fund accounting enters the amount representing its “net assets” (assets minusliabilities) on line 17 of Part IX, Section B, Form 1023. A corporation’s net assets equal the sum of its capital stock,paid-in or capital surplus, retained earnings, and endowment funds. A trust’s net assets are equal to the balance ofits principal.


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Example 4H-1 Reporting equity accounts when fund accounting is not used.

BCI does not use fund accounting. The total par value of its outstanding stock is $30,000, and there is nopaid-in surplus. BCI’s retained earnings are $462,116. Since BCI does not use fund accounting, the net assetsreported on line 17 include the balance in its capital accounts—common stock, paid-in surplus, and retainedearnings. The net assets reported on line 17 of BCI’s Section B should equal $492,116, which is the sum of itscommon stock and retained earnings.

Substantial Balance Sheet Changes

If there has been a substantial change in the organization’s assets or liabilities since the balance sheet date (i.e.,since the end of the most recently completed tax year), answer line 19 of Part IX affirmatively. Attach a statementthat describes the change(s) and explains the cause(s).

The purpose of line 19 is to require the disclosure of any subsequent event that could impact the organization’squalification for exemption or cause concern about its ability to satisfy one of the public support tests.


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SELF-STUDY QUIZ


22. What is the purpose of Part IX of Form 1023?

a. Providing information about contributions subject to the 2% limit.

b. Providing the organization’s financial data to the IRS.

c. Indicating whether the organization seeks exemption as a supporting organization.

d. Indicating that the organization has an appropriate dissolution provision.

23. Where should an organization provide information about its expenses on Form 1023?

a. Part IX, Section A.

b. Part IX, Section B.

c. In a separate statement attached to the form.

d. In a separate schedule attached to the form.

24. Which of the following nonprofit organizations has correctly provided information about its liabilities on Part IXof Form 1023?

a. TheRedOrganization provides a brief summary ofmortgages and notes payable on line 14 so the IRS canrequest more information from the lender, if needed.

b. The Blue Organization submits an itemized list of all the liabilities reported on line 15 along with itsapplication.

c. The Green Organization, which uses the accrual method of accounting, records contributions from thecurrent year on line 13.

d. The Yellow Organization, which uses the cash method of accounting, records payables and accruedexpenses on line 12.


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SELF-STUDY ANSWERS


22. What is the purpose of Part IX of Form 1023? (Page 227)

a. Providing information about contributions subject to the 2% limit. [This answer is incorrect. Onlyorganizations seeking public charity status under IRC Sec. 170(b)(1)(A)(vi) must complete line 6a of PartX (not Part IX) for Form 1023.]

b. Providing theorganization’s financialdata to the IRS. [Thisanswer iscorrect.Part IX (FinancialData)of Form 1023must be completed by all organizations requesting recognition of their exempt statusunder IRC Sec. 501(c)(3). The primary purpose for the details of an organization’s sources ofrevenue is to provide backup for the IRS’s calculation of public support (for any organizationclaiming nonprivate foundation status as a publicly supported organization). Therefore, thefinancial data should report contributions, gross receipts, and other income in the same categoriesthese amounts are reported for calculating public support.]

c. Indicating whether the organization seeks exemption as a supporting organization. [This answer isincorrect. An organization seeking exemption as a supporting organization under IRC Sec. 509(a)(3)checks the box on line 5d, Part X (not Part IX) for Form 1023.]

d. Indicating that the organization has an appropriate dissolution provision. [This answer is incorrect. Thisoccurs on line 7 of Part II of Form 1023-EZ (Not Part IX of Form 1023). Organizations check the box on thisline to attest that the applicant’s organizing document provides that upon dissolution, any remainingassets will be used exclusively for IRC Sec. 501(c)(3) purposes.]

23. Where should an organization provide information about its expenses on Form 1023? (Page 231)

a. Part IX, Section A. [This answer is correct. The expense information provided on Form 1023, PartIX, gives the IRS insight into whether the amounts are being, or will be, expended for a purpose thatjeopardizes the organization’s exemption application. This information is provided in Section A ofPart IX.]

b. Part IX, Section B. [This answer is incorrect. Section B of Form 1023, Part IX, is a balance sheet detailingthe organization’s assets, liabilities, and fund balances or net assets.]

c. In a separate statement attached to the form. [This answer is incorrect. The financial informationpresentedinPart IX of Form1023 should reflect themethodof accounting the organization uses for keeping its booksand records. However, if the organization uses a method other than the cash receipts and disbursementsmethod, a statement should be attached to Form 1023 explaining the method used. Information aboutexpenses would not exclusively be in such a statement.]

d. Ina separate scheduleattached to the form. [Thisanswer is incorrect. Itemssuchascorporate stocksmustbe reported on Form 1023 and included in a separate, attached schedule. However, expense informationwould not solely be included on an attached schedule.]


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24. Which of the following nonprofit organizations has correctly provided information about its liabilities on Part IXof Form 1023? (Page 236)

a. TheRedOrganization provides a brief summary ofmortgages and notes payable on line 14 so the IRS canrequestmore information from the lender, if needed. [This answer is incorrect. On line 14, the organizationshould report the dollar amount of all of its mortgages and notes payable. Each of these liabilities shouldbe evidenced by a written document. For each mortgage or note payable, attach a separate schedule tothe application detailing the lender’s name, purpose of the loan, the repayment terms of the loan, the rateof interest, the original amount of the loan, and thebalance at year-end. Therefore, in this scenario, theRedOrganization has not disclosed enough information about this topic on Part IX of Form 1023.]

b. The Blue Organization submits an itemized list of all the liabilities reported on line 15 along with itsapplication. [This answer is correct. Any liability not reported on lines 12–14 should be reported online 15. Examples of such liabilities include (1) loans from officers, directors, and other employeesand (2) contributions received but designated for use in future periods by the grantor. Theorganization should submit an itemized list of these liabilities, including the amounts owed.Therefore, by providing this itemized list, the Blue Organization has correctly provided theinformation required for Part IX of Form 1023.]

c. The Green Organization, which uses the accrual method of accounting, records contributions from thecurrent year on line 13. [This answer is incorrect. Any contributions or grants an organization is requiredto make in future years are recorded on line 13. An example of this type of liability would be the last threeyears of a four-year scholarship awarded to a college student whose freshman year is the organization’scurrent year.Althoughanorganizationusing thecashmethodofaccountingwill not normallyhaveanentryon this line, they should consider attaching a schedule to the application describing any commitments toprovide future grants or contributions. Therefore, in this scenario, theGreenOrganizationhasnot reportedcontributions or grants from the appropriate time period on Part IX of Form 1023.]

d. The Yellow Organization, which uses the cash method of accounting, records payables and accruedexpenses on line 12. [This answer is incorrect. For organizations using the accrual method of accounting,all payables to suppliers and others, as well as any accrued expenses, should be recorded on line 12.Normally, entities using the cashmethodof accounting (like theYellowOrganization)will not have anentryon this line.]


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Companion to PPC’s 990 Deskbook—Course 2—Form 1023 (990TG182)










3. Each answer sheet sent for print grading must be accompanied by the appropriate payment ($95 for answersheets sent by email or fax; $105 for answer sheets sent by regular mail). Discounts apply for three or morecourses submitted for grading at the same time by a single participant. If you complete three courses, the pricefor grading all three is $271 (a 5% discount on all three courses). If you complete four courses, the price forgrading all four is $342 (a 10% discount on all four courses). Finally, if you complete five courses, the price for


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grading all five is $404 (a 15% discount on all five courses). The 15% discount also applies if more than fivecourses are submitted at the same time by the same participant. The $10 charge for sending answer sheets inthe regular mail is waived when a discount for multiple courses applies.





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1. Which of the following is a benefit of attaining tax-exempt status under IRC Sec. 501(c)(3)?

a. Paying a reduced amount of income tax.

b. Increased fundraising due to deductible contributions.

c. Exemption from paying interest on loans.

d. Free mail services through the United States postal system.

2. Heart & Souls (H&S) is a small nonprofit organization with a mission to help homeless children. It has been inexistence for three years. Tobe automatically exempt from income taxes,H&S’s total gross receipts for all threeyears cannot be higher than what amount?

a. $5,000.

b. $7,500.

c. $12,000.

d. $15,000.

3. H&S, a calendar-year organization, discovers that it has exceeded the gross receipts test on June 30, 2018.By what date must it file an exemption application or risk losing its tax exempt status?

a. September 28, 2018.

b. December 31, 2018.

c. March 31, 2019.

d. June 30, 2019.

4. Which of the following organizations must file an exemption application (Form 1023 or Form 1023-EZ) to berecognized as tax exempt?

a. The Animal Cruelty Prevention Association.

b. The Bluestown Teacher Retirement Fund.

c. Commonwealth Nonprofit Health Insurance.

d. Haven Bible Church.

5. A group exemption letter can cover which of the following?

a. A group of related exempt organizations.

b. A group of private foundations.

c. A subsidiary organized and operated in a foreign country.

d. The subsidiaries of an exempt organization.


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6. Under what circumstances might a group exemption letter be revoked or terminated for the whole group?

a. One subordinate no longer conforms to the requirements for inclusion in the exemption.

b. The central organization no longer qualifies for tax exemption under IRC Sec. 501(c).

c. More than one, but not all, subordinates fail to file Form 990 or be covered in a group filing.

d. The central organization has severe financial difficulties.

7. What is the general deadline for an organization’s exemption application?

a. Ninety days from the date its governing document is adopted.

b. Ninety days after the end of its first business year.

c. Twenty-seven months after it files its first Form 990.

d. Twenty-seven months from the end of the month in which it was formed.

8. Harvest Bounty files Form 1023 to request tax exemption. Three months later, the organization’s Form 990becomes due, but the IRS has not yet responded to Harvest Bounty’s Form 1023. How should Harvest Bountyproceed at this time?

a. It should hold its Form 990 until the IRS responds to Form 1023.

b. It should file Form 990 by its normal due date.

c. It should call the IRS and request a determination letter.

d. It should request expeditious handling of its Form 1023 via letter.

9. Coleman’s Kids is a tax-exempt organization. It received its exemption by filing Form 1023. The organizationis required to do which of the following?

a. Make a copy of its Form 1023 and other documents issued by the IRS available for public inspection.

b. Allow requestors to view copies of Form 1023 at the organization, but not provide them a personal copy.

c. Alert all donors to any previous attempts to gain tax-exempt status that were denied by the IRS.

d. Keep its Form 1023 and all related IRS documents confidential to preserve tax-exempt status.

10. Which of the following might cause an organization’s tax-exempt status to be revoked?

a. A ruling by the Tax Court.

b. A complaint of misconduct from a donor.

c. Failure to file annual returns.

d. Earning a profit from a business endeavor.


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11. Animal Advocates receives an adverse determination letter from the IRS regarding its tax-exempt status. Whatis the first avenue the organization should pursue?

a. File suit in a U.S. District Court.

b. File suit in the U.S. Tax Court.

c. Protest the decision through the IRS Appeals Office.

d. Seek a declaratory judgment.

12. How can an organization using an automatic tax exemption get listed in EO Select Check?

a. By confirming its tax-exempt status by requesting a determination letter.

b. By petitioning the IRS to add them to the online tool.

c. By filing a group exemption letter.

d. By filling out an online request form.

13. What pieces of information should be provided on lines 1–5 of Part I of Form 1023?

a. Line 1: full name of organization; Line 2: mailing address; Line 3: “in care of” name; Line 4: the last monthof the annual accounting period; Line 5: Employer Identification Number (EIN).

b. Line 1: “in care of” name; Line 2: full name of organization; Line 3: EIN; Line 4: mailing address; Line 5:last month of the annual accounting period.

c. Line 1: mailing address; Line 2: EIN; Line 3: full name of organization; Line 4: “in care of” name; Line 5:last month of the annual accounting period.

d. Line 1: full name of organization; Line 2: “in care of” name; Line 3: mailing address; Line 4: EIN; Line 5:the last month of the annual accounting period.

14. Part II of Form 1023 informs the IRS about what?

a. The applicant’s legal structure.

b. Whether the applicant met the organizational and operational tests.

c. How officers, directors, trustees, and organization employees are compensated.

d. General information about the applicant.

15. For an organization to qualify for Section 501(c)(3) exempt status under the organizational test, which of thefollowing must occur?

a. The organization must have a specific exempt purpose in certain categories, such as religious.

b. The organizing document must empower the organization to engage in a variety of purposes, includingthose that further its purpose.

c. The organizing document must allow the organization to participate in self-dealing and retain excessbusiness holdings.

d. The organizing document can allow net earnings to benefit private shareholders only if funding goals forits purpose have been met.


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16. ASection 501(c)(3) organization’s exempt purpose should dowhich of the following to pass the organizationaltest?

a. Limit its activities to those listed in IRC Sec. 501(c)(3).

b. Mention IRC Sec. 501(c)(3), as required by law.

c. Use permissible terminology from the statute, such as educational.

d. Be very specific in describing exactly what the organization does now.

17. Argyle Warmth is a nonprofit organization that provides socks, scarves, and hats to the homeless. If theorganizationshouldceaseoperations, itsorganizingdocumentprovides that any remainingassetswill beusedto further its exempt purpose. Argyle Warmth has satisfied which of the following?

a. The organizational test.

b. The dissolution test.

c. The operational test.

d. The cy pres doctrine.

18. Paying unreasonable compensation may do which of the following?

a. Indicate a family or business relationship between persons associated with the organization.

b. Save an organization from failing if its objective becomes impossible to fulfill.

c. Have its exemption revoked by the IRS because of unrelated business activities.

d. Hinder an organization from qualifying for tax exemption.

19. What is the best practice for dealing with a conflict of interest policy?

a. An organization must adopt one because it is required by the IRS as a condition for being tax exempt.

b. An organization does not need to adopt one because it is not required by the IRS.

c. While not required, adopting one is easier than convincing the IRS that the policy is unnecessary.

d. Though many organizations adopt them, they create unnecessary paperwork and should be avoided.

20. Is it permissible for a tax-exempt organization to place limitations onwho can receive its goods or services andstill retain its tax-exempt status?

a. Yes, it is within the right of any organization to place any limitations they choose on such recipients.

b. Yes, if the organization provides additional information with its Form 1023, it can have any limitations itchooses.

c. Yes,butonlynondiscriminatory limitationsareallowed if theproperadditional information issubmittedwithForm 1023.

d. No, placing any limitations on who can receive goods or services is prohibited if an organization wants tobe tax exempt.


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21. The Green Spaces organization is a successor to a different nonprofit organization called City ParkImprovements (CPI). Which of the following will Green Spaces need to report on Line 1 of Part VII of its Form1023?

a. Any activities it engages in that were not previously run by CPI.

b. The exact percentage of any CPI assets that it has taken over.

c. When CPI applied for nonprofit/tax-exempt status.

d. Any officers, directors, or trustees it has in common with CPI.

22. During the next year, the Hungry Animals Group plans to conduct three fundraising activities to further itsexempt purpose. Where should it indicate this on Part VIII of its Form 1023?

a. Line 3a.

b. Line 4a.

c. Line 7a.

d. It should not indicate these activities on Form 1023 because they have not yet occurred.

23. Julia contributes the rights to a song she wrote to Moms United, a nonprofit organization. What will her initialdeduction be for this contribution?

a. The lesser of her basis in the intellectual property or its fair market value.

b. The greater of the intellectual property’s fair market value or her basis in it.

c. The amount of net income the organization receives from the property during the first year.

d. A 12-year sliding scale of a percentage of the net income received by the organization that exceeds fairmarket value.

24. If anorganizationhasmore than fivepersonswhocouldbe listedonLine8ofPart I of Form1023-EZ,whowouldbe the first person listed?

a. The chairperson of the organization’s governing body.

b. The chief financial officer or treasurer.

c. Any officers, directors, or trustees who are substantial contributors.

d. The chief operating officer, chief executive officer, or president.

25. Which of the following is an exception that allows a Section 501(c)(3) organization to be classified as a publiccharity instead of a private foundation?

a. Being religious in nature.

b. Providing classes for the general public.

c. Providing medical care.

d. Receiving support from a grant.


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26. Due to Bill of Rights issues, the IRS uses core factors of certain instead of issuing regulations to determinewhether an organization meets the functional test to qualify as which of the following?

a. A church.

b. An educational organization.

c. A hospital.

d. An educational endowment fund.

27. Helpers United (HU) received $100,000 of support during the past year. When that total is broken down,$55,000 came from public donations during HU’s annual fundraising events; $30,000 came from a federalgrant; and the rest came from interest on HU’s holdings. HU qualifies as which of the following?

a. A public charity, because it passes the 331/3% test.

b. A private foundation, because it does not receive enough support from a governmental unit.

c. A private foundation, because it does not receive enough support from the general public.

d. A private foundation because it receives too much support from its own investments.

28. An organization’s support is tested for how many years when applying the 331/3% test?

a. The current year.

b. The current year and the years immediately preceding and succeeding.

c. The current year and two prior years.

d. The current year and four prior years.

29. If an organization fails tomeet the 331/3% test, itmay still qualify as a public charity usingwhichof the following?

a. The private foundation test.

b. The facts and circumstances test.

c. The more than one-third test.

d. The one-third or less test.

30. Assuming they are related to the organization’s exempt purpose, which of the following would be consideredpart of an organization’s total support for purposes of the more than one-third test?

a. Unusual grants.

b. Capital gains.

c. Loan repayments.

d. Membership fees.


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31. The Derby Fund (DF) is a nonprofit supporting organization. Every year, the organization distributes 90% of itsadjustednet income to itsbeneficiaryorganization.DF’sbeneficiaryorganization is attentive toDF’soperationsand DF meets the responsiveness tests for this beneficiary. DF qualifies as which of the following?

a. A Type III functionally integrated organization.

b. A Type III non-functionally integrated organization.

c. A governmental supported organization.

d. A private operating foundation.

32. Which of the following is an advantage enjoyed by Type III supporting organizations that are functionallyintegrated?

a. They are subject to the excess business holding rules.

b. Their annual payout requirements are lower.

c. Private foundations can classify grants to them as qualifying distributions.

d. They are exempt from the restrictions on prohibited persons.

33. Which of the following statements best describes the rules for unusual grants?

a. Unusual grants are excluded from the 331/3%,more than one-third test, and one-third or less tests, but theyare included in the 10% requirement for the facts and circumstances test.

b. The determination of whether a contribution is considered an unusual grant depends on specificrequirements in the regulations that are applied the same to all organizations.

c. It is unnecessary for anorganization topayauser feewhen requesting anadvance rulingabout anunusualgrant on Form 8940.

d. The ability to exclude unusual grants allows organizations more flexibility to retain public charity statuswhen they receive an unexpected donation.

34. Part X of Form 1023, lines 6 and 7, are used to report which of the following?

a. Additional information about sources of contributions to public charities that passed the public supporttests.

b. Whether the organization qualifies as a private operating foundation and information about when it will betreated as a public charity.

c. Whether the organization qualifies as a Type I, Type II, or Type III supporting organization and a list of allrelevant beneficiaries.

d. Additional information about any prohibited persons and their relationships with the public charity.

35. Memorial Hospital qualifies as a public charity because it passes the function test. Which schedule will it needto attach to its Form 1023?

a. Schedule A.

b. Schedule C.

c. Schedule F.

d. Schedule H.


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36. Safe Corners, a nonprofit organization, files a Form 1023 during its second year of existence. It must provideinformation on its revenues and expenses for how many years?

a. The current year of operations.

b. The current year and the previous year.

c. The current year, the previous year, and a projection of one future year.

d. The current year, the previous year, and a projection of two future years.

37. Whichof the followingwould beconsideredgross receipts fromexempt functionactivities and recordedon line9 of Section A of Form 1023?

a. Admission fees to an exempt function activity.

b. A grant used for direct benefit of the public.

c. Taxes levied on the organization’s behalf.

d. Income from dividends, interest, rents, and royalties.

38. What is one purpose of the detailed schedule about disbursements to or for the benefit of members that isincluded along with Part IX of Form 1023?

a. Helps the IRS determine whether the organization received any unusual grants.

b. Helps the IRS determine whether the organization complied with the Family Educational Rights andPrivacy Act.

c. Helps the organization determine whether payments are for the public’s benefit.

d. Indicates whether goods or services were provided in return for membership fees.

39. Which of the following statements best describes an aspect of how an organization’s assets are reflected onPart IX of Form 1023?

a. The value of any inventory held by the organization should be reported at its fair market value.

b. Buildings and equipment used as investments are reported on a different line from those used by theorganization for its exempt purpose.

c. If the organization has not completed a full tax year, it should report projections of financial information asof the end of the year.

d. A list of bonds and notes receivable on the form itself is sufficient information for the IRS to process Form1023.

40. Where would a user look on Part IX of Form 1023 to determine if there are any subsequent events that couldaffect the organization’s qualification for exemption?

a. Part A, line 2.

b. Part A, line 14.

c. Part B, line 17.

d. Part B, line 19.


253

GLOSSARY

Attempts to influence legislation: This includes both direct lobbying (i.e., attempts to influence legislators) andindirect “grass roots” lobbying (attempts to influence the electorate or general public). If substantial, both of theseactivities can prevent a private foundation from being considered tax-exempt.

Common control: The applicant and one or more other organizations have (1) a majority of their governing boardsor officers appointed by the same organization(s) or (2) amajority of their governing boards or officers consist of thesame individuals. This also occurs when the applicant and one or more commonly controlled organizations havea majority ownership in a corporation, partnership, or trust.

Cy pres doctrine: A doctrine of equitable approximation, which is a principle of law that courts use to save acharitable organization from failing when a charitable objective is (or later becomes) impossible or impractical tofulfill. In such cases, the court may substitute another charitable objective that approximates the original charitablepurpose of the entity. The doctrine is applied on a state-by-state basis and can be important to the dissolution test.

Develop: The planning, financing, construction, or provision of similar services involved in the acquisition of realproperty.

Dissolution test: An organization’s assets are considered permanently dedicated to its exempt purpose if, upon itsdissolution, the assets will, because of a provision in the organizing document or by operation of state law, bedistributed for an exempt purpose (or to federal, state, or local governments to be used exclusively for publicpurposes). The assets of the organization are dedicated to an exempt purpose by operation of state law if, upondissolution, the assets will be distributed by a court order to another organization to be used in a manner that bestaccomplishes the general purposes for which the dissolved organization was formed.

Donor advised fund: A separate account maintained by a Section 501(c)(3) organization for a contribution by adonor whereby the donormay give nonbinding advice to the organization concerning the investment of fund assetsand the recipients of distributions of the fund.

Economic development organizations: Organizations created to combat community deterioration in a specifiedeconomically depressed geographic area, eliminate prejudice and discrimination, or lessen the financial burdensof a governmental entity.

Exempt purpose: The stated purpose for an exempt organization. It can be as broad as those listed in IRC Sec.501(c)(3) (but not broader) or more specific. It does not need to refer to IRC 501(c)(3) specifically, but it mustspecifically refer to one of the permissible purposes using either the terminology of the statute or the applicableregulations.

Fixed payment: A payment that is either a set dollar amount or fixed through a specific formula where the amountis nondiscretionary.

Form 1023: The application that nonprofit organizations without an automatic exemptionmust file to be recognizedas tax exempt under IRC Sec. 501(c)(3). The application must be approved by the IRS.

Governmental unit: A state, a possession of the U.S., any political subdivision of a state or possession of the U.S.,the U.S. itself, and the District of Columbia. If an entity is created by, controlled by, or closely related to one of these,it would be considered affiliated with a governmental unit for the purposes of Form 1023.

Non-fixed payment: Any payment that is discretionary, such as a performance bonus or other incentives.

Operated in connection with a beneficiary organization (Type III): A relationship between a supportingorganization and its beneficiary organization in which the beneficiary organization is normally specified by name inthe organization’s articles of incorporation, unless a historic and continuing relationship exists between theorganizations. This type of relationship is not preferred by the IRS because it can lead to abuse.

Operated, supervised, or controlled by a beneficiary organization (Type I):A relationship between a supportingorganization and its beneficiary organization in which the governing body, members of the governing body, officers


254

acting in their official capacity, or the membership of one or more publicly supported organizations elect or appointa majority of the officers, directors, or trustees of the supporting organization. This relationship ensures that thesupporting organization is under the direction of, and accountable or responsible to, the beneficiary organization.

Private foundation: All Section 501(c)(3) organizations are presumed to be private foundations unless they meetone of the exceptions to qualify for nonprivate foundation status.

Private operating foundation: A hybrid organization that for certain purposes is treated as a public charity and forothers as a private foundation.

Public charity: These Section 501(c)(3) organizations are not subject to the private foundation excise taxes; haveless restrictive rules for charitable contributions; may engage in limited lobbying activities; and, if small, are eligibleto file Form 990-EZ or, if annual receipts are less than $50,000, only have to file Form 990-N. They are also callednonprivate foundations.

Successor organization: An organization is a successor to another organization if it (1) has taken over, or will takeover, the activities of another organization; (2) has taken over 25% or more of the fair market value of the net assetsof another organization; (3) was created upon the conversion of a for-profit entity to nonprofit status or through themerger of other organizations; or (4) installed the same officers, directors, or trustees as another organization(regardless of whether taxable or tax-exempt) that no longer exists and that had purposes similar to the applicant’spurposes. The IRS considers this a parent-subsidiary relationship.

Supervised or controlled in connection with a beneficiary organization (Type II): A relationship between asupporting organization and its beneficiary organization in which the control or management of the supportingorganization is vested in the same persons who control or manage the beneficiary organization. The IRS views thisas a brother-sister relationship.

Unusual grant: A grant that (1) is a substantial contribution or bequest from a disinterested party; (2) was attractedby reason of the publicly supported nature of the organization; (3) is unusual or unexpected with respect to amount;and (4) would, by reason of its amount, result in the organization not meeting the applicable public support test.


255

INDEX

This index is a list of general topics discussed in this course. More specific key word searches can be performedusing the search feature of this PDF.

A

ACCOUNTING PERIODS AND METHODS¯ Periods¯¯ Exemption application 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

AMENDED RETURN¯ Activities of exempt organization 148. . . . . . . . . . . . . . . . . . . . . . . .

APPEALS¯ Adverse determination from IRS on exemption application 155. .

ARTICLES OF INCORPORATION¯ Form 1023 attachment 165. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B

BALANCE SHEETS¯ Material changes in¯¯ Form 1023, Part IX, reporting 237. . . . . . . . . . . . . . . . . . . . . . . .

BUSINESS RELATIONSHIP¯ Reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

C

CHARITABLE ASSISTANCE¯ Provided to¯¯ Public 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Specified group 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CHILDCARE ORGANIZATIONS¯ Exemption requirements 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CHURCH¯ Automatic exemption from tax 137. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Defined 196. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COMMUNITY TRUSTS¯ Defined 198. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COMPENSATION¯ Conflict of interest policy 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Independent contractors¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Key employees¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Non-fixed, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Officers, directors, and trustees¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COMPENSATION PRACTICES¯ Reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONFLICT OF INTEREST¯ Reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONTRIBUTIONS MADE¯ Form 1023, Part IX, reporting 231. . . . . . . . . . . . . . . . . . . . . . . . . . .

CONTRIBUTIONS PAYABLE¯ Form 1023, Part IX, reporting 236. . . . . . . . . . . . . . . . . . . . . . . . . . .

CONTRIBUTIONS RECEIVED¯ Grant versus payment for goods or services¯¯ Form 1023, Part IX, reporting 228. . . . . . . . . . . . . . . . . . . . . . . .

¯ Membership dues distinguished from 228. . . . . . . . . . . . . . . . . . . .¯ Organizations seeking public charity status 221. . . . . . . . . . . . . . .¯ Unusual grants 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Volunteer out-of-pocket expenses 198. . . . . . . . . . . . . . . . . . . . . . .

CY PRES DOCTRINE¯ Application of 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

D

DECLARATORY JUDGMENT¯ Deadline for filing 155. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DEPLETION¯ Reporting on Form 1023 231. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DEPRECIATION¯ Completion of¯¯ Form 1023 231, 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DIRECTORS¯ Compensation, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DISCRIMINATION¯ Private school’s racial nondiscrimination policy 178. . . . . . . . . . .

DISSOLUTION¯ Articles of organization, clause in 166. . . . . . . . . . . . . . . . . . . . . . . .

DUE DATES¯ Exemption application 148, 150. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 1023 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

E

EDUCATIONAL ORGANIZATION¯ Qualifying as 196. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ELECTIONS¯ Lobbying expenses of public charities 179. . . . . . . . . . . . . . . . . . .

EMPLOYER IDENTIFICATION NUMBER¯ Necessity for filing Form 1023 163. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Obtaining 163. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ENDOWMENT FUNDS¯ Educational 196. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EQUITY ACCOUNTS¯ Form 1023 reporting 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXCESS BUSINESS HOLDINGS¯ Qualifying as public charity 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXEMPT FUNCTION INCOME¯ Expenses incurred in connection with 231. . . . . . . . . . . . . . . . . . . .¯ Reporting¯¯ Form 1023 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXEMPTION APPLICATION¯ Adverse determination, IRS 155. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Automatic exemption, organizations eligible for 137. . . . . . . . . . .¯ Due dates 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Effective date of 150. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Expeditious handling 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Extension of time to file 150. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Filing requirements while pending 148. . . . . . . . . . . . . . . . . . . . . . .¯ Financial data, providing¯¯ Accounting method for 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Assets 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


256

¯¯ Expenses 231. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Fund balances or net assets 236. . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Liabilities 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Periods for which information must be provided 227. . . . . . . .¯¯ Reporting changes in 237. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Revenues 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Form 1023 checklist 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 1023, completion of¯¯ Childcare 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Contributions received, information required about 221. . . . .¯¯ Disclosure of information aboutofficers, directors, etc. 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Effective date of exemption 150. . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Foreign 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Fundraising activities 168, 179. . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Gaming 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Incomplete 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Interactive 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Limited liability company 165. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Necessity to file to obtain official recognition 137. . . . . . . . . . .¯¯ Organizational history 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Organizational structure—Part II 165. . . . . . . . . . . . . . . . . . . . .¯¯ Organization’s activities and operations 168. . . . . . . . . . . . . . .¯¯ Organizations providing benefits,services, or products 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Part I of form 163. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Part IX of form 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Political activities 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Private operating foundation, qualifying as 219. . . . . . . . . . . .¯¯ Public charity, qualifying as 195. . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Schedules A through H 221. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Successor organization 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Supporting organizations 212. . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Unusual grants 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Form 1023-EZ¯¯ Organizations permitted to file 139. . . . . . . . . . . . . . . . . . . . . . .

¯ Form 1023-EZ, completion of 185. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Gross receipts test for exemption 137. . . . . . . . . . . . . . . . . . . . . . .¯ Group application 141. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Low-income housing 222. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Organizations required to file 139. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Public charity¯¯ 33 1/3% test for status as 198. . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Facts and circumstances test for status as 202. . . . . . . . . . . .¯¯ Functional tests for qualification as 196. . . . . . . . . . . . . . . . . . .¯¯ Low-income housing 222. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Material changes in support 198. . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Private foundation status versus status as 195. . . . . . . . . . . . .¯¯ Section 501(a)(2) test for status as 203. . . . . . . . . . . . . . . . . . .¯¯ Supporting organization rules 212. . . . . . . . . . . . . . . . . . . . . . .¯¯ Unusual grants 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Volunteer expenses 198. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Public inspection of Form 1023 152. . . . . . . . . . . . . . . . . . . . . . . . .¯ Reinstate tax-exempt status 152. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Single member limited liability company 139. . . . . . . . . . . . . . . . .¯ Tax-exempt status, benefits of 137. . . . . . . . . . . . . . . . . . . . . . . . . . .

EXEMPT PURPOSES¯ Summary of 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXTENSION¯ Time to file¯¯ Exemption application (Form 1023) 148, 150. . . . . . . . . . . . .

F

FACTS AND CIRCUMSTANCES¯ Tests for status as a publicly supported charity 202. . . . . . . . . . . .

FAMILY RELATIONSHIPS¯ Reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FOREIGN ACTIVITIES¯ Reporting

¯¯ Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FORMS, COMPLETING¯ 1023 [Application for Recognition of ExemptionUnder Section 501(c)(3) of the InternalRevenue Code] 163, 165, 166, 168,. . . . . . . . . . . . . . . . . . . . . . . .

170, 178, 179¯¯ Part IX, Financial Data 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ 1023-EZ [Streamlined Application for Recognitionof Exemption Under Section 501(c)(3) of the InternalRevenue Code] 185. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ 1023—Interactive 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ 1024 [Application for Recognitionof Exemption Under Section 501(a)] 150. . . . . . . . . . . . . . . . . . . .

¯ 8976 [Notice of Intent to Operate UnderSection 501(c)(4)] 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FORMS, FILING OF¯ 8976 [Notice of Intent to Operate UnderSection 501(c)(4)] 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Form 8940 212, 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FUND ACCOUNTING¯ Reporting balances on¯¯ Form 1023 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FUNDRAISING¯ Expenses of 231. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 1023 reporting 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

G

GAMING ACTIVITIES¯ Reporting¯¯ Form 1023 reporting 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GOVERNMENTAL UNIT¯ Defined, publicly supported charity test 198. . . . . . . . . . . . . . . . . .¯ Supported organization, governmental 212. . . . . . . . . . . . . . . . . . .

GRANTS¯ Reporting¯¯ Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Unusual 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GROSS RECEIPTS¯ Membership fees distinguished from 203. . . . . . . . . . . . . . . . . . . .¯ Public charity, test for qualification as 203. . . . . . . . . . . . . . . . . . . .¯ Tax-exempt status, test for 137. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ User fee determination 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GROUP EXEMPTION LETTER¯ Applying for 141. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Compliance checks 141. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

H

HEALTH INSURANCE INSURERS¯ Exempt status 139. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

I

INDEPENDENT CONTRACTORS¯ Compensation, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Names and addresses, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INTELLECTUAL PROPERTY¯ Ownership of, reporting¯¯ Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INVENTORY¯ Reporting requirements¯¯ Form 1023, Part IX 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


257

INVESTMENTS¯ Reporting¯¯ Form 1023 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

J

JOINT VENTURE ARRANGEMENTS¯ Participation in, reporting¯¯ Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

K

KEY EMPLOYEES¯ Compensation, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

L

LAND, BUILDINGS, AND EQUIPMENT¯ Reporting¯¯ Form 1023 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LATE FILING¯ Form 1023 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LOBBYING¯ Disclosing on Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Expenditure test election 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Influencing legislation 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

M

MEMBERS¯ Disbursements to 231. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

MEMBERSHIP DUES¯ Distinguished from¯¯ Gross receipts 203. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

MORTGAGES AND OTHER NOTES PAYABLE¯ Reporting¯¯ Form 1023 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

N

NONDISCRIMINATION¯ Private schools 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

NOTES AND LOANS RECEIVABLE¯ Reporting¯¯ Form 1023 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

O

OFFICERS¯ Compensation, reporting¯¯ Form 1023 170, 231. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Names and addresses, reporting 185. . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 1023-EZ 185. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

OPERATIONAL TEST¯ Qualifying as a supporting organization 212. . . . . . . . . . . . . . . . . .

ORGANIZATIONAL DOCUMENTS¯ Changes to 148. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Dissolution test 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 1023 attachment 165. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Organizational test 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Provisions required 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Submitting 166. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ORGANIZATIONAL TEST¯ Qualifying as a supporting organization 212. . . . . . . . . . . . . . . . . .¯ Qualifying for Section 501(c)(3) status under 166. . . . . . . . . . . . . .

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POLITICAL ACTIVITIES¯ Describing on Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

POLITICAL CAMPAIGNS¯ Form 1023 reporting 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PRIVATE FOUNDATIONS¯ Defined 195. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Investments jeopardizing charitable purposes 233. . . . . . . . . . . .

PRIVATE INUREMENT¯ Fundraising activities 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Organizational test for exempt status 166. . . . . . . . . . . . . . . . . . . .

PRIVATE OPERATING FOUNDATION¯ Qualifying as 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PRIVATE SCHOOLS¯ Nondiscrimination policy 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PROFESSIONAL FEES¯ Form 1023 231. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PUBLICATION 78¯ EO Select Check (IRS) 157. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reporting organizations eligible fortax-deductible contributions 157. . . . . . . . . . . . . . . . . . . . . . . . . . . .

PUBLIC CHARITY¯ Private foundations versus status as 195. . . . . . . . . . . . . . . . . . . . .¯ Qualifying as¯¯ Facts and circumstances test 202. . . . . . . . . . . . . . . . . . . . . . . .¯¯ More than one-third and one-third or less tests 203. . . . . . . . .¯¯ Section 509(a)(1) (33 1/3%) test 198. . . . . . . . . . . . . . . . . . . . .¯¯ Supporting organization rules 212. . . . . . . . . . . . . . . . . . . . . . .

PUBLIC INSPECTION¯ Form 1023 152. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 1024 152. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

R

REINSTATEMENT¯ Tax-exempt status 152. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

RELATED ENTITIES¯ Reporting compensation from¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Reporting on¯¯ Form 1023 179. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

RELATED PERSONS¯ Benefits to, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Dealing with, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

RETAINED EARNINGS¯ Form 1023 reporting 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

REVOCATION¯ Exemption (tax-exempt status) 152. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reinstatement after revocation 152. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Relief procedure 152. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

RULINGS¯ Status as an exempt organization¯¯ Advance 139. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Unusual grant status, advance ruling 219. . . . . . . . . . . . . . . . . . . .

S

SAVINGS ACCOUNTS¯ Balance sheet reporting¯¯ Form 1023 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


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SCHOOLS¯ Nondiscrimination 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 501(c)(4) ORGANIZATIONS¯ Notice of intent to operate as 148. . . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 509(a)(3) SUPPORTING ORGANIZATIONS¯ Qualifying as public charity 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SELECT CHECK¯ IRS tool 157. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SFAS 116¯ Form 1023 reporting 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SFAS 117¯ Form 1023 reporting 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

STATE LAW¯ Satisfying the dissolution test for exempt status 166. . . . . . . . . . .

SUBORDINATE ORGANIZATION¯ Group exemption letter 141. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SUBSTANTIAL CONTRIBUTORS¯ Furnishing a list of 221. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SUPPORTING ORGANIZATIONS¯ Qualifying as public charity 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Type III 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ User fee 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SUPPORT TEST¯ Form 1023 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ For status as public charity 195. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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TAX-EXEMPT STATUS¯ Benefits of 137. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Confirmation of 157. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Effective date of 150. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Public charities 195. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reinstatement of 152. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Revocation of 152. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

TRUSTEES¯ Compensation, reporting¯¯ Form 1023 170. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

TRUSTS¯ Community, defined 198. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

TYPE III SUPPORTING ORGANIZATIONS¯ Classification 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Functionally integrated¯¯ “But-for” test 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Parent of beneficiary organization(s) 212. . . . . . . . . . . . . . . . . .

¯ Non-functionally integrated¯¯ Attentiveness test 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Distribution requirement 212. . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Notification requirement 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Responsiveness test 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

U

UNRELATED TRADE OR BUSINESS¯ Assets used in 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reporting on Form 1023 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

UNUSUAL GRANTS¯ Advance ruling 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Defined 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ User fee 219. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

USER FEES¯ Application for reinstatement of exempt status 152. . . . . . . . . . . .


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COURSE 3

SELECTED TOPICS RELATED TO FORM 990 (990TG183)

OVERVIEW

COURSE DESCRIPTION: This interactive self-study course looks at several topics related to Form 990 andForm 990-EZ. Lesson 1 discusses general filing information for Form 990, andLessons 2, 3, and 4 discuss various issues related to different parts of the form(highlighting an organization’s accomplishments; governance, management, andrequired disclosure; and reporting functional expenses, respectively). Finally,Lesson 5 discusses how to prepare Form 990-EZ.


February 2018














Lesson 1—General Filing Information—Form 990

Completion of this lesson will enable you to:¯ Identify general filing requirements for Forms 990, 990-EZ, and990-N andorganizations that have special filingrequirements.


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¯ Determine the correct method for dealing with exceptions to the requirement to file a return, charitable trusts,group returns, other special filing circumstances, extension requests, failure to file penalties, and amendedreturns.

Lesson 2—Highlighting an Organization’s Accomplishments

Completion of this lesson will enable you to:¯ Identify thebasicpreparation requirements for theheadingsectionofForm990;how tosummarize themission,governance, and operational information; and how to report program service accomplishments.

¯ Determine thebestmethod for explaininganorganization’s exemptpurposeachievements, reporting thevalueof donated services, dealing with public interest law firms, and completing Schedule N for a terminatingorganization.

Lesson 3—Governance, Management, and Required Disclosure

Completion of this lesson will enable you to:¯ Determine the best method for completing Parts IV and V of Form 990.¯ Identify the information needed to complete Part VI of Form 990.

Lesson 4—Reporting Functional Expenses

Completion of this lesson will enable you to:¯ Identify generalmethods for reporting functional expenses on Form990 and how to allocate expenses tomorethan one function, report grants and other assistance (Part IX and Schedule I), report benefits paid to or formembers, and report compensation and related benefits (Part IX).

¯ Determine the bestmethods for dealingwith fees for services paid to independent contractors, other expenses(advertising, travel, etc.), and payments to affiliates.

Lesson 5—Preparing Form 990-EZ

Completion of this lesson will enable you to:¯ Identify the general information necessary to complete and file Form 990-EZ and how to report revenue,expense, and changes in fundbalance (Part I); balance sheets (Part II), andprogramservice accomplishments(Part III).

¯ Determine the best method for completing Parts IV, V, and VI of Form 990-EZ.










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Lesson 1: General Filing Information—Form 990Introduction

The IRS’s goals for Form 990 are increased transparency, good governance, and increased accountability for filingorganizations. Also, it is important to remember while preparing Form 990 that this is a publicly disclosed docu-ment. Use this opportunity to tell the organization’s story by effectively stating its mission and program serviceaccomplishments. The Form 990 can be a valuable marketing and development tool; therefore, careful considera-tion should be given to all the information presented.

This course provides information on the Form 990 core form and related schedules. Where other sources ofauthority have not been cited, the IRS instructions are the authority used throughout. The IRS has included aglossary of definitions in the Form 990 instructions. It is important to understand both the instructions and the termsdefined in the glossary when preparing the return. This course is limited in scope to four specific topics. Moreinformation about Form 990 in general can be found in PPC’s 990 Deskbook.

In addition to filing the annual information return (Form 990 or 990-EZ), a tax-exempt organization may be requiredto file Form 990-T (Exempt Organization Business Income Tax Return) to report unrelated trade or business income.An unrelated trade or business is any trade or business, the conduct of which is not substantially related to theexercise or performance by the organization of its exempt purpose. The fact that an organization needs or uses theprofits from a business activity to support its program services has no bearing on determining if the activity isunrelated.


Completion of this lesson will enable you to:¯ Identify general filing requirements for Forms 990, 990-EZ, and990-N andorganizations that have special filingrequirements.

¯ Determine the correct method for dealing with exceptions to the requirement to file a return, charitable trusts,group returns, other special filing circumstances, extension requests, failure to file penalties, and amendedreturns.

Filing Forms 990, 990-EZ, and 990-N

In General

Tax-exempt organizations generally must file either an annual information return on Form 990 (Return of Organiza-tion Exempt From Income Tax), Form 990-EZ (Short Form Return of Organization Exempt From Income Tax), or anannual electronic notice using Form 990-N [Electronic Notice (e-Postcard) for Tax-Exempt Organizations NotRequired To File Form 990 or 990-EZ], depending on the organization’s gross receipts and total assets. Exceptionsto the filing requirements apply to organizations with gross receipts below a specific amount and to certain religiousand governmental organizations.

Since Form 990 and Form 990-EZ are publicly disclosed documents, these forms may be the public’s primary orsole source of information about a particular organization. This includes potential employees. Therefore, theorganization should carefully consider how the public will perceive the information being presented and especiallyuse the mission statement and program service accomplishment responses to tell the organization’s story.

In addition, these forms are sometimes used to meet state filing obligations. However, some states have their ownspecific forms that must be used to fulfill their requirements.

Unless otherwise specified, information should be provided for the organization’s tax year. Consequently, anorganization should answer “Yes” to a question asking whether it conducted a certain type of activity only if itconducted that activity during the tax year.


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Some lines request information reported on other tax forms filed by the organization (e.g., Forms W-2, 1099, or990-T). If the organization is aware the amount reported on the other form is incorrect, the correct informationshould be reported on Form 990 and the other form(s) should be amended. Do not report negative numbers; use“-0-” instead, unless the instructions specifically state otherwise.

If an organization files either a Form 990 or 990-EZ, it must include all required schedules for the return to becomplete. If the organization chooses to file a return, even though not required to do so, it must still file a completereturn and provide all the information requested. Schedule O is a required schedule for all Forms 990 and 990-EZ(i.e., a Form 990 or 990-EZ filed without a Schedule O is incomplete).

Unless specifically instructed to skip a line or leave blank, answer all applicable questions on the return. Generally,if the IRS allows non-applicable possibilities, an “N/A” box will be available. Leaving an item blank unless instructedto do so can sometimes be construed as not wanting to answer a question. Items left blank can also cause anelectronically filed return to reject.

Certain tax-exempt organizations do not file Form 990 or 990-EZ, but file another form instead. For example, privatefoundations file Form 990-PF [Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable TrustTreated as a Private Foundation] and welfare benefit and pension plans [other than Section 501(c)(9) VEBAs] fileForm 5500 Series returns. Additionally, homeowners associations have several filing options. (Filing requirementsfor homeowners associations are beyond the scope of this course but are addressed in PPC’s Guide to Homeown-ers’ Associations and Other Common Interest Realty Associations.)

Who Must File

Most organizations exempt from income tax under IRC Sec. 501(a) must file an information return (Form 990 or990-EZ) or submit an annual electronic notice (Form 990-N), depending on the organization’s gross receipts andtotal assets. (A discussion of filing requirements prior to approval of tax-exempt status by the IRS appears later inthis lesson.)

Form 990. For 2017, an organization exempt from income tax under IRC Sec. 501(a) (including an organization thathas not applied for recognition of exemption) must file Form 990 if it has either gross receipts of $200,000 or moreor total assets of $500,000 or more at the end of the tax year. This includes the organizations described in—

¯ IRC Sec. 501(c)(3) (other than private foundations), or

¯ other Section 501(c) subsections (other than black lung benefit trusts).

Gross receipts are the total amounts the organization received from all sources during its tax year (before subtract-ing any costs or expenses). Total assets is the amount reported by the organization on its balance sheet as of thetax year end before subtracting any liabilities (i.e., the amount reported on Part X, line 16, Column B).

For Form 990 reporting, Section 501(c)(3) organizations include Section 4947(a)(1) trusts and organizationsexempt under IRC Secs. 501(e) and (f) (cooperative service organizations), 501(j) (amateur sports organizations),501(k) (child care organizations), and 501(n) (charitable risk pools). In addition, any organization described in oneof these sections is also subject to IRC Sec. 4958 if it obtains a determination letter from the IRS stating that it isdescribed in IRC Sec. 501(c)(3).

Form 990-EZ. An organization may choose to file Form 990-EZ (Short Form Return of Organization Exempt FromIncome Tax) instead of Form 990 if its gross receipts for the year are less than $200,000 and its total assets at theend of the tax year are less than $500,000.

Form 990-N. The Form 990-N [Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to FileForm 990 or 990-EZ] must be submitted electronically by the 15th day of the fifth month after the tax year end (thereis not a paper form). There is no cost for submitting the Form 990-N and software does not have to be purchasedto file it. Internet access and an email address is all that is required to file. The IRS will not send an email indicatingwhether the Form 990-N was accepted or rejected. However, the filer can check the status of the filing on theelectronic filing systemwebsite. The form cannot be amended once filed. Corrections and updates to the organiza-tion’s information are made on the following year’s Form 990-N.


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Most small tax-exempt organizations with gross receipts that are normally $50,000 or less must submit the Form990-N annually. Exceptions to this requirement include—

¯ organizations that are included in a group return; and

¯ churches, their integrated auxiliaries, and conventions or associations of churches.

The following organizations cannot submit the Form 990-N but must file different forms instead:

1. Tax-exempt organizationswith annual gross receipts that are normally greater than $50,000must file Form990 or Form 990-EZ.

2. Private foundations must file Form 990-PF.

3. Section 509(a)(3) supporting organizations that are required to file Form 990 or Form 990-EZ.

4. Section 527 (political) organizations required to file an annual exempt organization return must file Form990 or Form 990-EZ (i.e., political organizations are not required to submit Form 990-N).

To access the Form 990-N electronic system, go to www.irs.gov and search for 990-N (note that a one-timeregistration is required to access the system on the IRS’s website). To complete Form 990-N, the followingorganization information is needed:

¯ Employer identification number (EIN).

¯ Tax year.

¯ Legal name and mailing address.

¯ Other names the organization uses (if any).

¯ Name and address of a principal officer.

¯ Website address (if applicable).

¯ Confirmation that the organization’s annual gross receipts are normally $50,000 or less.

¯ A statement that the organization has terminated or is terminating (if applicable).

An organization that is exempt under IRC Sec. 501(a) and required to file Form 990, (or 990-EZ, or 990-N) willautomatically lose its exemption for failing to file the return for three consecutive years. The revocation of theorganization’s tax-exempt status will not occur until the filing due date of the third year. However, the IRSencourages the submission of Form 990-N (for eligible organizations) even if it is late.

The IRS Customer Account Services should be contacted at (877) 829-5500 for any of the following:

¯ An organization that is otherwise eligible to file Form 990-N has an exemption application pending. Anofficer of the organization must call and ask that the organization be set up to allow filing.

¯ An organization is required to file Form 990-N, even though it was not required to apply for exempt status(e.g., because its gross receipts are normally not more than $5,000).

¯ The organization cannot submit the Form 990-N because another organization has used its EIN.

Other Filing Requirements

An organization that is not required to file Form 990 is still responsible for other applicable returns (e.g., payrollreturns or an unrelated business tax return). (Lesson 3 discusses these other filing requirements.)


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Gross Receipts Test

Gross receipts for determining whether to file Form 990 or 990-EZ are the gross amounts received from all sourcesduring the year, without reduction for any costs or expenses. However, funds collected merely as an agent foranother are not included. In addition, gross sales (or receipts) may be reduced by returns and allowances.

Gross receipts are the following:

Form 990. Part VIII, line 12, Column A increased by the deductions on lines 6b (both columns), 7b (bothcolumns), 8b, 9b, and 10b.

Form 990-EZ. Part I, line 9 increased by the deductions on lines 5b, 6c, and 7b.

Example 1A-1 Calculating gross receipts for the $50,000 gross receipts exception.

The Quincy Art Museum (Quincy) had the following items related to income during its current reporting year.

1. Contributions from the general public $ 16,8002. Dues from museum society members 6,6003. Dues collected on behalf of the National Organization of Museum Patrons (NOMP)(Quincy collects these dues merely as a courtesy to NOMP; it has no right to retainany of the funds) 900

4. Loss on sale of office equipment (gross sales price $1,400; purchased new for$4,200 and $1,600 of depreciation had been recorded) (1,200 )

5. Gross profit from operation of the museum gift shop (gross proceeds of $36,000 less$25,400 cost of goods sold) 10,600

6. Income from investments:a. Interest and dividends 1,600b. Gain on sale of stock (sales price $2,400 less basis of $600) 1,800

7. Net income from an unrelated business (gross receipts of $9,000 less expenses of$5,400) 3,600

Total $ 40,700

Quincy’s gross receipts for this filing test are $73,800, calculated as follows:

Contributions $ 16,800Museum society members’ dues 6,600Gross proceeds from sale of office equipment 1,400Gross receipts from operating gift shop 36,000Interest and dividend income 1,600Gross proceeds from stock sale 2,400Gross receipts from unrelated business 9,000

Total $ 73,800

The gross receipts test generally is based on a three-year average. Thus, an organization with more than $50,000of gross receipts for a single year still can be exempt from filing Form 990 or 990-EZ under this exception. However,the organization will still be required to submit Form 990-N (unless it meets one of the exceptions). The method fordetermining if gross receipts normally exceed $50,000 depends on how long an organization has existed.

$50,000 Test. An organization’s gross receipts normally are not more than $50,000 if it has existed for—

1. one year or less and has received (or donors have pledged) gross receipts of $75,000 or less during thefirst tax year;


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2. more than one year, but fewer than three, and the average gross receipts received in the first two tax yearsare $60,000 or less; or

3. at least three years, and the average gross receipts received in the immediately preceding three years(including the year the return would be filed) are $50,000 or less.

Example 1A-2 Determining if an organization meets the gross receipts exception to filing a return.

Assume the same facts as in Example 1A-1. Quincy has existed for at least three years. For the two reportingyears preceding the current year, Quincy’s gross receipts for the gross receipts test were $41,200 and$32,600. To determine if it meets the gross receipts exception to filing a current year return, it must calculatethe average of its gross receipts for the current and two preceding years. The average of those three years’gross receipts is $49,200 [($73,800 + $41,200 + $32,600) ÷ 3]. Quincy is not required to file Form 990 orForm 990-EZ for the current year. However, Quincy must file Form 990-N.

$5,000 Test. For the special filing requirements that apply to Section 509(a)(3) supporting organizations (where arediscussed later in this lesson), an organization’s gross receipts normally are not more than $5,000 if it has existedfor—

1. one year or less and has received (or donors have pledged) gross receipts of $7,500 or less during the firsttax year;

2. more than one year, but fewer than three, and the average gross receipts received in the first two tax yearsare $6,000 or less, or

3. at least three years, and the average gross receipts received in the immediately preceding three years(including the year the return would be filed) are $5,000 or less.

Electronic Filing

Any organization may file Forms 990 and 990-EZ (and related forms, schedules, and attachments), 990-PF, 8868,1120-POL, and 7004 electronically. However, certain organizations are required to file Forms 990 and 990-PFelectronically. Organizations must submit Form 990-N electronically. For additional information on the electronicfiling requirement, visit www.irs.gov and search for “efile for charities and non-profits.”

Mandatory Electronic Filing. If an organization files at least 250 returns of any type (including income, employment,and excise tax returns) during the calendar year ending with or within its tax year and has total assets of $10 millionor more at the end of the tax year, it must file electronically (e.g., each Form W-2 and quarterly Form 941 isconsidered a separate return). To determine if the organization meets the $10 million asset test, use the amount onForm 990, Part X, line 16 (total assets), column (B).

Requesting a Waiver from Required e-Filing. A tax-exempt organization can request a waiver from the electronicfiling requirement if the following criteria are satisfied:

1. The exempt organization cannot meet electronic filing requirements due to technology constraints.

2. Compliance with the requirements would result in an undue financial burden on the filer.

Returns Ineligible for e-Filing. Returns involving the following situations cannot be e-filed:

1. The organization’s exempt status has not yet been approved by the IRS.

2. The organization has changed its name.

3. The return is for less than a full year unless it is a final return for which the “final return/terminated” box ischecked in Item B of the Heading.

4. Returns older than the two prior years.


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Disclosure of Related Organizations

Although a consolidated Form 990 is not allowed or required, Form 990 requires that related organizations bedisclosed on attached schedules to Form 990 by the reporting organization.

Before beginning the actual preparation of the Form 990, an organization must determine if it has any relatedorganizations that must be reported on one of the 16 schedules it could have to attach to the form. Disregardedentities are treated as a branch or division of the parent organization and financial information related to that activityis reported as if the parent organization operated the activity.

An organization is a related organization if any of the following relationships exist with the filing organization:

1. Parent. An organization that controls the filing organization.

2. Subsidiary. An organization controlled by the filing organization.

3. Brother/Sister. An organization controlled by the same person or persons that control the filingorganization.

4. Supporting/Supported. An organization that is at any time during the tax year—

a. a supporting organization [under IRC Sec. 509(a)(3)], or

b. a supported organization, if the filing organization is a supporting organization.

5. Sponsoring Organization of a VEBA.

6. Contributing Employer of a VEBA.

A discussion about determining related organizations appears later in this lesson.

Schedule R of Form 990 is used by an organization to provide information on related organizations.

Where and When to File

All Forms 990 and 990-EZ for domestic organizations are filed with the Department of Treasury, Internal RevenueService Center, Ogden, UT 84201-0027. If the organization’s principal business, office, or agency is located in aforeign country or U.S. possession, file the forms with the Internal Revenue Service Center, P.O. Box 409101,Ogden, UT 84409.

The due date is the 15th day of the fifth month after year-end. If the regular due date falls on a Saturday, Sunday, orlegal holiday; file on the next business day. (Specific rules must be followed if using a private delivery service ratherthan the U.S. mail to file a return.) If the return is not filed by the due date (including extensions), include areasonable cause explanation for a delinquent return in a separate attachment to the return. Electronic filing ofForms 990 and 990-EZ is available and in certain cases, required. A discussion of when electronic filing ismandatory was provided earlier in this lesson.

Public Inspection

An organization’s Form 990, schedules, and attachments (whether original or amended) must be made availablefor public inspection. However, special rules apply to Schedule B (Form 990, 990-EZ, or 990-PF). The formsprovided must be clear enough to photocopy legibly.

Organizations That Have Special Filing Requirements

Foreign and U.S. Possession Organizations

Foreign organizations and U.S. possession organizations as well as domestic organizations (defined later in thislesson) must file Form 990 or 990-EZ unless specifically excepted. Report in U.S. dollars, and state what conversion


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rate the organization uses. Combine amounts from within and outside the U.S., and report the total for each item.Provide all information in English.

Foreign Organization. An organization that is not a domestic organization. A foreign organization includes anaffiliate that is organized as a legal entity separate from the filing organization, but does not include any branchoffice, account, or employee of a domestic organization located outside the U.S.

U.S. Possession. Includes the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands,Guam, American Samoa, and the U.S. Virgin Islands.

Domestic Organization. A corporation or partnership is domestic if created or organized in the United States orunder the law of the United States or of any state or possession. A trust is domestic if a court within the United Statesor a U.S. possession is able to exercise primary supervision over the administration of the trust, and one or moreU.S. persons (or persons in possessions of the United States) have the authority to control all substantial decisionsof the trust.

Sponsoring Organizations of Donor Advised Funds

If a sponsoring organization of a donor advised fund is required to file an annual information return for the year, theorganization must file Form 990 and not Form 990-EZ. A sponsoring organization of a donor advised fund is anyorganization that—

1. is described in IRCSec. 170(c), other thangovernmental units described in IRCSec. 170(c)(1) andwithoutregard to IRC Sec. 170(c)(2)(A);

2. is not a private foundation as defined in IRC Sec. 509(a); and

3. maintains one or more donor advised funds.

A donor advised fund is a fund or account—

1. that is separately identified by reference to contributions of a donor or donors;

2. that is owned and controlled by a sponsoring organization; and

3. for which the donor or donor advisor has or reasonably expects to have advisory privileges in thedistribution or investment of amounts held in the donor advised funds or accounts because of the donor’sstatus as a donor.

A donor advised fund does not include any fund or account—

1. that makes distributions only to a single identified organization or governmental entity, or

2. in which a donor or donor advisor gives advice about which individuals receive grants for travel, study, orother similar purposes, if—

a. the donor or donor advisor’s advisory privileges are performed exclusively by such person in his orher capacity as a committee member in which all of the committee members are appointed by thesponsoring organization;

b. no combination of donors or donor advisors (and related persons as defined within this list) directlyor indirectly control the committee; and

c. all grants from the fundor account are awardedonanobjective andnondiscriminatorybasis followinga procedure approved in advance by the board of directors of the sponsoring organization [theprocedure must be designed to ensure that all grants meet the requirements of IRC Sec. 4945(g)(1),(2), or (3)]; or


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3. that the IRS exempts from being treated as a donor advised fund because either such fund or account isadvised by a committee not directly or indirectly controlled by the donor or donor advisor or such fundbenefits a single identified charitable purpose.

Rev. Proc. 2011-33 provides reliance criteria for private foundations and sponsoring organizations of donor advisedfunds to determine whether a potential grantee is a qualifying organization.

Controlling Organizations Described in IRC Sec. 512(b)(13)

A controlling organization of one or more controlled entities, as described in IRC Sec. 512(b)(13), must file Form990 and not Form 990-EZ if it is required to file an annual information return for the year and if there was any transferof funds between the controlling organization and any controlled entity during the year. A controlling organizationunder IRC Sec. 512(b)(13) is an exempt organization that controls a controlled entity. IRC Sec. 512(b)(13) treatspayments of interest, annuity, royalties, and rent from a controlled entity to a controlling organization as unrelatedbusiness taxable income under certain circumstances. Control for this purpose means ownership of more than—

¯ 50% (vote or value) of a corporation,

¯ 50% of the profits interest or capital interest in a partnership, or

¯ 50% of the beneficial interest in any other entity.

The constructive ownership rules under IRC Sec. 318 apply for determining ownership of corporate stock. Similarprinciples apply for determining ownership of interests in any other entity.

Section 509(a)(3) Supporting Organizations

A Section 509(a)(3) supporting organization is a public charity claiming status on Form 990 or otherwise underSection 509(a)(3). A supporting organization is organized and operated exclusively to support one or morebeneficiary organizations. Supporting organizations are classified as either Type I (operated, supervised, or con-trolled by one or more supported organizations), Type II (supervised or controlled in connection with one or moresupported organizations), Type III functionally integrated (operated in connection with one or more supportedorganizations if the supporting organization’s activities perform the functions of or carry out the purposes of suchsupported organizations, and, if not for the supporting organization’s involvement, such activities would normallybe engaged in by the supported organizations themselves), or Type III other (operated in connection with one ormore supported organizations and not functionally integrated). A supporting organization may not be controlleddirectly or indirectly by one or more disqualified persons (as defined in IRC Sec. 4946).

As previously discussed, an organization exempt under IRC Sec. 501(a) is not required to file Form 990 or 990-EZif its gross receipts are normally $50,000 or less, it is affiliated with a church or convention or association ofchurches, or is an affiliate of a government unit. However, these general provisions do not apply to Section509(a)(3) supporting organizations. Consequently, a Section 509(a)(3) supporting organization must file Form 990or 990-EZ, unless it qualifies as—

1. an integrated auxiliary of a church as described in Reg. 1.6033-2(h);

2. the exclusively religious activities of a religious order; or

3. an organizationwhose gross receipts are normally notmore than $5,000 that supports a Section 501(c)(3)religious organization.

If the organization is described in 3 (but not in 1 or 2), submit Form 990-N unless the organization voluntarily filesForm 990 or Form 990-EZ.

Section 501(c)(7) and 501(c)(15) Organizations

Sections 501(c)(7) and 501(c)(15) organizations apply the same gross receipts test as other organizations todetermine whether theymust file Form 990, but use a different definition of gross receipts to determine whether theyqualify as tax-exempt for the tax year.


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Section 501(c)(29) Organizations

Section 501(c)(29) nonprofit health insurance issuersmust file Form 990 rather than Form 990-EZ, regardless of theamount of their gross receipts and total assets.

Section 527 Political Organizations and Political Action Committees

Political organizations enjoy special tax status under IRC Sec. 527. They are exempt from income tax on contribu-tions as well as proceeds from political fundraisers and bingo games (“exempt function income”). They are,however, taxable on net income from investments and nonpolitical fundraising events at the highest corporateincome tax rate (presently 35%).

A political organization is any party, committee, fund, or similar organization (even a separate bank account) whosepurpose is to accept contributions and/or make expenditures for political campaign activities.

A political organization that has taxable income in excess of the $100 specific deduction allowed under IRCSec. 527 is required to file an annual income tax return on Form 1120-POL (U.S. Income Tax Return for CertainPolitical Organizations). Some organizations file Form 1120-POL even when it is not required in order to start thestatute of limitations period running.

Generally, a tax-exempt political organization that has gross receipts of $25,000 or more for the tax year (even if itsgross receipts are normally $50,000 or less) is required to file Form 990 (or 990-EZ). However, a qualified state orlocal political organization is not required to file unless its gross receipts are $100,000 or more; and certain otherorganizations are exempt from filing, including an organization required to report under FECA, a state or localcommittee of a political party, and a political committee of a state or local candidate. A Section 527 organizationfiling Form 990 or 990-EZ should check the box on page 1 under item I (“527”). General Instruction A in the IRSinstructions to the 2017 Forms 990 and 990-EZ contains more information on these reporting requirements.Organizations required to file Form 990 or 990-EZ must make their Form 8871, Form 8872, and Form 990 (or990-EZ) available for public inspection in the same manner as annual information returns of Section 501(c)(3)organizations.

The instructions to Form 990 offer no guidance on its proper completion by political organizations. Presumably, theincome and deduction classifications utilized in preparing Form 1120-POL should be used in preparing Form 990.

Political Action Committees (PACs). A tax-exempt organization that conducts, or contemplates conducting, politicalactivities should consider setting up a separate segregated fund [described in IRC Sec. 527(f)(3)]. Such a fund iscommonly referred to as a political action committee (PAC). The advantages of having a PAC include (1) expendi-tures made from, and earnings of, the PAC are not attributed to the exempt organization; (2) investment income ofthe exempt organization is not attributed to the PAC; and (3) the PAC is taxed as a political organization (whichgenerally results in only its investment income being taxed).

Example 1B-1 PAC expenditures.

Graham Guides, a social welfare organization, is developing an election-year voter guide to promote itsagenda. The guide, however, does not expressly favor or oppose identified candidates. Graham separatelyfinances political advocacy for and against candidates in federal elections.

Graham is considering establishing a new separately segregated fund to support the voter guide program.Money from the fund will reimburse Graham for its out-of-pocket expenses in establishing the fund. The fundwill be prohibited from spendingmoney to expressly advocate for the election or defeat of political candidatesor parties. In addition to voter guides, the fund will finance the distribution of candidates’ voting records. It alsoplans to accept donations to the fund.

The new fund is a tax-exempt PAC under IRC Sec. 527(f)(3). Fund disbursements for the distribution of voterguides and candidates’ voting records will be for exempt purposes within the meaning of IRC Sec. 527(e)(2).Fund expenditures directed at influencing voters’ views on the connection between Graham’s agenda andcandidates also will be for an exempt purpose.


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Section 4947(a)(1) Nonexempt Charitable Trusts

A nonexempt charitable trust described in IRC Sec. 4947(a)(1) (if it is not treated as a private foundation) is requiredto file Form 990 or Form 990-EZ, unless excepted. If such a trust does not have any taxable income under SubtitleA of the Code, it can file Form 990 or Form 990-EZ to meet its Section 6012 filing requirement and does not have tofile Form 1041 (U.S. Income Tax Return for Estates and Trusts).


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SELF-STUDY QUIZ


1. Which of the following would most likely file Form 990?

a. A private foundation.

b. A black lung benefit trust.

c. A child care organization.

d. A for-profit entity.

2. Which of the following organizations is most likely to pass the $50,000 gross receipts test?

a. The Red Organization has been in existence for over five years.

b. The Blue Organization has existed for six months and has pledges of $60,000.

c. The Yellow Organization has existed for two years and its average gross receipts are $75,000.

d. The Green Organization collects funds as an agent for another organization.

3. A donor advised fund will be which of the following?

a. Owned and operated by a sponsoring organization.

b. Able to make distributions only to one entity.

c. Exempted by the IRS.

d. A private foundation.


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SELF-STUDY ANSWERS


1. Which of the following would most likely file Form 990? (Page 261)

a. A private foundation. [This answer is incorrect. Private foundations are not included in the list of Section501(c)(3) organizations required to file Form 990. Private foundations must file Form 990-PF.]

b. A black lungbenefit trust. [This answer is incorrect. The types of organizations described inSection 501(c)subsectionsother than IRCSec.501(c)(3) that typically fileForm990specificallyexcludeblack lungbenefittrusts.]

c. A child care organization. [This answer is correct. Tax-exempt organizations with the appropriateamount of gross receipts or total assets will file Form 990. This includes those organizationsdescribed in IRC Sec. 501(c)(3) and other Section 501(c) subsections. For Form 990 reporting,Section 501(c)(3) organizations include, among others, child care organizations described in IRCSec. 501(k). Therefore, assuming a child care organization has gross receipts or total assets thatqualify, it will file Form 990.]

d. A for-profit entity. [This answer is incorrect. Organizations that are exempt from income tax under IRCSec.501(a) (including organizations that have not applied for recognition of exemption) must file Form 990 iftheir gross receipts and total assets meet the appropriate thresholds. Form 990 is for nonprofitorganizations specifically. For-profit entities must pay income tax and, therefore, will file different returns.]

2. Which of the following organizations is most likely to pass the $50,000 gross receipts test? (Page 261)

a. The RedOrganization has been in existence for over five years. [This answer is incorrect. While the lengthof time in existence is a factor in this test, the amount of pledges and gross receipts also have to be takeninto account. Based on this factor alone, the RedOrganization would not pass the $50,000 gross receiptstest.]

b. The Blue Organization has existed for six months and has pledges of $60,000. [This answer iscorrect. Rev. Proc. 2011-15 outlines the $50,000 gross receipts test. One condition in which anorganization’s gross receipts normally are not more than $50,000 is if it has been in existence forone year or less andhas received (or donors havepledged) gross receipts of $75,000or less duringthe first tax year. Based on this information, the Blue Organization would pass this condition of the$50,000 gross receipts test.]

c. TheYellowOrganizationhasexisted for twoyearsand its averagegross receipts are$75,000. [This answeris incorrect. According toRev. Proc. 2011-15, an organization’s gross receipts are generally notmore than$50,000 if it has existedmore than one year, but fewer than three, and the average gross receipts receivedin the first two tax years are $60,000 or less. Because the Yellow Organization had more than $60,000 ofgross receipts in its two years, it may have more gross receipts than allowable to pass the $50,000 grossreceipts test.]

d. The Green Organization collects funds as an agent for another organization. [This answer is incorrect.According to Ltr. Rul. 9803015, fundscollectedmerely as anagent for another arenot included in thegrossreceipts test. Therefore, based solely on this information, it cannot be known whether or not the GreenOrganization would pass the $50,000 gross receipts test. More information about the organization’s owngross receipts is needed.]


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3. A donor advised fund will be which of the following? (Page 266)

a. Owned and operated by a sponsoring organization. [This answer is correct. A donor advised fundis a fund or account (1) that is separately identified by reference to contributions of a donor ordonors, (2) that is owned and controlled by a sponsoring organization, and (3) for which the donoror advisor has or reasonably expects to have advisory privileges in the distribution or investmentof amounts held in the donor advised funds or accounts because of the donor’s status as a donor.]

b. Able to make distributions only to one entity. [This answer is incorrect. A donor advised fund does notinclude any fund or account that makes distributions only to a single identified organization orgovernmental entity.]

c. Exempted by the IRS. [This answer is incorrect. Any fund or account that the IRS exempts from beingtreated as a donor advised fund because (1) either such fund or account is advised by a committee notdirectly or indirectly controlled by the donor or (2) donor advisor or such fund benefits a single identifiedcharitable purpose is not considered a donor advised fund.]

d. A private foundation. [This answer is incorrect. The sponsoring organization of a donor advised fundcannot be a private foundation; however, the criteria for being a donor advised fund donotmention privatefoundations.]


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Exceptions to the Requirement for Tax-exempt Organizations to File aReturn

Tax-exempt organizations generally must file an annual Form 990 or Form 990-EZ. However, certain organizations(primarily religious) and those entities with gross receipts below a specified level are statutorily exempt from filing.Such an organization does not have to file Form 990 or 990-EZ even if it has up to $200,000 of gross receipts for thetax year or $500,000 of total assets as described in this lesson [except for Section 509(a)(3) supporting organiza-tions—the special filing requirements for supporting organizations were described in the previous section]. Inaddition, the IRS has discretionary authority to exempt any organization from the annual filing requirement when areturn is not necessary for the efficient administration of the tax laws.

Certain Religions, Government, Political, and Other Organizations

Based on statutory authority, the discretionary authority of the IRS, and a limited number of court decisions, theorganizations currently exempt from filing an annual return include the following.

Certain Religious Organizations

1. A church. The Code and regulations related to the Form 990 reporting requirements do not specificallydefine the term church. However, the IRS has developed 14 criteria it applies in determining if an entity isa church. For exempt organization purposes, the term church is applied generically as a place of worshipthat includes, for example, mosques and synagogues. As defined for unrelated business income taxpurposes, a church includes a religious organization or order that is an integral part of, and engaged incarrying out, the functions of a church.

2. An interchurch organization of local units of a church, a convention or association of churches, or anintegrated auxiliary of a church. Including individuals as well as churches as members or allowingindividuals to have voting rights in the organization will not prevent it from qualifying as “a convention orassociation of churches.”

An integrated auxiliary of a church is an entity that meets these requirements:

a. It is tax-exempt as a result of being described in IRC Sec. 501(c)(3) (i.e., it is organized and operatedexclusively for religious, charitable, scientific, educational, etc., purposes) and is described in IRCSec. 509(a)(1), (2), or (3).

b. It is affiliated with a church or convention or association of churches. An organization is affiliated withanother entity for this purpose if it is—

(1) covered by a common group exemption letter;

(2) operated, supervised, or controlled by, or in connection with such other entity; or

(3) affiliated based on the relevant facts and circumstances (e.g., the sharing of common religiousdoctrines, a common name, or the ability of the church or convention of churches to control theappointment of at least one of the organization’s officers or directors).

c. It is internally supported. For this purpose, an organization is internally supported unless it both—

(1) sells products or services to the general public (other than on an incidental basis) for somethingother than a nominal charge or a substantial discount from cost; and

(2) normally receives more than 50% of its support from a combination of governmental sources;public solicitations of contributions (e.g., a community fund drive); and receipts from the sale ofadmissions, goods, performance of services, or furnishing of facilities in activities that are not anunrelated business.


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Specifically included within the definition of an integrated auxiliary are a men’s or women’s organization,a religious school, a mission society, and a youth group.

3. An organization operated, supervised, or controlled by one or more churches, integrated auxiliaries, orconventions or associations of churches that carries out church-related financing, funding, or pensionprograms.

4. A school below college level that is affiliated with a church (i.e., controlled by or associated with a churchor a convention or association of churches) or operated by a religious order, provided the school has aprogram of a general academic nature, maintains a regular faculty and curriculum, and normally hasregularly enrolled students in attendance where its educational activities are regularly carried on.

5. Amissionsociety sponsoredbyor affiliatedwithoneormorechurchesor churchdenominations.However,to qualify under this exception, more than one-half of the society’s activities must occur in, or be directedat persons in, foreign countries.

6. An organization that is an exclusively religious activity of any religious order.

Certain Government Organizations

7. A state institution that derives income solely from performing essential governmental functions. Thisincludes operating a public utility company.

8. A governmental unit or affiliate described in Rev. Proc. 95-48.

9. A corporation that is an instrumentality of the U.S. and that was organized under an Act of Congress, if itmeets the requirements of IRC Sec. 501(c)(1).

Certain Political Organizations

10. A political organization that is—

a. a state or local committee of a political party;

b. a political committee of a state or local candidate;

c. a caucus or association of state or local officials; or

d. required to report under the Federal Election Campaign Act of 1971 as a political committee [asdefined in Section 301(4) of such Act].

Certain Organizations with Limited Gross Receipts

11. An organization with gross receipts that are normally $50,000 or less for the year. Such organizationsgenerally are required to submit Form 990-N if they choose not to file Form 990 or 990-EZ. Special rulesare applied to determine an organization’s gross receipts and to determine if they are normally $50,000or less. (See Examples 1A-1 and 1A-2.)

12. In addition, certain foreign organizations that normally have $50,000 or less in annual gross receipts fromU.S. sources and that did not engage in significant activity in the U.S. (other than investment activity) arenot required to file based on this exemption. However, a foreign organization or a U.S. possessionorganization required to file Form 990 or 990-EZ must use its worldwide gross receipts and assets whendetermining whether it qualifies to file Form 990-EZ.

Certain Organizations That File Different Kinds of Annual Information Returns

13. A private foundation (including a private operating foundation) exempt under IRC Sec. 501(c)(3) anddescribed in IRC Sec. 509(a). Use Form 990-PF (Return of Private Foundation). Use Form 990-PF also for


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a taxable private foundation, a Section 4947(a)(1) nonexempt charitable trust treated as a privatefoundation, and a private foundation terminating its status by becoming a public charity under IRC Sec.507(b)(1)(B) (for tax years within its 60-month termination period).

14. Ablack lungbenefit trust described in IRCSec. 501(c)(21).UseForm990-BL (Informationand Initial ExciseTax Return for Black Lung Benefit Trusts and Certain Related Persons).

15. A religious or apostolic organization described in IRC Sec. 501(d). Use Form 1065 (U.S. Return ofPartnership Income).

16. A stock bonus, pension, or profit-sharing trust that qualifies under IRC Sec. 401. Use Form 5500 (AnnualReturn/Report of Employee Benefit Plan).

Some of the categories of organizations exempt from filing Form 990 refer to the term religious order, but neither theCode nor regulations define religious order. The IRS has published a list of the seven criteria it uses to determine ifan organization is a religious order.

Filing Requirements for Charitable Trusts

Trusts normally file Form 1041 (U.S. Income Tax Return for Estates and Trusts). However, certain trusts file Form 990or 990-EZ instead, including exempt charitable trusts that are not private foundations (i.e., they are consideredpublic charities) and Section 4947(a)(1) trusts that are not private foundations and have no taxable income. Section4947(a)(1) trusts that are not private foundations but have taxable income must file Form 1041 in addition to Form990.

A charitable trust is exempt from income tax under IRC Sec. 501(a) if it is described in IRC Sec. 501(c)(3). In otherwords, it is organized and operated solely for religious, charitable, scientific, etc., purposes, with none of its benefitsinuring to private individuals, with no substantial part of its activities devoted to influencing legislation, and withnone of its activities related to campaigning for or against a candidate for public office.

A Section 4947(a)(1) trust—

1. is not exempt under IRC Sec. 501(a) [e.g., because it fails to satisfy the organizational test of IRC Sec.501(c)(3)];

2. has all its unexpired interests devoted to religious, charitable, scientific, literary, or educational purposes,or to foster national or international amateur sports competition (but only if no part of its activities involvethe provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals; and

3. is a trust for which the grantor obtained a charitable contribution deduction for income, estate, or gift taxpurposes.

A Section 4947(a)(1) trust generally completes all sections of Form 990 (or Form 990-EZ, if qualified) and schedulesthat Section 501(c)(3) organizations must complete. However, a few special rules apply. The Section 4947(a)(1)box in item I in the Heading Section of Form 990 (or item J in the Heading Section of Form 990-EZ on page 1)should be checked, and Part V, line 12a of Form 990 should be answered “Yes” (or line 43 of Form 990-EZchecked). In addition, the tax-exempt interest received during the year by the trust either directly or indirectly (e.g.,by way of a mutual fund dividend) should be entered in the space provided on Part V, line 12b (or line 43 on Form990-EZ). [Lines 12a and 12b of Part V, Form 990 (or line 43 on Form 990-EZ) only apply if the Section 4947(a)(1)trust does not have any taxable income and is filing Form 990 (or 990-EZ) in lieu of Form 1041.]

A Section 4947(a)(1) trust that normally has $50,000 or less of gross receipts (as previously defined) and no taxableincome for the year must complete (1) lines 12a and 12b of Part V and the signature block on page 1 of Form 990(or line 43 and the signature block on page 4 of Form 990-EZ) and (2) items A, B, C, D, and I in the Heading Sectionof Form 990 (or items A, B, C, D and J in the Heading Section of Form 990-EZ).


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Supporting Organizations

Exempt charitable trusts and Section 4947(a)(1) trusts are private foundations unless they qualify as publiccharities. Since trusts are typically funded by a few grantors, the most practical way for them to qualify for publiccharity status is to qualify as a supporting organization for another public charity.

Example 1D-1 Charitable trust filing Form 990 in lieu of a fiduciary income tax return.

TheHenry R. Lucas Charitable Trust (Lucas Trust) was created under the will of Henry Lucas. Before his death,Mr. Lucas was a leader and active member of the First Church (FC) of Morton, Texas, a tax-exempt publiccharity. Lucas Trust’s sole purpose is to provide financial support for FC and its related institutions. Theoriginal trustees of Lucas Trust are FC members and hold important offices in one or more of its relatedinstitutions. By the terms of the trust instrument, all successor trusteesmust also be FCmembers and leaders.

Lucas Trust is a tax-exempt organization under IRC Sec. 501(a) as a result of being described in IRC Sec.501(c)(3), and is not a private foundation (because it is a supporting organization to FC, a public charity).Thus, the trust files Form 990 as its annual return and is not required to file a fiduciary income tax return (Form1041).

Organizations Filing a Group Return

Qualifying for Inclusion in a Group Return

Organizations that are exempt under a group exemption letter and that meet certain other requirements can filetheir annual returns on a group basis using the annual accounting period of their common central (parent)organization.

A central, parent, or similar organization can file a group return on Form 990 for two or more subordinate or localorganizations if they—

1. areaffiliatedwitha central tax-exemptorganization (that is not aprivate foundation) at theendof its taxyear;

2. are subject to the general supervision or control of the central organization;

3. have the same tax year as the central organization; and

4. have been issued a group exemption number that is in effect at year end.

Example 1E-1 Organizations with the option to be included in a group return.

The Childhood Educational Clinic, Inc. (CECI), is the parent organization of six local clinics. All the entities,including the parent organization, have the same annual accounting period and are tax-exempt under IRCSec. 501(c)(3), and none are private foundations. CECI obtained a group exemption letter several years agofor the local clinics. Thus, each of the local clinics may be included in a group return. CECI is responsible forfiling the group return; however, it may not include its own activity in this return. CECI must file a separateannual return for itself.

Choosing to Be Included in a Group Return

Each local or subordinate organization may file its own separate return without preventing the filing of a groupreturn for two or more other affiliated organizations. However, a qualified organization that wants to be included ina group return must comply with the following procedures:

1. Annually give written authorization to the parent organization to include it in the group return.

2. Provide the parent organization with statements specifically detailing its items of gross income, receipts,expenses, and other information required to be included in the group return.


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3. Make the authorization and statements under the penalties of perjury and have them signed by a dulyauthorized chapter officer.

The parent organizationmust retain the authorization and other information received from each local chapter for sixyears after the last year for which a group return filed by the parent organization includes that chapter.

Preparing a Group Return

The regulations provide relatively little specific guidance regarding the preparation of a group return. However, thereturn must be based on the annual accounting period of the central (parent) organization (or on the calendar yearif the central organization does not have an established accounting period). Thus, all the local or subordinateorganizations included in the group return must have the same tax year-end.

If the organization answers “Yes” to item H(a) in the Heading Section of Form 990 but “No” to item H(b), attach a list(not in Schedule O) indicating the name, address, and EIN of each subordinate organization included in the groupreturn.

Consequences of Parent’s Loss of Tax-exempt Status

If the tax-exempt status of the parent or central organization of a group of affiliated organizations is automaticallyrevoked for failure to file its own annual return for three consecutive years, the group exemption also is dissolved asof the automatic revocation date. Consequently, all subordinate organizations covered as part of the group rulingwill no longer be included in the group exemption or be recognized as tax-exempt by the IRS. This is true even if theparent or central organization has filed a group return for the subordinate organizations within the three-year periodending with the automatic revocation, or if the subordinate filed its own annual return or notice within the samethree-year period. If the subordinate or its parent filed such a return within that three-year period, however, thesubordinate will not be included in the list of revoked organizations on the IRS website.

If a parent or central organization of a group of affiliated organizations does not file a group return for threeconsecutive years, then any subordinate organizations covered as part of the group ruling and that have not filedtheir own annual returns or notices for three consecutive years are automatically revoked and will no longer betax-exempt under federal law. Each subordinate organization whose exemption is revoked may be required to fileincome tax returns. To be recognized by the IRS as exempt from income tax, it must file an application forexemption. The central organization cannot add the subordinate back to the group ruling after the subordinate’sexempt status has been automatically revoked.

Special Circumstances for Filing

Filing a Return When Exemption Application Is Pending

An organization that claims tax-exempt status must file any returns that come due while its application is pendingas well as those that are due before the exemption application has been filed with the IRS. Thus, Form 990, 990-EZ,or 990-N is filed (or submitted) according to its normal due date (i.e., the 15th day of the fifth month after year-end).Organizations appealing a proposed adverse determination of their exempt status by the IRS should also follow thisprocedure.

The organization should check the “Application pending” box in item B, in the Heading Section of page 1 of Form990 (or 990-EZ) if it is claiming tax-exempt status but has not yet filed an exemption application, or has filed one andis awaiting a response from the IRS.

Example 1F-1 Reporting requirements when application for exemption is pending.

United Charities, Inc. (United), began operations on October 5, 2017, using the calendar year as its annualaccounting period. In February 2018, United filed Form 1023 [Application for Recognition of Exemption UnderSection 501(c)(3) of the Internal Revenue Code] to be recognized as a public charity. On May 15, 2018 (thedue date for a calendar-year Form 990), United’s exemption application was still pending with the IRS.


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Although the IRS has not approved United’s request for tax-exempt status, United must file Form 990 for thepart of 2017 it operated, assuming it had more than $75,000 of gross receipts (or donor pledges) during theperiod. (See Example 1A-2.) The return or an extension request must be filed by the normal due date of May15. United should check “Application pending” in item B on page 1 of Form 990.

Section 501(c)(29) Organizations. Rev. Proc. 2015-17 explains how and when Section 501(c)(29) qualified non-profit health insurance organizations can apply for recognition of exempt status. An organization claiming Section501(c)(29) exempt status that intends to file a letter application for exemption but has not done so should file anyForm 990 that would be due and check “Application pending” in Item B of the Heading Section on page 1.

Filing a Return When the Exemption Request Is Denied

An organization’s application for exemption may ultimately be rejected. If the exemption request is denied, theorganization is treated as a taxable entity from its inception. Thus, for all years the statute of limitations has not run(normally the shorter of three years or the period since the organization’s inception), it must file the same return asany other taxable entity of its type [e.g., a corporation would file Form 1120 (U.S. Corporation Income Tax Return)].Filing Form 990 (or Form 990-EZ) for a year, based on a good faith belief that the organization is exempt, starts thestatute of limitation period for that year.

Example 1F-2 Filing requirements when exemption application is not approved.

Assume the same facts as in Example 1F-1. United is notified in September 2018 that it does not qualify fortax-exempt status. By March 2019, United has unsuccessfully exhausted all of its appeal rights and isconsidered a taxable corporation from October 5, 2017 (the date of its inception).

United should file Form 1120 for 2018 because it is a taxable corporation. Additionally, although Unitedpresumably acted in good faith when it filed its 2017 Form 990, the three-year statute of limitations for 2017 didnot close before the determination wasmade that United was not tax-exempt. Thus, it must also file Form 1120for 2017.

Variation: Assume United filed its Form 990 for 2017 by May 15, 2018. Its administrative appeal with the IRSof the adverse determination is not completed until August 10, 2021. If United filed a Form 990 for 2017 basedon a good faith determination that it was tax-exempt, it need not refile for this same year using Form 1120. Thestatute of limitations for 2017 closed on May 15, 2021, before the August 10, 2021, determination that Unitedwas not tax-exempt.

Filing Requirements in Final Year

When an exempt organization liquidates, dissolves, or terminates, special reporting rules generally apply. For acomplete liquidation or termination, check the “Final return/terminated” box in item B, in the Heading Section onpage 1 of Form 990 (or Form 990-EZ). An organization that checks this box may also be required to attachSchedule N. (See Lesson 2 for a discussion of Schedule N.)

An organization’s final return is due on or before the 15th day of the fifth month following its liquidation, dissolution,or termination. Thus, unless an organization dissolves during the final month of its regular accounting period, itsfinal return (or a request for an extension to file the final return) will be due before the normal filing deadline.

Requesting an Extension

Extending the Deadline for Filing a Single Return

Form 990 (or Form 990-EZ) must be filed by the 15th day of the fifth month after the close of the organization’s taxyear (e.g., May 15 for a calendar-year entity). Organizations filing Form 990 series returns for tax years beginningafter December 31, 2015, can obtain a single six-month automatic extension period (e.g., November 15 for acalendar year entity) for filing their annual return by submitting a timely filed extension request.

Form 8868 (Application for Extension of Time To File an Exempt Organization Return). The six-month automaticextension request must be filed on or before the due date of Form 990 or Form 990-EZ. The extension is made on


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Form 8868 and filed electronically or with the Department of the Treasury, Internal Revenue Service Center, Ogden,UT 84201-0045. Only the original of the form is required in this situation. It will be granted if the Form 8868 isproperly completed, filed with the IRS, and the balance due on line 3c is paid electronically by the return’s due datefor which the extension applies using EFTPS.

Example 1G-1 Requesting an extension to file Form 990.

Amalgamated Charities, Inc. (ACI), keeps its books on a calendar-year basis. ACI’s accounting manager,Janet Hill, is primarily responsible for gathering the information needed to prepare the return. In March 2018,Janet suffered a personal injury and was unable to return to work until May 1, two weeks before theorganization’s original filing deadline. As a result, ACI needs additional time to file its return.

Before the deadline for filing the return (May 15, 2018), ACI must file Form 8868 with the IRS. If it is properlycompleted and timely filed, a six-month extension is automatically granted.

Extending the Deadline for Filing a Group Return

A central organizationmay apply for an extension of time to file a group return. Complete and check the appropriatebox and enter the group exemption number (GEN) in the Group Return bullet (above line 1). If the extension is notfor all the organizations that are part of the group return, attach a schedule to Form 8868 identifying the name andemployer identification numbers of each organization to be included in the group return. (A discussion of groupreturns appeared earlier in this lesson.)

Penalties for Failing to File

Against the Organization

A penalty of $20 a day, not to exceed the smaller of $10,000 (adjusted for inflation after 2014) or 5% of the grossreceipts of the organization for the year, may be charged when a return is filed late unless the organization canshow that the late filing was due to reasonable cause. Organizations with annual gross receipts exceeding $1million are subject to a penalty of $100 for each day the return is late (with a maximum penalty with respect to anyone return of $50,000, adjusted for inflation after 2014). The penalty applies on each day after the due date that thereturn is not filed. Tax-exempt organizations that are required to file electronically but do not are deemed to havefailed to file the return (even if a paper return is submitted).

Revocation

The exempt status of an organization that fails to file the required annual return or notice for three consecutive yearsis automatically revoked.

Incomplete Returns

The penalty may also be charged if the organization files an incomplete return. Avoid an incomplete return by—

1. completing all applicable line items;

2. answering each question on the return unless instructed to skip a line (if answering a line is predicated ona “Yes” answer to the preceding line, and if the answer to the preceding line was “No,” then leave the “IfYes” line blank);

3. making an entry (including a zero when appropriate) on all lines requiring an amount or other informationto be reported;

4. providing all required explanations; and

5. attaching all required schedules (including Schedule O, which is required for all Forms 990 and 990-EZ).


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This penalty may also be imposed if the organization’s return contains incorrect information (i.e., an organizationthat reports contributions net of related fundraising expenses may be subject to this penalty).

Use of a paid preparer does not relieve the organization of its responsibility to file a complete return.

Penalty Against Responsible Person(s)

If the organization does not file a complete return (or does not furnish correct information), the IRS will send theorganization a letter that includes a fixed time to fulfill these requirements (generally 90 days from the mailing date ofthe demand letter). After that period expires, the person(s) failing to comply will be personally liable for a penalty of$10 a day. The maximum penalty on all persons for failures with respect to any one return shall not exceed $5,000.

There are also penalties (fines and imprisonment) for willfully not filing returns and for filing fraudulent returns andstatements with the IRS. States may impose additional penalties for failure to meet their separate filing requirements.

Amended Returns

An amended return should be filed if gross receipts were omitted, if there is a change in the status of a publiccharity, or if there is a change in unrelated business income. Since no tax is usually involved, deciding when todisclose a correction on the following year’s return or file an amended return may be difficult.

To change the organization’s return for any year, refile the entire return including any required schedules not just thenew or corrected information. Use the version of Form 990 (or Form 990-EZ) applicable to the year being amended.Check the “Amended return” box in item B in the Heading Section of page 1 of Form 990 (or Form 990-EZ). Statein Schedule O which parts and schedules of the Form 990 were amended and describe the amendments.

Example 1I-1 Determining when to file an amended return.

Good Deeds, Inc. (GDI), omitted $100,000 in gross receipts on its 2017 Form 990 due to a bookkeeping error.Thus, GDI should file an amended Form 990 for 2017.

Use Form 4506 (Request for Copy of Tax Return) to obtain a copy of the filing organization’s previously filed return.

According to General Instruction G to Form 990, if the originally filed Form 990 (or Form 990-EZ) must be amendedor additional information is requested from the IRS on specific line items, the same information may be required tobe provided to any state with which the Form 990 or Form 990-EZ was filed. A state may require an organization toamend its Form 990 or Form 990-EZ to satisfy state reporting requirements, even if the original return was acceptedby the IRS.

The amended return must be made available for public inspection for the later of three years from (1) the date offiling the amended return or (2) the date the original return was due (including valid extensions).


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SELF-STUDY QUIZ


4. The Carmine Group is a nonprofit parent organization. Assuming all other conditions are met, the CarmineGroup can include which of the following organizations on its group Form 990?

a. Merit Limited is affiliated with a private foundation.

b. Bread Basket is under the control of the Carmine Group.

c. Knitters Unite has a different tax year than the Carmine Group.

d. Welcome Home neglects to give the Carmine Group written authorization of inclusion.

5. If gross receipts were omitted, the status of a public charity changed, or unrelated business income changedafter Form 990 is filed, what should an organization do?

a. File for an exemption from filing Form 990.

b. Preserve its tax exemption by qualifying as a supporting organization.

c. File Form 8868.

d. File an amended Form 990.


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SELF-STUDY ANSWERS


4. The Carmine Group is a nonprofit parent organization. Assuming all other conditions are met, the CarmineGroup can include which of the following organizations on its group Form 990? (Page 277)

a. Merit Limited is affiliated with a private foundation. [This answer is incorrect. To be part of a group Form990, one condition anorganizationmustmeet is to be affiliatedwith a central tax-exempt organization (thatis not a private foundation) at the end of its tax year. Therefore, Merit Limited’s affiliation with a privatefoundation does not give Carmine Limited the right to include Merit Limited on the group Form 990.]

b. Bread Basket is under the control of the Carmine Group. [This answer is correct. A central, parent,or similar organization (like theCarmineGroup) can file a group return on Form 990 for two ormoresubordinate or local organizations if they meet specific conditions, including being subject to thegeneral supervision or control of the central organization (like Bread Basket is) and being issueda group exemption number that is in effect at year end.]

c. Knitters Unite has a different tax year than the Carmine Group. [This answer is incorrect. To be part of thegroup Form 990, Knitters Unite would need to have the same tax year as the central organization. Sinceit does not, the Carmine Group cannot include Knitters Unite.]

d. Welcome Home neglects to give the Carmine Group written authorization of inclusion. [This answer isincorrect. A qualified organization that wants to be included in a group return must comply with certainprocedures, including giving annual written notice to the parent organization to include it in the groupreturn. Therefore, if Welcome Home is to be included, it needed to give such authorization to the CarmineGroup.]

5. If gross receipts were omitted, the status of a public charity changed, or unrelated business income changedafter Form 990 is filed, what should an organization do? (Page 281)

a. File for an exemption from filing Form 990. [This answer is incorrect. Organizations that meet certainqualifications are statutorily exempt from filing Form 990 or Form 990-EZ. The IRS also has thediscretionary authority to exempt any organization from the annual filing requirementswhen a return is notnecessary for the efficient administration of the tax laws. However, neither of these reasons for exemptionis applicable in the circumstances described above, in which a Form 990 was already filed.]

b. Preserve its tax exemption by qualifying as a supporting organization. [This answer is incorrect. Exemptcharitable trusts and Section 4947(a)(1) trusts are private foundations unless they qualify as publiccharities. Since trusts are typically funded by a few grantors, the most practical way for them to qualify forpublic charity status is to qualify as a supporting organization for another public charity. However, publiccharity status is unrelated to the circumstances described above, so there is a better answer to thisquestion.]

c. File Form 8868. [This answer is incorrect. Form 8868 (Application for Extension of Time To File an ExemptOrganization Return) is used when organizations need an extension on the due date of their Form 990 orForm 990-EZ.]

d. File an amended Form 990. [This answer is correct. An amended return should be filed if grossreceipts were omitted, if there is a change in the status of a public charity, or if there is a change inunrelated business income. To change the organization’s return for any year, refile the entire returnincluding any required schedules not just thenewor corrected information. Use the version of Form990 (or Form 990-EZ) applicable to the year being amended.]


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Lesson 2: Highlighting an Organization’sAccomplishmentsIntroduction

The first two pages of Form 990 report general information about the organization and summary financial informa-tion. In an effort to enhance transparency, information included on page 1 is intended to provide a snapshot of theorganization’s key financial, compensation, governance, and operational information. Much of the required sum-mary information is pulled from other parts of the return. Therefore, these schedules must be completed before thesummary information can be compiled.

Program service accomplishments are highlighted in Part III of Form 990. These are activities of the organizationthat accomplish its exempt purpose.


Completion of this lesson will enable you to:¯ Identify thebasicpreparation requirements for theheadingsectionofForm990;how tosummarize themission,governance, and operational information; and how to report program service accomplishments.

¯ Determine thebestmethod for explaininganorganization’s exemptpurposeachievements, reporting thevalueof donated services, dealing with public interest law firms, and completing Schedule N for a terminatingorganization.

The Heading Section of Form 990 and Allowable Attachments

Schedule O is used to report information that requires additional explanation to items reported on the core Form990 and other schedules. In fact, only five attachments to the core Form 990 and schedules are allowed. Thefollowing items are required to be attached to the Form 990 rather than reported in Schedule O:

1. Name change amendment to organizing document, required by item B in the Form 990 heading.

2. List of subordinate organizations included in a group return, required by item H in the Form 990 heading.

3. Articles of merger or dissolution, resolutions, and plans of liquidation or merger, required by Schedule N.

4. Reasonable cause explanation for a delinquent return.

5. A copy of the most recent audited financial statements of a hospital organization that files Schedule H(Hospitals) of Form 990.

Completing the Heading Section of Form 990

Item A—Accounting Period. Use the 2017 Form 990 (or Form 990-EZ) for calendar year 2017 and for fiscal yearsthat begin in 2017 and end in 2018. If the organization uses a fiscal year, complete the tax year beginning andending in the space provided in item A at the top of Form 990 (or Form 990-EZ). A short accounting period (i.e., lessthan 12 months) may occur when an organization begins operations, changes accounting periods, or terminates.If a short year begins in 2017 and ends before December 31, 2017, the organization may use either the 2016 or2017 Form 990 for the short year return. The 2017 form may also be used for a short period beginning in 2018 andending before December 31, 2018 (not on or after December 31, 2018). When doing so, provide the information fordesignated years listed on the return, as if they were updated on the 2018 form. For example, provide theinformation in Schedule A, Part II for the tax years 2014–2018, rather than for tax years 2013–2017.

Item B—Checkboxes. Check all boxes that apply.


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Address Change. Check this box if the organization has changed its address and has not reported the change ona previous return, Form 8822-B, or in a correspondence with the IRS.

Name Change. Check this box if the organization changed its legal name and has not reported this name changeon a prior return or in a correspondence to the IRS. If the “Name change” box is checked, provide whichever of thefollowing is appropriate for its legal form:

1. If a corporation—a copy of the amendments to the articles of incorporation with proof of filing with theappropriate state authority.

2. If a trust—a copy of the amendment to the trust agreement, or a resolution to amend the trust agreement,reflecting the effective date of the name change; and signed by at least one trustee.

3. If an unincorporated association—a copy of the amendments to the articles of association, constitution,bylaws, or other organizing document reflecting the effective date of the name change, and with thesignatures of at least two of the officers, trustees, or members.

If the organization changes its “Doing Business As” name, do not check the name change box or attach additionaldocuments.

Initial Return. Check this box if this is the first time an organization is filing Form 990 and it has not previously fileda Form 990-EZ, 990-PF, 990-T, or 990-N.

Final Return/terminated. Check this box if the following have occurred:

¯ The organization has terminated its existence. If the organization liquidated, terminated, or dissolvedduring the year, also check the “Yes” box in Part IV, line 31, and attach Schedule N.

¯ The organization is no longer exempt under IRC Sec. 501(a) or 527 and, therefore, is filing its final exemptorganization return.

Amended Return. If the organization is amending a previously filed return, check this box, complete and file anamended return, and explain in Schedule O which parts and schedules of Form 990 or 990-EZwere amended. Alsodescribe in Schedule O the actual amendments.

Application Pending. Check this box if the organization claims tax-exempt status under IRC Sec. 501(a) and isrequired to file and either (1) has not yet filed a Form 1023, Form 1023-EZ, or 1024 or (2) is awaiting an IRSresponse to a filed Form 1023, Form 1023-EZ, or Form 1024. If this box is checked, all parts of Form 990 or 990-EZand required schedules should be completed.

Organizations that can claim tax-exempt status without filing an exemption application (i.e., self declarers) shouldalso check this box.

Item C—Name and Address. The organization should show its legal name in item C. This should be the name usedon the organization’s exemption application (e.g., Form 1023 or 1023-EZ) or on a subsequently legal name changefiled with the IRS (see the discussion earlier in this lesson about the information required for a legal name change).If it operates under a different name, give the legal name and then identify the alternate name on the “DoingBusiness As” (DBA) line.

If the organization receives its mail in care of a third party (e.g., an attorney or accountant), enter on the streetaddress line “C/O” followed by the third party’s name and street address or P.O. box. Include the suite, room, orother unit number after the street address. If the U.S. Postal Service does not deliver mail to the street address, butthe organization has a P.O. Box, show the box number instead of the street address.

For foreign addresses, enter information in the following order: city or town, province or state, the name of thecountry, and the postal code. Do not abbreviate the country name.


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Item D—Employer Identification Number (EIN). Enter the organization’s EIN. An EIN can be applied for online byfollowing the instructions atwww.irs.gov (search “Apply for EIN”). In an online application, the instructions must befollowed precisely; otherwise, the application will be rejected. At the beginning of the online application process,the organization will be asked to check a box that best describes its legal structure (e.g., corporation, trust, limitedliability company, or unincorporated association). The preliminary validation process offers prompts for invalidinformation. The EIN will be issued immediately upon validation of the application information.

Alternatively, an EIN can be requested by faxing a completed Form SS-4 (Application for Employer IdentificationNumber) to (855) 641-6935, or by mailing it to the IRS, Attn: EIN Operation, Cincinnati, OH 45999.

Item E—Telephone Number. Provide a telephone number that can be used by either the general public orgovernment personnel during regular business hours to obtain information about the organization’s finances oractivities. If the organization does not have a telephone number, enter the telephone number of an organizationofficial who can provide such information.

Item F—Name and Address of Principal Officer. Provide the name and complete mailing address of the principalofficer that the IRS can contact, if necessary. If the address is the same as the organization’s, enter “same as itemC above.” For this purpose, the principal officer is the person, regardless of title, who has the ultimate responsibilityfor implementing the decisions of the organization’s governing body or for overseeing the management, adminis-tration, and operation of the organization.

Item G—Gross Receipts. Report the total of Part VIII, column A, lines 6b [both columns (i) and (ii)], 7b [bothcolumns (i) and (ii)], 8b, 9b, 10b, and 12. There are exceptions to filing Form 990 based on gross receipts and totalassets. Lesson 1 discussed these exceptions.

Item H—Group Return and Exemption Number. If the “Yes” box in item H(a) and the “No” box in item H(b) arechecked, attach a list with the following items for each local or subordinate organization included in the groupreturn: (1) name, (2) address, and (3) nine-digit EIN.

This is one of the few times when the organization will not complete Schedule O to provide additional information.Follow these rules when attaching a list:

1. Show the form number (e.g., Form 990) and the tax year.

2. Include the group exemption name and nine-digit EIN.

3. Record the four-digit group exemption number (GEN).

4. Use the same size paper as the form.

Note that a central or subordinate organization filing its separate return does not attach a list.

For item H(c), enter the four-digit GEN (not the nine-digit EIN) number if the organization is—

1. filing a group return, or

2. a central or subordinate organization in a group exemption and is filing a separate return.

For additional discussion of the group return filing requirements, see Lesson 1.

Item I—Tax-exempt Status. An organizationmust indicate the IRC Section that governs its exempt status. Organiza-tions exempt under IRC Sec. 501(c) must fill in the appropriate paragraph number. For example, enter “4” if exemptunder IRC Sec. 501(c)(4). An organization’s IRS exemption letter may be out of date because of changes in itsactivities since inception. Therefore, the Exempt Organizations Business Master File, which is continuouslyupdated, is the most definitive source of the IRC section governing an organization’s exempt status, rather than itsexemption letter.


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Item J—Website. Provide the organization’s current (as of the date of filing the return) website address or enter“N/A” if the organization does not have a website. It is important to maintain an accurate and up-to-date website. Byincluding the website address as part of the return, the IRS, reporters, and potential donors will have access to anyinformation posted. It can be an excellent marketing tool for an organization. But, the IRS may look at the websitefor potential political activity that would threaten an organization’s exemption, unrelated business income, or othertax related issues.

Item K—Form of Organization. Check the appropriate box for the legal type of entity (or state law status) in its stateof legal domicile. If the specific type is not listed, check “Other” and write the type (e.g., partnership or LLC) in thespace provided. Check “Other” if it is a group return with more than one organization form.

Item L—Formation Year. Enter the year the entity was legally created under state or foreign law (e.g., a corporationenters the year of incorporation). Leave item L blank if the return is a group return.

Item M—State of Legal Domicile. Record the place of legal domicile as follows:

1. For a corporation—the state (if U.S.) or country (if outside of the U.S.) of incorporation. This information isreflected in the articles of incorporation, articles of organization, or other document under which it wasestablished.

2. For a trust or other entity—the state (if U.S.) or country (if outsideof theU.S.)whose lawsgovern the internalaffairs of the organization.

Leave item M blank if the return is a group return.

The Mission, Governance, and Operational Information

Summary Information

Part I provides a snapshot of the organization’s mission, governance, and key financial, compensation, andoperational information.

Line 1—Mission or Significant Activity. Use this limited space to highlight and describe either the organization’smission (i.e., the organization’s main reason for exemption) or its most significant activity for the year. Note that theorganization’s approved mission statement is described on line 1 of Part III.

Line 2—Discontinued Operations or Major Disposition. Check this box if either (1) the organization liquidated,terminated, or dissolved and ceased operations (i.e., Part IV, line 31, was answered “Yes”); or (2) the organizationsold, exchanged, disposed of, or transferred more than 25% of its net assets (i.e., Part IV, line 32, was answered“Yes”). If this box is checked, complete Part I or II of Schedule N, which is discussed later in this lesson.

Example 2B-1 Sale of major asset by organization.

Caring Hands is an exempt organization under IRC Sec. 501(c)(3). During the year, Caring Hands sold abuilding (with a cost basis of $800,000) for $1 million. The net assets of the organization before the saletotaled $3 million. Caring Hands is still in operation.

Caring Hands should check the box on line 2 of Form 990 as it has disposed of more than 25% of its netassets. It should also complete Schedule N.

Line 6—Volunteers. Report the number of full- and part-time volunteers (including volunteer members of thegoverning body) who provided services to the organization during the return year. If detailed records are not kept,a reasonable estimate can be provided. The organization can use any reasonable basis for determining thisestimate. The instructions do not describe reasonable basis. Organizations can use this as an opportunity tohighlight the amount of volunteer hours provided to them as many organizations would not survive without theirdedicated volunteers.


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Line 7b—Unrelated Business Taxable Income. If the organization has not filed its Form 990-T, enter an estimate ofthe amount it expects to report on Form 990-T, line 34. If no Form 990-T is required for the tax year, enter “0.”

Lines 8–19—Prior Year Column. If this is the organization’s initial return (or if the organization previously filed Form990-EZ or Form 990-PF), do not complete the “Prior Year” column. Use the same lines from the prior year return todetermine what to report for prior year revenue and expense amounts.

Line 16a—Professional Fundraising Fees. The total of the professional fundraising fees reported in Part IX, column(A), line 11e, and the portion of the amount reported in Part IX, column (A), lines 5 and 6, comprising professionalfundraising fees paid to officers, directors, trustees, key employees, and disqualified persons, whether or not suchpersons are employees of the organization is entered on line 16a. Fundraising fees paid to officers, directors,trustee, key employees, and disqualified persons are not reported on Part I, line 15.

Signature Block

Signature of Officer. A current officer of the organization who is authorized to sign the returnmust sign as of the datethe return is filed. This can be the president, vice president, treasurer, assistant treasurer, chief accounting officer,or other corporate officer (i.e., a tax officer) authorized to sign. A receiver, trustee, or assignee must sign for anyreturn he or she files for a corporation or association. The authorized trustee(s) must sign for a trust.

Paid Preparer Signature. A nonemployee paid preparer must complete the “Paid Preparer’s Use Only” area asfollows:


2. Complete the preparer information including the preparer’s PTIN (not his or her social security number).


Paid preparers can obtain (or renew) a preparer’s taxpayer identification number (PTIN) by completing paper FormW-12 [IRS Paid Preparer Tax Identification Number (PTIN) Application and Renewal] available on the IRS websiteat www.irs.gov (search “PTIN”). Form W-12 may also be completed online through the IRS website. However, beaware that a paper application can take four to six weeks to process, whereas a PTIN can usually be obtained in 15minutes using the online application process.

Check “Yes” on the last line of Part II (Part VI of Form 990-EZ) if the IRS is authorized to contact the paid preparerto answer any questions arising while processing the return as well as—

1. provide any missing information from the return;

2. contact the IRS about processing the return; and

3. respond to certain IRS notices about math errors, offsets, and return preparation.

However, checking “Yes” does not authorize the paid preparer to bind the organization to anything or represent theorganization before the IRS. If the organization checks “No,” the IRS will contact the principal officer listed in itemF of the Heading Section instead of the paid preparer.

Reporting an Organization’s Program ServiceAccomplishments

Generally

Form 990, Part III, is used to describe the organization’s major accomplishments during the year toward fulfilling itsexempt purpose. This purpose is achieved through the organization’s program services (i.e., through those activi-ties forming the basis for the organization’s tax-exempt status). In addition to describing their program services in


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Part III of the return, Section 501(c)(3) and (c)(4) organizations (i.e., the entities generally entitled to receive taxdeductible contributions) must also enter the grants and allocations to others and the total amount of expensesthey incurred for each program service.

Part III provides the organization an excellent opportunity to communicate to the public its activities and accom-plishments. Therefore, in larger organizations, Part III probably should be completed by an employee (e.g., a publicrelations person) rather than the outsider preparer. Be sure that the information in Part III is consistent with theorganization’s website.

IRS Use of Part III of the Return

Data on Form 990, Part III, helps the IRS evaluate whether an organization’s program services focus on appropriateactivities (including level of activity and content) for its exempt status. For Section 501(c)(3) and (c)(4) organizationsrequired to provide the expenses by each program service, the information provided in Part III also supplements theexpenditures shown in Part IX of Form 990. (The completion of Form 990, Part IX, is discussed in Lesson 4.)

Do not report a fundraising activity as a program service accomplishment unless it is substantially related tofulfilling the organization’s exempt purpose.

Developing and Maintaining a Positive Public Image

The public disclosure rules require that an organization furnish a copy of its Form 990, 990-EZ, 990-T 990-PF, 1023,or 1023-EZ in response to an in-person or written request for it. Alternatively, an organization can make its returnavailable on its website. Copies of many organizations’ returns are posted on the websites of other entities. Somestates also provide significant online access to organizations’ returns.

Part III offers an organization the opportunity to increase awareness about itself by fully describing its programservices and accomplishments as well as all related expenditures. These activities can exert a positive influenceupon a prospective donor. Conversely, the lack of activities can provide an investigative reporter with an idea for anegative news story. Therefore, an organization should complete Part III of Form 990 carefully and accurately.

Information Required in Part III

Check the box in the heading of Part III if Schedule O contains any information related to Part III.

Line 1—Mission. Briefly describe the organization’s mission. This should be a formal mission statement adopted orratified by the organization’s governing body. The mission statement typically addresses why the organizationexists, who it serves (or intends to serve), and the information about activities it will undertake to accomplish itsmission. Unless there is a significant change in the organization’s primary exempt purpose, this statement will likelybe the same each year. “None” if the organization’s governing body has not formally adopted or ratified a missionstatement.

Line 2—New Significant Program Service. Check the “Yes” box if the organization undertook a new significantprogram service activity prior to the end of the tax year that has not been described on a prior year return (i.e., Form990 or Form 990-EZ). Answer “No” if the organization has never filed a Form 990 or 990-EZ. If the “Yes” box ischecked, describe the new activity on Schedule O.

Line 3—Discontinued or Significant Changes in Program Services. Check the “Yes” box if the organization—

1. madeanysignificant changesprior to theendof the taxyear inhow it conducts itsprogramserviceactivitiesto further its exempt purposes; or

2. discontinued a significant program service that was conducted in a previous year.


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The IRS Exempt Organizations (EO) Determinations no longer issue letters confirming the tax-exempt status oforganizations that report new services or significant changes. An organizationmust report new, significant programservices or significant changes (including program cessation) in how it conducts program services on its Form 990,Part III, rather than in a letter to IRS EODeterminations. Correctly completing lines 2 and 3 is critical since this is howan organization updates the IRS regarding its continued qualification for exempt status.


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SELF-STUDY QUIZ


6. What type of information is reported on Schedule O?

a. An amendment to change the names in the organizing document.

b. A list of the subordinate organizations that are included in a group return.

c. Explanations and additional information about reported items.

d. Articles of merger or dissolution, resolutions, and plans of liquidation or merger.

7. What do organizations report on line 6 of Part I of Form 990?

a. Its full-time and part-time volunteers.

b. The reason for its exemption.

c. Its unrelated business taxable income.

d. Information about its prior year.


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SELF-STUDY ANSWERS


6. What type of information is reported on Schedule O? (Page 285)

a. An amendment to change the names in the organizingdocument. [This answer is incorrect. Oneof the fiveattachments allowed to Form 990 is a name change amendment to the organizing document, required byitem B in the Form 990 heading; therefore, this information would not be included on Schedule O.]

b. A list of the subordinate organizations that are included in a group return. [This answer is incorrect. A listof subordinate organizations included in a group return, required by item H in the Form 990 heading, isone of the attachments that is allowed to Form 990. Therefore, this list would not be included on ScheduleO.]

c. Explanations and additional information about reported items. [This answer is correct. Schedule Ois used to report information that requires additional explanation to items reported on the coreForm990 and other schedules. Only five attachments to the core Form 990 are allowed, so otherinformation is reported on Schedule O.]

d. Articles of merger or dissolution, resolutions, and plans of liquidation or merger. [This answer is incorrect.Sucharticles, resolutions, andplans, as requiredbyScheduleN,are anallowable attachment toForm990.Thus, because the information can be attached separately, it does not have a place on Schedule O.]

7. What do organizations report on line 6 of Part I of Form 990? (Page 288)

a. Its full-time and part-time volunteers. [This answer is correct. On line 6 of Part I of Form 990,organizations report thenumber of full-timeandpart-time volunteers (including volunteermembersof the governing body) who provided services to the organization during the return year. If detailedrecords are not kept, a reasonable estimate can be provided.]

b. The reason for its exemption. [This answer is incorrect. Organizations use the limited space on line 1 ofPart I (not line 6) to highlight and describe either the organization’s mission (i.e., the organization’s mainreason for exemption) or its most significant activity for the year.]

c. Its unrelated business taxable income. [This answer is incorrect. If the organization has not filed its Form990-T, it should use line 7b (not line 6) of Part I to enter an estimate of the amount it expects to report onForm 990-T, line 34. If no Form 990-T is required for the tax year, “0” is entered.]

d. Information about its prior year. [This answer is incorrect. The “Prior Year” column consists of lines 8–19(not line 6).]


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Explaining the Organization’s Exempt Purpose Achievements

Measuring the Benefits Provided by the Program Services (Part III)

Lines 4a–4c. Fully describe each of the organization’s three largest program services measured by total expensesincurred. Do not include any value for donated services or the use of donated materials, equipment, or facilities.More information on reporting donated services and what to do if the organization has more than three significantprograms is provided later in this lesson. Rank the programs according to the total expenses allocated to each. Usethe following guidelines for describing the program service:

1. For program service accomplishments, use specific measurements such as clients served, days of careprovided, number of sessions or events held, or publications issued.

2. Describe the activity’s objective, for both the period covered by the return and the overall long-term goal,if the output is intangible, such as in a research activity.

3. If exact figures are not available, use reasonable estimates for statistical information and indicate thatestimates were used.

4. Include the amount of donated services or the use of materials, equipment, or facilities in the narrativedescription of the program services. However, do not include these amounts in the amounts reported forrevenue, expenses, or grants in lines 4a–4e.

5. Be clear, concise, and complete.

6. If additional space is needed, use Schedule O.

Codes

The numerical codes are intended to capture information about activities that could provide improved researchcapabilities for the IRS and public researchers. For 2017, leave the “Code” space blank.

Reporting Expenses for Each Program Service

Section 501(c)(3) and (c)(4) organizations must enter the total expenses incurred, including the total grants andallocations (if any) included within the total expenses for each program service listed in Part III, line 4.

Example 2D-1 Completing the Statement of Program Service Accomplishments.

The Rocky Mountain Society (RMS), a Section 501(c)(3) organization, regularly conducts free educationalprograms to inform the public about the dangers of RockyMountain Spotted Fever. They are the sole programservice activity of RMS and are the reason for its tax-exempt status.

During the current year, RMS incurred a total of $127,418 in expenses, allocated to the following functions:program services—$91,152, management and general—$23,221, and fundraising—$13,045.

The $91,152 amount of program service expenses shown in the expenses space agrees with the total in theprogram services column of Part IX, line 25, column (B).

An organization may conduct multiple program service activities within the same year. In this situation, it is notunusual to have expenditures relating to more than one program. Thus, to correctly complete Part III, line 4, anorganization may need to allocate various expenses among its different activities. The IRS instructions do notindicate how expenses common to more than one program service activity should be allocated. Any reasonableapproach taken in the organization’s books and records should be acceptable for the return.

Example 2D-2 Allocating common expenses among program activities.

Associated Charities, Inc. (ACI), a Section 501(c)(3) organization, operates a public assistance program forindigent families. It also awards two $20,000 scholarships annually to allow the recipients to attend college full


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time pursuing an advanced social services degree. Direct expenses for these two programs as well asexpenses common to both are as follows: public assistance—$280,000, scholarships and othergrants—$50,000, and common expenses—$35,000.

ACI believes it is reasonable to allocate the joint costs based on the ratio of direct expenses for each activityto total direct expenses of all such activities. Therefore, joint expenses would be allocated $29,697 [$280,000÷ ($280,000 + $50,000) × $35,000] to public assistance and $5,303 [$50,000 ÷ ($280,000 + $50,000) ×$35,000] to scholarships and other grants.

If expenses are not allocated in the organization’s accounting records, the appropriate allocation method isnormally determined by the return preparer. (See Lesson 4 for a discussion of alternatives for allocating joint orindirect expenses.) Use the same method consistently each year, unless a material change occurs in the entity’sactivities that warrants a new allocation method.

Payments to Domestic Individuals or Other Domestic Organizations

Section 501(c)(3) and (c)(4) organizations must separately report (in the space provided) any grants or allocationspaid during the year and associated with a program service activity listed in Part III, line 4. (The payment should beincluded in the expenses shown for that program service.) The total of these payments for all program servicesshould equal the amount entered on the grants and allocations lines (lines 1 through 3) of Part IX, column (B) ofForm 990. If an organization has more than three program services, the grants and allocations can be reported onSchedule O for these additional programs.

Example 2D-3 Reporting grants and allocations.

ACI (see Example 2D-2) also provides grants and awards to other charitable organizations. For example,during the current year, it granted $10,000 to Charities Management, Inc. to assist it in starting local charitableorganizations in communities throughout the state.

A summary of ACI’s program service expenses for the year is as follows:

ProgramGrant/Allocation

OtherExpenses

Public assistance (Direct $280,000 + Allocated $29,697) $ — $ 309,697Scholarshipsa 40,000 4,242Assistance to other charitable entitiesb 10,000 1,061

$ 50,000 $ 315,000

Notes:

a ($40,000 ÷ $50,000) × $5,303 = $4,242

b ($10,000 ÷ $50,000) × $5,303 = $1,061

Reporting Revenue from Program Activities

For each program service activity listed in line 4, Section 501(c)(3) and (c)(4) organizations must enter any revenuederived directly from the activity. This might include fees for services or revenue from the sale of goods that directlyrelate to the listed activity.

Revenue reported here includes—

1. program service revenue in Part VIII, line 2, column (A);

2. other amounts reported in Part VIII, lines 3–11, as related or exempt function revenue; and

3. unrelated business income fromabusiness that exploits an exempt function (e.g., advertising in a journal).


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Reporting Multiple Program Services

Line 4d. If an organization has more than three programs, list the three largest ones (based on total expenses foreach) in Part III, line 4, and, if desired, list the remaining programs on Schedule O. Report the total expenses,grants, and revenue for these remaining programs on Part III, line 4d. Section 501(c)(3) and (c)(4) organizationsmust provide a breakdown of expenses, grants, and revenues by program service for these additional services inthe same manner as for the programs listed in Part III, line 4.

Example 2D-4 Reporting on more than three program services.

Assume the same facts as in Example 2D-1, except RMS engages in five program services: conductingseminars, producing a newsletter, producing DVDs, giving speeches to civic organizations, and visitingpatients in hospitals. Its program service expenses are $191,252.

RMS must complete Part III, line 4, for the three largest programs and may attach Schedule O to the returnshowing the fourth and fifth program services and [because it is a Section 501(c)(3) organization] its relatedexpenses, grants, and revenues. Total program service expenses listed on Schedule O are reported in Part III,line 4d.

Reporting the Value of Services That Were DonatedWhen the organization receives donated services or the use ofmaterials, equipment, or facilities, the organizationmay show in Part III, line 4, the value of such noncash donations used in each program service. However, theamounts can only be included in the descriptions of the program services. They should not be included in theamounts in revenue, expenses, or grants reported in lines 4a–4e even if prepared in accordance with generallyaccepted accounting principles.

Example 2E-1 Disclosing the value of donated facilities.

United Charities, Inc. (United), operates a shelter for the homeless in a privately owned building. AlthoughUnited is responsible for all of the utilities, upkeep, and routine building maintenance, it rents the facility foronly $10 per year. If United were paying a FMV rental rate, its annual rent would be about $40,000 higher.

United is not required to disclose the value of the benefit it is receiving. However, it may be beneficial to makea disclosure so potential donors can evaluate the extent of public support United receives. United candisclose the value it is receiving from the use of the building in the narrative section of Part III, line 4 (on the linethe program service involving operation of the shelter is reported). United may not list the $40,000 of free rentas an expense in the expense space of Part III, line 4.

Considerations for Public Interest Law FirmsIf the organization is a public interest law firm exempt under Section 501(c)(3) or (c)(4), it must include a list of allthe cases in litigation or that have been litigated during the year. For each case—

1. describe the disputed matter,

2. explain how the litigation will benefit the general public, and

3. report the fees sought and recovered in each case.

Schedule N (Form 990 or 990-EZ)Schedule N (Form 990 or 990-EZ) is used to provide information related to an organization that is terminating ordisposing of more than 25% of net assets through sale, exchange, or other disposition. Schedule N is required if theorganization—

1. answered “Yes” to Form 990, Part IV, line 31 or 32; or

2. for Form 990-EZ filers, answered “Yes” to line 36, Part V, of Form 990-EZ.


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Due dates for this form were discussed in Lesson 1.

Complete Part I if the organization completely liquidated, terminated, or dissolved and ceased operations duringthe tax year. An organization that was in the process of winding up its affairs at the end of the tax year but that hadnot completely liquidated, terminated, or dissolved and ceased operations may need to complete Part II instead ofPart I. Complete Part II if there was a significant disposition of net assets. If there are more transactions to report inParts I and II than space available, use copies of Schedule N to report the additional information for Parts I or II.

Exemptions from the Reporting Rules Related to Dissolutions

The tax-exempt organizations in the following list are not required to provide the details of a liquidation, dissolution,or termination:

1. Churches, their integrated auxiliaries, conventions, or associations.

2. Organizations (which are not private foundations) with gross receipts that are normally $5,000 or less—forthis purpose, the word “normally” has the same meaning as in Example 1A-2, except that $7,500 issubstituted for $75,000; $6,000 for $60,000; and $5,000 for $50,000.

3. Exempt employee benefit trusts if the employer established that the trust includes the required informationrelated to any liquidation, dissolution, termination, or substantial contraction in its own return. [This appliesto Section 401(a) trusts that file a Form 5500 Series return instead of Form 990.]

4. Instrumentalities of the U.S. that are tax-exempt under IRC Sec. 501(c)(1) and any related entity organizedto hold title to property, collect income from the property, and turn over its total income (net of expenses)to a Section 501(c)(1) organization.

5. Nonprofit credit unions without capital stock that are organized and operated for themutual benefit of theirmembers and that are subject to a group exemption letter.

6. Subordinated units of a central organization that established their exempt status under the groupexemption procedures and for which the central organization files an annual group information return(which should contain the required information regarding the liquidation, dissolution, or termination).

7. An organization that is no longer exempt from tax and that during its exemption was not an organizationdescribed in IRC Sec. 501(c)(3) (related to religious, charitable, educational, etc., purposes) nor an entitythat heldproperty for suchanorganization. In addition, other organizationsdescribed in suchother sectionas prescribed by publication, form, or instructions are exempt from the reporting rules related todissolutions, liquidations, or terminations.

These exemptions relate only to entities that are not private foundations.

Liquidation, Termination, or Dissolution (Schedule N, Part I)

Part I is completed when an organization ceases operations and has no plans to continue any activities oroperations. This includes dissolutions, liquidations, terminations, ormergers into a successor organization. Organi-zations answering “Yes” to Form 990, Part IV, line 31, or Form 990-EZ, line 36 (for a liquidation, termination, ormerger with a successor organization), should complete Part I.

Attach a certified copy of articles of dissolution or merger, resolutions, or plans of liquidation or merger. Anorganization filing Schedule N should not report its liquidation, termination, or dissolution in a letter to the IRSExempt Organizations Determinations as they no longer issue letters confirming termination of exempt status uponliquidation, termination, or dissolution.

Line 1. Provide information on the assets transferred in the liquidation, termination, dissolution, or merger. If thereare more transactions to report than space available, Part I can be duplicated to report the additional transactions.


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Column (a). Assets can be combined into categories and adequately described. Related transaction expenses ofat least $10,000 should be listed separately. Related transaction expenses are payments to a professional or otherthird party for services rendered to assist in the transaction or the winding down of the organization’s activities (e.g.,attorney or accountant). Brokerage fees are not considered transaction expenses [but can be included in column(c)].

Column (b). Enter either the asset distribution date or the date the transaction expense was paid.

Column (c). Record the FMV of the asset distributed or the amount of the transaction expense paid.

Column (d). For assets distributed, report the valuation method. This could be an appraisal, comparables, bookvalue, actual cost, or outstanding offer. For transaction expenses, report the method for determining the expense(e.g., hourly rate or fixed fee).

Columns (e) and (f). Enter the name, address, and EIN of each recipient of assets distributed or transactionexpenses paid. If it is a membership organization that transfers assets to its members, individual names need notbe listed. Instead, members can be listed as a class of membership or listed as one group (if there is only one classof membership).

Column (g). If the recipient is a tax-exempt organization, enter the IRC Section under which the recipient is exempt.If the recipient is not tax-exempt, enter the type of entity (e.g., government agency or unit or LLC) or individual (if therecipient is not an entity). Examples of types of entities for recipients that are not tax-exempt include a corporation(S or C), partnership, LLC, trust, or association. Enter individual if the recipient is not an entity.

Line 2. Answer the questions appropriately to report whether any officer, director, trustee, or key employee listed inForm 990, Part VII, Section A is (or is expected to become) involved in a successor or transferee organization bygoverning, controlling, or having a financial interest in that organization. Having a financial interest includesreceiving payments from a successor or transferee organization as an employee, independent contractor, or anyother capacity.

Line 2d. Compensation or other similar payment includes a severance payment, a “change in control” payment, orany other payment that would not have been made to the individual if the dissolution, liquidation, or termination ofthe organization had not occurred.

Line 3. If this line is answered “No,” explain in Part III.

Lines 6b and 6c. If line 6b was answered “Yes,” explain in Part III how the bond liabilities were discharged,defeased, or otherwise settled during the year. If line 6b was answered “No,” explain in Part III if any bond liabilitieswere settled other than in accordance with the Code or applicable state law. If 6a is answered ”No,” leave line 6bblank.

Sale, Exchange, Disposition, or Other Transfer (Schedule N, Part II)

If the organization has made a significant disposition of net assets during the tax year, answer “Yes” to Form 990,Part IV, line 32, and complete Part II of Schedule N. For Form 990-EZ filers, a “Yes” answer to line 36 will requirecompleting Part II only if there is a significant disposition of net assets.

A significant disposition of the organization’s net assets includes a(n) sale, exchange, disposition, or other transferof more than 25% of the FMV of its net assets during the year, regardless of whether the organization received fulland adequate consideration. A significant disposition of net assets involves—

1. one or more dispositions during the tax year totaling more than 25% of the FMV of the organization’s netassets as of the beginning of its tax year; or

2. oneof a seriesof relateddispositionsor events commenced in aprior year that,whencombined, totalmorethan 25% of the FMV of the organization’s net assets as of the beginning of the tax year when the firstdisposition in the series was made.


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A significant disposition of net assets may result from either an expansion or a contraction of operations.

The following types of sales or exchanges are reported as significant dispositions:

1. Sales or exchanges of exempt assets for cash or other consideration.

2. Sales, contributions, or other transfers of assets to establish or maintain a partnership, joint venture, or acorporation (regardless of whether the sale or transfer is covered under IRC Sec. 721 or 351, or whetherthe transferor received an ownership interest in exchange for the transfer).

3. Sales of assets by a partnership or joint venture in which the organization has an ownership interest.

4. Transfers of assets pursuant to a reorganization in which the organization is a surviving entity.

The following situations need not be reported in Part II.

1. Transfers to a disregarded entity of which the organization is the sole member.

2. Change in the composition of publicly traded securities held in an investment portfolio.

3. Sales made in the ordinary course of the organization’s exempt purposes such as the gross sales ofinventory.

4. Decrease in the net assets’ value because of market fluctuations in the value of assets held.

5. Grants or other assistance made in the ordinary course of the organization’s exempt activities toaccomplish itsexemptpurposes (e.g., regular charitabledistributionsof aUnitedWayorganizationorotherfederated fundraising organization).

Lines 1 and 2. This portion of Part II is completed just like Part I. See the discussion earlier in this lesson on how tocomplete lines 1 and 2.

Supplemental Information

Use Part III to provide narrative information related to Part I, lines 2e, 3, 6c, or Part II, line 2e, and to provideadditional narrative explanations and descriptions to support responses in Part I or II. Use asmany separate copiesof Part III as needed. Identify the specific part and line(s) that the response supports.

Example 2G-1 Reporting a substantial disposition of assets.

The Hall County Volunteer Fire Department (Hall) is a tax-exempt Section 501(c)(3) organization that operateson a calendar-year basis. It has net assets of $100,000 on January 1, 2017. During 2017, Hall sells afive-year-old fire truck worth $30,000 to the Crowley Fire Department.

Hall must report the sale of the truck on Schedule N (Form 990 or 990-EZ) of its 2017 Form 990 as asubstantial disposition of assets. The combined distributions equal at least 25% of Hall’s assets at the start of2017 ($30,000÷ $100,000 = 30%). Hall should attach Schedule N to its return to report the sale. In addition,Hall should check “Yes” on line 32, Part IV, of Form 990.

Penalty for Failing to Furnish Certain Information

A penalty applies if information related to an organization’s liquidation, dissolution, termination, or substantialcontraction of net assets or operations is missing from the organization’s annual return.


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SELF-STUDY QUIZ


8. A donor allows Equal Rights to use office space for free. How should Equal Rights include this donation on itsForm 990?

a. As part of the revenue reported on lines 4a–4e of Part III.

b. In the descriptions of program services on line 4 of Part III.

c. On Schedule N.

d. On Schedule O.

9. Which of the following would be reported as a significant disposition on Part II of Schedule N?

a. A transfer to a disregarded entity in which the organization is the only member.

b. A change in the composition of the organization’s publicly traded security investments.

c. Decreases in the organization’s net assets due to market fluctuations.

d. The sale or exchange of any of the organization’s exempt assets.


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SELF-STUDY ANSWERS


8. A donor allows Equal Rights to use office space for free. How should Equal Rights include this donation on itsForm 990? (Page 297)

a. As part of the revenue reported on lines 4a–4e of Part III. [This answer is incorrect. Even if prepared inaccordance with generally accepted accounting standards, these amounts should not be included in theamounts in revenue, expenses, or grants reported in lines 4a–4e; therefore, doing so would mean EqualRights has not correctly filled out Part III of Form 990.]

b. In the descriptions of program services on line 4 of Part III. [This answer is correct. When theorganization receives donated services or the use of materials, equipment, or facilities, theorganizationmay show in Part III, line 4, the value of such noncash donations used in each programservice. However, the amount can only be included in the descriptions of the program services, notin specific amounts recorded. Therefore, by limiting this information to the descriptions, EqualRights will have correctly filled out this portion of Part III.]

c. On Schedule N. [This answer is incorrect. Schedule N is used to provide information related to anorganization that is terminating or disposing of more than 25% of net assets through sale, exchange, orother disposition. Therefore, the information about Equal Right’s noncash donation would be includedelsewhere on its Form 990.]

d. On Schedule O. [This answer is incorrect. If additional space is needed, Equal Rights might include thisinformation on Schedule O; however, there is a better place to include that information, assuming spaceis not an issue.]

9. Which of the following would be reported as a significant disposition on Part II of Schedule N? (Page 297)

a. A transfer to a disregarded entity in which the organization is the only member. [This answer is incorrect.When the organization is the sole member of such a disregarded entity, the transfer does not need to bereported as a significant disposition on Part II of Schedule N.]

b. A change in the composition of the organization’s publicly traded security investments. [This answer isincorrect. A change in the composition of publicly traded securities held in an investment portfolio is notconsidered a significant disposition and, therefore, is not reported on Schedule N, Part II.]

c. Decreases in the organization’s net assets due tomarket fluctuations. [This answer is incorrect. Decreaseinnet assets’ valuebecauseofmarket fluctuations in the valueof assetsheld is not considereda significantdisposition; therefore, an organization is not required to report it on Part II of Schedule N.]

d. The sale or exchange of any of the organization’s exempt assets. [This answer is correct. If theappropriateconditionsaremet, the following typesofsalesorexchangesare reportedassignificantdispositions: (1) sales or exchanges of exempt assets for cash or other consideration; (2) sales,contributions, or other transfers of assets to establish or maintain a partnership, joint venture, ora corporation; (3) sales of assets by a partnership or joint venture in which the organization has anownership interest; and (4) transfers of assets pursuant to a reorganization in which theorganization is a surviving entity.]


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Lesson 3: Governance, Management, andRequired DisclosureIntroduction

Part IV asks several questions (i.e., trigger questions) to determine whether a particular schedule must be com-pleted. Part V asks several questions about other IRS filing requirements not related to the Form 990. Thesequestions are intended to alert organizations to other potential federal tax compliance and filing obligations.

Part VI asks questions about the governing body andmanagement policies, and whether and how the organizationpromotes transparency and accountability to its donors. The IRS believes the likelihood that the organization isoperating in compliance with federal tax law increases when an organization has (1) an independent governingbody and (2) well-defined governance and management policies and practices. Although the IRS’s authority tocollect this information has been questioned, the IRS instructions to Form 990 require all organizations to completethis part.


Completion of this lesson will enable you to:¯ Determine the best method for completing Parts IV and V of Form 990.¯ Identify the information needed to complete Part VI of Form 990.

Checklist of Required Schedules (Part IV)

For each “Yes” answer to a line in Form 990, Part IV, complete the applicable schedule (or part or line of theschedule) indicated in the following subtopics. All pages of a required schedule should be filed even if only a partof the schedule must be completed.

Schedule A—Public Charity Status and Public Support

Line 1. Answer “Yes” and complete Schedule A if the organization is a Section 501(c)(3) organization that is not aprivate foundation. Answer “Yes” even if the organization claims Section 501(c)(3) status but has not yet filed anexemption application or received a determination letter. All other organizations answer “No.”

Schedule B—Schedule of Contributors

Line 2. Answer “Yes” and complete Schedule B if any of the following applies:

1. A Section 501(c)(3) organization that met the 331/3% support test under the Section 509(a)(1) or170(b)(1)(A)(vi) regulations and received from any one contributor during the year contributions of thegreater of $5,000 (in money or property) or 2% of the amount on line 1h of Form 990, Part VIII.

2. A Section 501(c)(3) organization that did not meet the 331/3% support test under Section 509(a)(1) or170(b)(1)(A)(vi) regulations and received during the year contributions of at least $5,000 from any onecontributor.

3. A Section 501(c)(7), (8), or (10) organization that received during the year contributions of any amount foruse exclusively for religious, charitable, scientific, literary, or educational purposes, or the prevention ofcruelty to children or animals, or contributions of $5,000 or more not exclusively for such purposes fromany one contributor.

4. Any other organization that received contributions of $5,000 or more during the year from any onecontributor [e.g., a Section 501(c)(4) organization].


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Schedule C—Political Campaign and Lobbying Activities

A “Yes” answer to any of the following requires that various parts of Schedule C be completed.

Line 3—Political Campaign Activities. All organizations must answer this question, even if they are not subject to aprohibition against political campaign activities. Answer “Yes” whether the activity is conducted directly or indirectlythrough a disregarded entity or a joint venture or other arrangement that is treated as a partnership for federal taxpurposes and in which the organization is an owner.

Line 4—Lobbying Activities. Complete only if a Section 501(c)(3) organization. (All others leave this line blank.)Answer “Yes” if the organization engaged in lobbying activities or had a Section 501(h) election in effect during thetax year.

Line 5—Section 6033(e) Notice, Reporting, and Proxy Tax. Answer “Yes” only if the organization is a Section501(c)(4), 501(c)(5), or 501(c)(6) organization that receives membership dues, assessments, or similar amounts.(All others answer “No.”)

Schedule D—Supplemental Financial Statements

A “Yes” answer to any of the following items requires that various parts of Schedule D be completed.

Line 6—Donor Advised Funds and Similar Accounts. Answer “Yes” if the organization maintained any donoradvised fund or similar account which a donor (or person appointed by the donor) had advisory privileges over theuse or investment of any portion of the account at any time during the year.

Line 7—Conservation Easements. Answer “Yes” if the organization received or held any conservation easement atany time during the year, regardless of how the easement was acquired or whether a charitable deduction wasclaimed by the donor.

Line 8—Collections of Works of Art and Similar Assets. Answer “Yes” if, at any time during the year, the organizationmaintained collections of works of art, historical treasures, or other similar assets as described within FASB ASC958-360-20 (regardless of whether the organization reported revenues and assets relating to such collections in itsfinancial statements).

Line 9—Escrow Account Liability, Custodial Arrangements, or Credit Counseling. Answer “Yes” if the organization(1) had an escrow or custodial account liability, (2) provided credit counseling, debt management, credit repair, ordebt negotiation services, or (3) acted as an agent, trustee, custodian, or other intermediary for contributions orother assets not included in Part X at any time during the tax year.

Line 10—Endowments. Answer “Yes” if the organization, a related organization, or an organization formed andmaintained exclusively to further one or more exempt purposes of the organization [such as a foundation formedand maintained exclusively to hold endowment funds to provide scholarships and other funds for a college oruniversity described within IRC Sec. 501(c)(3)] held assets in a temporarily restricted endowment, permanentendowment, or quasi-endowment fund at any time during the year, regardless of whether the organization followsFASB ASC 958 or reports endowments in Part X, line 32.

Line 11—Schedule D Items. Answer “Yes” and complete the applicable section of Schedule D if the organizationreported an amount in Part X: (1) for land, buildings, equipment, or leasehold improvements in line 10; (2) forinvestments in other securities, program related investments, or other assets in lines 12, 13, or 15 that are 5% ormore of the total assets reported on Part X, line 16; or (3) for other liabilities in line 25. “Yes” should also be checkedif the organization’s financial statements for the year include a footnote addressing the organization’s liability foruncertain tax positions under FASB ASC 740 (including a statement that the organization had no liability foruncertain tax positions).

Line 12a—Audited Financial Statements. Answer “Yes” if the organization received a separate, independentaudited financial statement prepared in accordance with GAAP for the return year or if the organization is reportingfor a short year that is included in, but not identical to, the period for which the audited financial statement was


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obtained. All other organizations answer “No.” Answer “No” if the organization was included in a consolidatedaudited financial statement unless it also received a separate audited financial statement. If the organizationanswers “No” but has prepared unaudited financial statements for the tax year, it may (but is not required to)provide the reconciliations contained in Schedule D, Parts XI–XII.

Line 12b. Answer “Yes” if the organization was included in a consolidated, independent audited financial statementprepared in accordance with GAAP for the return year or if the organization is reporting for a short year that isincluded in, but not identical to, the period for which the audited financial statement was obtained. All otherorganizations answer “No.” If line 12b is “Yes” but line 12a is “No,” completing Schedule D, Parts XI–XII is optional.

Schedule E—Schools

Line 13—Schools. Answer “Yes” and complete Schedule E if the organization checked the box on line 2 ofSchedule A (Form 990 or 990-EZ), Part I, indicating that it is a school.

Schedule F—Statement of Activities Outside the United States

A “Yes” answer to any of the following requires that various parts of Schedule F be completed.

Lines 14 through 16—Activities Outside the United States. Answer “Yes” to line 14a if the organization maintainedan office, or had employees or agents, outside the U.S. Answer “Yes” to line 14b if the organization had totalrevenue or expenses of more than $10,000 from or attributable to grantmaking, fundraising activities, business,investments, and program service activities outside the U.S.; or if the book value of the organization’s aggregateinvestments in foreign partnerships, foreign corporations, and other foreign entities was $100,000 or more at anytime during the tax year. An organization that answers “Yes” to line 14a should complete the applicable parts ofSchedule F only if it satisfies one or more of the dollar thresholds described in line 14b, 15, or 16 and answers “Yes”to any of those questions.

Answer “Yes” on line 15 if the organization reported on Part IX, column (A), line 3, more than $5,000 of grants andother assistance to any foreign organization or entity (including a foreign government), or to a domestic organiza-tion or domestic individual for a designated foreign organization(s).

Answer “Yes” on line 16 if the organization reported on Part IX, column (A), line 3, more than $5,000 of aggregategrants and other assistance to foreign individuals or to domestic individuals or organizations for the purpose ofproviding grants or other assistance to a designated foreign individual or individuals.

Schedule G—Supplemental Information Regarding Fundraising or Gaming Activities

A “Yes” answer to any of the following requires that various parts of Schedule G be completed.

Lines 17 through 19—Professional Fundraising or Gaming. Line 17 should be answered “Yes” if the total amountreported for professional fundraising services in Part IX, column (A) (line 11e plus a portion of the line 6 amountattributable to professional fundraising services) exceeds $15,000. Line 18 should be answered ”Yes,” if the sum ofthe amounts reported on lines 1c and 8a (Form 990, Part VIII) exceed $15,000. If an organization answers “No” toany of these, consider whether to complete Schedule G to report fundraising or gaming activities for state or otherreporting purposes.

Schedule H—Hospitals

Line 20—Hospitals. Answer “Yes” to line 20a and complete Schedule H if the organization operated (directly orindirectly through a disregarded entity or joint venture treated as a partnership for federal tax purposes) one ormorehospital facilities at any time during the tax year. Except in the case of a group return, do not include facilitiesoperated by another organization that is treated as a separate taxable or tax-exempt corporation for federal incometax purposes. For group returns, answer “Yes” if any subordinate within the group operated such a facility.

If line 20a is “Yes,” then the organization must attach a copy of its most recent audited financial statements andindicate the attachment on line 20b.


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Schedule I—Grants and Other Assistance to Domestic Organizations, Governments, and Individuals

A “Yes” answer to any of the following requires that various parts of Schedule I be completed.

Lines 21–22—Grantmaking. When answering lines 21 and 22, do not take into account grants or other assistanceprovided to any domestic organization, government, or individual designated for foreign organizations or foreignindividuals. The $5,000 grant threshold is per donee. For example, answer “No” to line 21 if the organization madea $4,000 grant to each of two domestic organizations and no other grants.

Schedule J—Compensation Information

Line 23—Compensation Information. All organizations are required to complete Part VII. Answer “Yes” to Part IV,line 23, and complete Schedule J if the organization answers “Yes” to line 3, 4, or 5 of Part VII, Section A, relatingto certain persons listed on line 1a of Section A.

Also answer “Yes” to Part IV, line 23, if the filing organization had knowledge that any person listed in Part VIIreceived or accrued compensation from an unrelated organization for services rendered to the filing organization.

Schedule K—Supplemental Information on Tax-exempt Bonds

Line 24—Tax-exempt Bonds. Lines 24a through 24d involve questions regarding tax-exempt bonds. All organiza-tions must answer line 24a. Organizations that answer “Yes” to line 24a must also answer lines 24b through 24dand complete Schedule K. If line 24a is answered “No,” skip to line 25a.

Line 24a—Tax-exempt Bonds. Answer “Yes” and complete Schedule K for each tax-exempt bond issued by or forthe benefit of the organization after December 31, 2002, including refunding bonds, with an outstanding principalamount of more than $100,000 as of the last day of the organization’s tax year. Bonds that have been legallydefeased, and as a result are no longer a liability of the organization, are not considered outstanding.

Line 24b—Temporary Period Exception. For this line, the organization does not need to include the following asinvestments of proceeds:

1. Any investment of proceeds relating to a reasonably required reserve or replacement fund as describedin IRC Sec. 148(d).

2. Any investment of proceeds properly characterized as replacement proceeds as defined in Reg.1.148-1(c).

3. Any investment of net proceeds relating to a refunding escrow as defined in Reg. 1.148-1(b).

Temporary period exceptions include a three-year temporary period applicable to proceeds spent for capitalprojects and a 13-month temporary period applicable to proceeds spent on working capital.

Line 24c—Escrow Accounts. The organization is treated as maintaining an escrow account if such account ismaintained by a trustee with respect to tax-exempt bonds issued for the benefit of the organization.

Line 24d—“On Behalf of” Issuances. Answer “Yes” if the organization received an advance ruling that its obliga-tions were issued on behalf of a state or local government, meets the conditions for issuing tax-exempt bondsunder Rev. Rul. 63-20, or is a constituted authority organized by a state or local governmental unit specifically toissue tax-exempt bonds to further public purposes. Also answer “Yes” if the organization has outstanding qualifiedscholarship funding bonds under IRC Sec. 150(d) or bonds of a qualified volunteer fire department under IRC Sec.150(e).

Schedule L—Transactions with Interested Persons

A “Yes” answer to any of the following requires that various parts of Schedule L be completed.


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Lines 25a and 25b—Excess Benefit Transactions. All Section 501(c)(3), 501(c)(4), or 501(c)(29)organizations mustanswer “Yes” or “No” to line 25a and line 25b. All other organizations should skip lines 25a and 25b and leave themblank. Answer “Yes” to line 25b if (1) the organization became aware (prior to filing the return) that it engaged in anexcess benefit transaction with a disqualified person in a prior year, and (2) the transaction has not been previouslyreported on the organization’s Form 990 or 990-EZ.

An excess benefit transaction may have serious implications for the disqualified person that entered into thetransaction with the organization, any organization managers that knowingly approved of the transaction, and theorganization itself. A Section 501(c)(3), 501(c)(4), or 501(c)(29) organization that becomes aware that it may haveengaged in an excess benefit transaction should—

1. obtain competent advice regarding IRC Sec. 4958,

2. pursue correcting any excess benefit, and

3. take other appropriate steps to protect its interestswith regard to such transaction and the potential impactit could have on the organization’s continued exempt status.

Lines 26 through 28—Transactions with Interested Persons. All organizations must answer the questions on lines26 through 28 regarding—

1. loans and other receivables and payables to/from the organization and certain interested persons,

2. grants and other financial assistance provided by the organization to certain interested persons, and

3. certain direct and indirect business transactions between the organization and current or formergovernance and management officials of the organization or their associated businesses or familymembers.

Schedule M—Noncash Contributions

A “Yes” answer to any of the following requires that Schedule M be completed.

Line 29—Noncash Contributions. Answer “Yes” if the organization received during the year more than $25,000 infair market value (FMV) of donations, gifts, grants, or other contributions of property other than cash, regardless ofthe manner received (e.g., for use in an auction). Do not include contributions of services or use of facilities.

Line 30—Contributions of Art, Historical Treasures or Similar Assets, or Conservation Easements. Answer “Yes” if,during the year, the organization received as a donation, gift, grant, or other contribution any:

1. work of art,historical treasure, historical artifact, scientific specimen, archeological artifact, or similar asset,including a fractional interest, regardless of amount or whether the organization maintains collections ofsuch items; or

2. qualified conservation contributions, regardless of whether the contributor claimed a charitablecontribution deduction for such contribution.

Schedule N—Liquidation, Termination, Dissolution, or Significant Disposition of Assets

A “Yes” answer to either of the following requires that one of the parts of Schedule N be completed.

Lines 31 and 32—Liquidations, Terminations, Dissolutions, Cessation of Operations, and Significant Dispositions ofAssets. Answer “Yes” if the organization liquidated, terminated, dissolved, ceased operations, or engaged in asignificant disposition of net assets during the year. A significant disposition of net assets may result from either anexpansion or contraction of operations. Organizations that answer “Yes” to either of these questions must alsocheck the box on line 2 of Part I and complete Schedule N, Part I or II.


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Schedule R—Related Organizations and Unrelated Partnerships

A “Yes” answer to any of the following requires that various parts of Schedule R be completed.

Lines 33 through 35—Related Organizations and Controlled Entities. All organizations must report on Schedule Rcertain information regarding ownership or control of, and transactions with, their disregarded entities and relatedtax-exempt and taxable organizations. Any organization that answers “Yes” to line 33 or 34 must list its disregardedentities and related organizations on Schedule R and provide specified information regarding such organizations.Controlled entities are a subset of related organizations. Any organization that is a controlling entity with respect toa controlled entity within the meaning of IRC Sec. 512(b)(13) must answer “Yes” to line 35a. If line 35a is answered“Yes,” line 35b must be answered “Yes” if it either received or accrued from its controlled entity any interest, rents,royalties, or annuities; made loans; or had any other transfer of funds to or from the controlled entity. Schedule R,Part V, line 2, must also be completed if line 35b is answered “Yes.” Consequently, line 35b, not line 35a, is thetrigger question. If the answer to line 35a is “No,” leave line 35b blank.

Line 36—Transfers by Charitable Organization to Exempt Non-charitable Organizations. Only Section 501(c)(3)organizations should complete line 36. All other organizations should skip to line 37. The instructions state that aSection 501(c)(3) organization should answer “Yes” only if it engaged in a transaction involving more than $50,000during the tax year with a related organization that was tax exempt under a section other than IRC Sec. 501(c)(3).

Line 37—Conduct of Substantial Activities through an Unrelated Partnership. Answer “Yes” if at any time during theyear the organization conducted more than 5% of its activities, measured by total gross revenue for the tax year ortotal assets of the organization at the end of its tax year, whichever is greater, through an unrelated organization thatis treated as a partnership for federal income tax purposes and the organization was a partner or member at anytime during the year (i.e., either the 5% of gross revenue or 5% of total assets test is satisfied). The 5% test is appliedon a partnership-by-partnership basis, although direct ownership by the organization and indirect ownershipthrough disregarded or tiered entities are aggregated for this purpose.

Schedule O—Supplemental Information to Form 990

Line 38—Completion of Schedule O. Answer “Yes” if the organization completed Schedule O and providedexplanations for Part VI, line 11b, concerning the process, if any, the organization uses to review Form 990, and line19 dealing with whether (and how) the organization made its governing documents and other policies available tothe public during the tax year. Certain filers must provide narrative responses to other questions in Form 990 onSchedule O, and all filers can supplement their answers to other questions on Schedule O.

Statements Regarding Other IRS Filings and Tax Compliance (Part V)

Part V serves as a checklist of other IRS compliance that might be required by an organization. It is intended to alertorganizations about potential other compliance requirements that are not necessarily related to the Form 990.

Payroll Information

Generally, tax-exempt organizations are subject to the same payroll tax rules as other for-profit organizations.However, certain exceptions may apply (e.g., the special payroll tax rules for ministers).

Line 1a—Number of Information Returns. Use Form 1096 to transmit paper Forms 1099, 1098, 5498, and W-2G tothe IRS, which are information returns reporting certain amounts paid (e.g., to independent contractors for servicesrendered) or received by the organization. If the organization transmits any of these forms electronically, add thisnumber to the total reported. Report all returns filed for the calendar year ending with or within the organization’s taxyear. For example, for a 2017 calendar year return, the number reported should be the actual number from the 2017Form 1096, as filed by the organization and its reporting agents (e.g., common paymasters and payroll agents)during 2018. Enter “-0-” if the organization did not file any such forms for the calendar year ending with or within itstax year, or if the organization is filing for a short year and no calendar year ended within its tax year.

Line 1b—FormsW-2G (Certain GamblingWinnings). FormW-2G pertains to certain gambling winnings. Enter “-0-”if none.


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Line 1c—Backup Withholding. For more information on backup withholding for missing or incorrect names ortaxpayer identification numbers, see IRS Pub. 1281.

Line 2a—Number of Employees. Form W-3 is used to transmit Forms W-2 to the IRS, which reports employeewages for the year. For this line, enter the number of the organization’s employees reported on a Form W-3 duringthe calendar year that ends with or within the organization’s tax year. If compensation for a person is included onlines 5-7 of Part IX, such person should be counted for line 2a. Enter -0- if the organization had no employees forsuch calendar year, or if the return is for a short year and no calendar year ended within the organization’s tax year.

Line 2b—Employment Tax Return Filings. If the organization reported at least one employee on line 2a, statewhether the organization or reporting agents of the organization filed all required federal employment tax returns(e.g., Forms 940 and 941) relating to such employees. Leave line 2b blank if no employees are reported on line 2a.

Unrelated Business Income

Line 3a—Unrelated Business Income. Answer “Yes” if the organization’s total gross income from all of its unrelatedtrades and businesses is $1,000 or more for the year.

Caution: Neither Form 990-T nor Form 990 is a substitute for the other. Report on Form 990 items of income andexpense that are also required to be reported on Form 990-T when the organization is required to file both forms.

Line 3b—Form 990-T (Exempt Organization Business Income Tax Return). Answer “Yes” if the organizationchecked “Yes” to line 3a and filed the Form 990-T by the time its Form 990 is filed. Answer “No” if the organizationanswered “Yes” to line 3a but has not yet filed Form 990-T, even if the organization has applied for an extension oftime for filing Form 990-T. If “No,” provide an explanation in Schedule O (Supplemental Information to Form 990 or990-EZ).

Foreign Financial Accounts

Line 4a—Foreign Accounts. If at any time during the calendar year ending with or within the organization’s tax year,the organization had an interest in, or signature or other authority over, a financial account in a foreign country (suchas a bank account, securities account, or other financial account), answer “Yes” if—

1. the combined value of the accounts was more than $10,000 at any time during the calendar year (and theaccounts were not with a U.S. military banking facility operated by a U.S. financial institution); or

2. the organization owns more than 50% of the stock in any corporation that owns such accounts.

An organization with foreign accounts may be required to submit a FinCEN 114 (Report of Foreign Bank andFinancial Accounts) by April 15 of the following year, if the $10,000 threshold is met with the Department of theTreasury using the FinCEN’s BSA E-Filing System. If the organization does not have all the information necessaryto submit a complete report by April 15, it should request a six-month extension to October 15. For more informa-tion, see www.fincen.gov.

Line 4b—Foreign Country. Enter the name of each foreign country in which a foreign account described in line 4ais located. Use Schedule O if more space is needed.

Tax Shelter Transactions

Line 5a—Prohibited Tax Shelter Transactions. Answer “Yes” if the organization was a party to a prohibited taxshelter transaction at any time during the organization’s tax year. A prohibited tax shelter transaction is any listedtransaction [as described in IRC Sec. 6707A(c)(2)] and any prohibited reportable transaction. A prohibitedreportable transaction is a confidential transaction within the meaning of Reg. 1.6011-4(b)(3) or a transaction withcontractual protection within the meaning of Reg. 1.6011-4(b)(4). A tax-exempt entity is considered to be a party toa prohibited tax shelter transaction if it facilitates the transaction by reason of its tax status or is identified inpublished guidance as a party to a prohibited tax shelter transaction.


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An organization that files Form 990 [other than a Section 527 political organization or a Section 4947(a)(1) trust]and is a party to a prohibited tax shelter transaction must file Form 8886-T (Disclosure by Tax Entity RegardingProhibited Tax Shelter Transaction). In addition, the organization may be required to file Form 4720 (Return ofCertain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code) and pay excise tax imposed by IRCSec. 4965.

Contributions Received

Line 6a—Solicitations of Nondeductible Contributions. Answer “Yes” only if the organization has annual grossreceipts that are normally greater than $100,000 and if, during the tax year, it solicited contributions not deductibleunder IRC Sec. 170. Organizations whose annual gross receipts are normally not more than $100,000 may answer“No” to line 6a. Additionally, organizations that are eligible to receive contributions that are deductible under IRCSec. 170(c) should answer “No.”

Section 170(c) organizations include the following:

1. A state or U.S. possession, or any political subdivision of these.

2. A corporation, trust, or community chest, fund, or foundation—

a. created or organized in or under the laws of the U.S., any state, the District of Columbia, or any U.S.possession;

b. organized and operated exclusively for religious, charitable, scientific, literary, or educationalpurposes; or to foster national or international amateur sports competition (excluding entities whoseactivities include providing athletic facilities or equipment); or for the prevention of cruelty to childrenor animals;

c. in which no part of the earnings inures to the benefit of a private shareholder or individual;

d. in which no substantial part of the activities involves attempting to influence legislation; and

e. that does not participate (or intervene) in any political campaign on behalf of (or against) anycandidate for public office.

3. A post or organization ofwar veterans; or an auxiliary unit or society of, or a trust or foundation for, any suchpost or organization—

a. organized in the U.S. or one of its possessions, and

b. in which no part of the net earnings inures to the benefit of a private shareholder or individual.

4. A domestic fraternal society, order, or association operating under the lodge system; but only if such entityis soliciting contributions to be used exclusively for religious, charitable, scientific, literary, or educationalpurposes; or for the prevention of cruelty to children or animals.

5. A cemetery company owned and operated exclusively for the benefit of its members; or a corporationchartered solely for burial purposes—

a. that is not permitted by its charter to engage in any businesses other than those necessary for itspurpose,

b. that is not operated for profit, and

c. in which none of the net earnings inures to the benefit of a private shareholder or individual.

In certain limited situations, organizations not listed in items 1.–5. may not have to comply with the requirement todisclose that a donation is not deductible as a charitable contribution. For example, a letter or phone call that is part


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of a fundraising campaign targeted to no more than 10 persons during the calendar year is exempt from thedisclosure requirement. In addition, organizations whose annual gross receipts normally do not exceed $100,000do not have to comply with the disclosure rules regardless of the size of the targeted fundraising audience.

Line 6b—Disclosure Rule. If line 6a is answered “Yes,” indicate on line 6b whether proper notice of nondeductibilitywas given.

Any fundraising solicitation by or on behalf of any Section 501(c) or 527 organization that is not eligible to receivecontributions deductible as charitable contributions for federal income tax purposes must include a disclosurestatement that contributions or gifts to the organization are not deductible as charitable contributions for federalincome tax purposes (i.e., disclosure rule). The statement may be in written or printed form, by television or radio,or by telephone, but must be in an easily recognizable format.

Line 7—Organizations That May Receive Deductible Contributions under IRC Sec. 170(c). Pertains only to organi-zations that may receive deductible charitable contributions under IRC Sec. 170(c). See the list in the previous line6 discussion for a description of such organizations. All other organizations should skip lines 7a–7h (leaving themblank) and go to line 8.

Lines 7a and 7b—Quid Pro Quo. Contributions to an organization entitled to receive tax-deductible donations areonly deductible to the extent a gift’s value exceeds the value of any goods or services the donor receives in return.

For donations in excess of $75, charities must provide the donor with a written statement indicating the donor’sdeduction is limited to the excess of the contribution over the value of any goods or services received in return. Thestatement normally must also give a good faith estimate of the value of the goods or services. Separate, unrelatedpayments made by the same donor need not be aggregated for determining if the $75 threshold is exceededduring the year. For quid pro quo (part contribution/part purchase) donations of $75 or less, the IRS presumablyexpects charities to voluntarily disclose to their donors how much of the contribution is deductible as a charitablecontribution.

Example 3B-1 Proper disclosure for quid pro quo contributions.

Jane Smith contributed $100 to Hope, Inc. (Hope) and received in exchange $48 dinner/dance tickets.Although the net contribution is less than $75 ($100− $48 = $52), the quid pro quo rule still applies since thegross payment exceeds $75. Hope must provide a written notice to Jane with either the solicitation or receiptof the ticket proceeds.

The notice should:

1. explain that the amount of the deductible contribution for federal income tax purposes is the excess of theamount ofmoney (and the value of any other property) contributed over the value of the goods or servicesprovided by Hope, and

2. provide Hope’s good faith estimate of the value of the goods or services furnished to the donor.

Regardless of the size of a quid pro quo contribution, the disclosure rule does not apply if the only benefits receivedby the donor are intangible religious benefits (i.e., those provided by a church that are generally not sold in acommercial transaction, such as admittance to a worship service). Nor does the rule apply if there is no donativeelement to the transaction (e.g., a museum patron makes a purchase in the gift shop) or if the donor merelyreceives de minimis or token benefits. For more information on quid pro quo contributions, see PPC’s Nonprofit Taxand Governance Guide: Helping Organizations Comply.

Internet and Social Media Fundraising. A Section 501(c)(3) organization is permitted to use an internet platform aspart of its fundraising efforts. Additionally, examiners can use donor reports easily generated from the organiza-tion’s online fundraising sources to assist in analyzing the Schedule B (Form 990, 990-EZ, or 990-PF) complianceand to help identify disqualified persons. Website or email solicitations must comply with the same rules discussedpreviously that apply to other solicitations and donations (e.g., a website page that can accept a donation) mustcontain the required disclosures regarding deductibility. Receipts generated by electronic donations must containa disclosure regarding the provision of any goods or services by the organization.


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Line 7c and 7d—Form 8282 (Donee Information Return). An organization that sells, exchanges, consumes, orotherwise disposes of donated property within three years after its contribution generally must provide the IRS withcertain details concerning the disposition on Form 8282 and answer “Yes” on line 7c. The organization mustindicate the number of Forms 8282 filed during the year on line 7d. Form 8282 does not have to be filed by thedonee if the value of the item was $500 or less at the time of the original donation or if the property was consumedby the donee in fulfilling its tax-exempt purpose.

The information required by Form 8282 helps the IRS determine whether the donormight have claimed a deductionfor more than the FMV of the property. In addition, the information that must be submitted indicates whether theorganization used the property for an exempt purpose.

Form 8282 must be filed with the IRS Service Center in Ogden, UT 84201-0027 within 125 days after a dispositionof property. A copy of the formmust be given to the donor of the property (although there appears to be no deadlinefor satisfying this requirement). Special rules apply if an organization transfers donated property to anothercharitable organization.

Line 7e and 7f—Form 8870 (Information Return for Transfers Associated With Certain Personal Benefit Contracts).If, in connection with a transfer of funds to the organization, the organization directly or indirectly pays premiums onany personal benefit contract, or there is an understanding or expectation that any person will directly or indirectlypay such premiums, the organization must report these premiums and any premiums paid by others but treated aspaid by the organization on Form 8870. A personal benefit contract is generally any life insurance, annuity, orendowment contract that benefits, directly or indirectly, the transferor (or a family member), or any other persondesignated by the transferor [other than an organization described in IRC Sec. 170(c)].

Line 7g—Form 8899 (Notice of Income from Donated Intellectual Property). Certain organizations that received acharitable gift of qualified intellectual property that produces net income (including capital gain on disposition)must file Form 8899. Answer “Yes” if the organization provided all required Forms 8899 for the year for net incomeproduced by donated qualified intellectual property. Such property includes patents, copyrights (other thanself-created copyrights), trademarks, trade names, trade secrets, know-how, certain software, or similar property. Italso includes applications for, or registrations of, such property.

Line 7h—Form 1098-C (Contribution of Motor Vehicles, Boats, and Airplanes). An organization that receives aqualified vehicle that has a claimed value of more than $500 must file Form 1098-C with the IRS and furnish CopyB to the donee. Copy B can also serve as the donee charity’s contemporaneous written acknowledgment of thecontribution. If so used, it must be furnished to the donor no later than 30 days after the:

1. date of sale in an arm’s-length transaction to an unrelated party;

2. date of contribution if the donee charity certifies that the vehicle will not be transferred for money, otherproperty, or services before the completion ofmaterial improvements (or repairs) or significant interveninguse; or

3. date of contribution if the donee charity certifies that the vehicle will be transferred to a needy individual forsignificantly below fair market value in furtherance of its charitable purpose.

An improvement or repair is material only if it significantly increases the vehicle’s value and is not funded by anadditional payment to the donee charity by the vehicle donor. A material improvement does not include painting orrustproofing, removal of dents or scratches, the cleaning or repair of upholstery, or the installation of theft deterrentdevices.

Significant intervening use requires that the donee charity actually use the vehicle to substantially further itsregularly conducted activities. IRS Notice 2005-44 suggests two potential uses: transportation and instruction invehicle repair. Significant intervening use is ultimately a subjective test that depends upon the nature, extent,frequency, and duration of the charity’s use.

The charity must indicate whether it provided any goods or services in consideration for the vehicle and, if so, adescription and good faith estimate of the value of such goods or services (or if such goods or services consistsolely of tangible religious benefits). This information is required in an acknowledgment.


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Donor Advised Funds

Line 8—Disclosure of Excess Business Holdings. Line 8 must be answered by sponsoring organizations maintain-ing donor advised funds. Answer “Yes” if such organization is the sponsoring organization of a donor advised fundthat had excess business holdings at any time during the organization’s tax year. All other organizations shouldskip this line and go to line 9. If “Yes,” it must be determined whether the organization is subject to the excessbusiness holdings tax under IRC Sec. 4943 and is required to file Form 4720 (Return of Certain Excise Taxes UnderChapters 41 and 42 of the Internal Revenue Code).

Donor Advised Funds. For purposes of the Section 4943 excise tax on excess business holdings, a donor advisedfund is treated as a private foundation. The organizationmust determine who is considered a disqualified person fordetermining the excise tax on excess business holdings for a donor advised fund.

Line 9—Section 501(c)(3) and Other Sponsoring Organizations Maintaining Donor Advised Funds. Line 9 must becompleted by sponsoring organizationsmaintaining a donor advised fund. All other organizations may skip this lineand go to line 10.

Line 9a—Section 4966 Taxable Distributions. Answer “Yes” if the sponsoring organization made any taxabledistributions under IRC Sec. 4966 during the organization’s tax year.

A distribution from a donor advised fund to an individual, estate, partnership, association, company, or corporationis a taxable distribution under IRC Sec. 4966 unless—

1. the distribution is for a charitable purpose [i.e., a purpose described in IRC Sec. 170(c)(2)(B)] and

2. the organization exercises expenditure responsibility with respect to the distribution.

This does not apply to distributions to any organization described in IRCSec. 170(b)(1)(A) [other than a disqualifiedsupporting organization, defined in IRC Sec. 4966(d)(4)], to the sponsoring organization of such donor advisedfund, or to any other donor advised fund.

Line 9b—Distribution to Donor, Donor Advisor, or Related Person. Answer “Yes” if the sponsoring organizationmade a distribution from a donor advised fund to a donor, donor advisor, or related person during its tax year. Forthis question, related person is any family member of the donor (or donor advisor) or any entity 35% controlled bythe donor or donor advisor.

If an organization makes a distribution from a donor advised fund resulting from the advice of a donor, donoradvisor, a family member, or a 35% controlled entity of any of these persons, and that distribution directly orindirectly provides more than incidental benefits to one of such persons, a tax is imposed on the following:

1. The person upon whose advice the distribution was made.

2. The beneficiary of the distribution.

3. A fund manager for knowingly agreeing to make the distribution.

Section 4958 Taxable Distributions. In addition, if an organization makes a distribution from a donor advised fundto a donor, donor advisor, family member, or 35% controlled entity of these persons, the transaction might besubject to the excess benefit rules in IRC Sec. 4958. Such transactions include any grant, loan, compensation, orother similar payment to those persons, as well as any other payment resulting in excess benefit.


Line 10—Section 501(c)(7) Organizations. Answer lines 10a and 10b only if the organization is exempt underSection 501(c)(7) (i.e., a social club). All other organizations should skip lines 10a and 10b. For a social club tomaintain its tax exemption, substantially all of its activities must be for the pleasure, recreation, and other nonprofit-able purposes of its members. A club meets this requirement if it satisfies two gross receipts tests. Lines 10a and


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10b gather the data necessary for the IRS to perform these tests (to the extent the data is not readily available fromthe other financial information presented in the return).

Gross Receipts Test.Neither the Code nor the regulations governing exempt social clubs mention any limitation oninvestment income as a prerequisite to exemption. However, legislative history indicates congressional intent thata club satisfy two gross receipts tests as part of the substantially all rule. These tests are:

1. Nonmember revenue (i.e., income from the general public) plus investment incomemust be nomore than35% of gross receipts.

2. Nonmember revenue itself must be no more than 15% of gross receipts.

Gross receipts for this purpose are receipts from the traditional, normal, and usual activities of the club, includingcharges, admissions, membership fees, dues, assessments, investment income, and normal recurring capitalgains on investments. Gross receipts generally do not include initiation fees, capital contributions (e.g., prorataassessments paid by each member for funding a new building), or income from nontraditional or unusual sources(e.g., the sale of the organization’s clubhouse). However, if a club (e.g., a college fraternity) charges membershipinitiation fees in lieu of normal dues, such fees are included in gross receipts.

Line 10a—Initiation Fees and Capital Contributions. Enter the amount of initiation fees, capital contributions, andunusual income included in Part VIII, Statement of Revenue, line 12, Total Revenue, but not included in grossreceipts for Section 501(c)(7) exemption purposes. However, if the organization is a college fraternity or sororitythat charges membership initiation fees but not annual dues, do not include such initiation fees.

Line 10b—Gross Receipts from Public Use of Facilities. Enter the amount of gross receipts included in Part VIII,Statement of Revenue, line 12, Total Revenue, derived from the general public for the use of the organization’sfacilities, that is, from persons other than members, their spouses, dependents, or guests.


Line 11—Section 501(c)(12) Organizations. Answer lines 11a and 11b only if the organization is a Section501(c)(12) organization; otherwise, skip these lines.

Tax-exempt organizations described in IRC Sec. 501(c)(12)(A) generally include—

1. benevolent life insurance associations whose activities are confined to a particular community or place,

2. mutual ditch or irrigation companies,

3. mutual or cooperative telephone companies, and

4. organizations that perform a service comparable to those performed by any of the entities listed in items1–3.

These organizations are entitled to tax-exempt status only when 85% or more of their gross income for the tax yearconsists of amounts collected from members for the sole purpose of meeting losses and expenses. Line 11 givesthe IRS the data necessary to determine if the 85% test has beenmet. Failure tomeet the requirement in a particularyear precludes exemption for that year, but has no effect on an organization’s exemption in years when the 85% testis met. If an organization uses the accrual method of accounting, compliance with the 85% test must be determinedunder that method.

Gross income for the test means gross receipts less cost of goods sold. It generally includes income from allsources, such as investment and capital gains income (unreduced by any capital losses) realized during the year.However, income properly reported under the installmentmethod is not included until the year payment is received.Additionally, mutual or cooperative telephone or electric companies are allowed to exclude revenue received fromutility pole rentals and various other sources.


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The IRS has held that the gross income of a taxable subsidiary must be combined with the parent’s for determiningwhether the 85% member income requirement is met.

Nonexempt Charitable Trusts

Line 12—4947(a)(1) Trusts. All organizations except Section 4947(a)(1) trusts should leave line 12 blank. If aSection 4947(a)(1) nonexempt charitable trust has no taxable income under Subtitle A, its filing of Form 990may beused to meet its income tax return filing requirement under IRC Sec. 6012. Such a trust must, if it answers “Yes” toline 12a, report its tax-exempt interest received or accrued (if reporting under the accrual method) during the taxyear on line 12b. [See Lesson 1 for a discussion of the definition of, and filing requirements for, a Section 4947(a)(1)trust.]


Line 13—Qualified Health Insurance Plans. Answer line 13a, 13b, or 13c only if the organization has received a loanor grant under the Department of Health and Human Services CO-OP Program and has been recognized asexempt under IRC Sec. 501(c)(29). The organizationmust indicate (line 13a) whether it is licensed inmore than onestate. Check “No” if the organization is licensed to issue qualified health plans in only one state. A list of each statein which the organization is licensed (even if only one) must be provided in Schedule O in accordance with theinstructions. In addition, certain information concerning the organization’s reserves must be entered on lines 13band 13c.

Tanning Services

Line 14—Receipts for Indoor Tanning. An organization must indicate on line 14a whether it received any paymentduring the year for indoor tanning services. Indoor tanning services use any electronic product designed toincorporate one or more ultraviolet lamps and intended for the irradiation of an individual by ultraviolet radiation,with wavelengths in air between 200 and 400 nanometers, to induce skin tanning. If it did, it must collect a 10%excise tax on the services then indicate (on line 14b) whether it has reported the services and related excise taxeson Form 720 (Quarterly Federal Excise Tax Return). The failure to file a required Form 720 must be explained onSchedule O. Reg. 49.5000B-1 provides the rules governing indoor tanning services.


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SELF-STUDY QUIZ


10. Which schedule should an organization fill out if it performs political campaign and lobbying activities?

a. Schedule A.

b. Schedule C.

c. Schedule E.

d. Schedule H.

11. Which of the following would be considered a Section 170(c) organization?

a. A trust that provides athletic equipment for amateur sports.

b. An organization that benefits both veterans and a private individual.

c. A fraternal society that meets for social reasons.

d. A state or a possession of the United States of America.

12. The Garden Club is a nonprofit social club under Section 501(c)(7). To maintain its tax-exempt status, it mustdo which of the following?

a. Ensure at least 75% of its activities must be for the pleasure and recreation of its members.

b. Limit income from the general public plus investment income to no more than 50% of its gross receipts.

c. Limit nonmember revenue to 15% or less of its gross receipts.

d. Ensure that all of its income is derived from its members instead of the general public.


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SELF-STUDY ANSWERS


10. Which schedule should an organization fill out if it performs political campaign and lobbying activities?(Page 303)

a. Schedule A. [This answer is incorrect. Schedule A is completed if an organization is a Section 501(c)(3)organization that is not a private foundation (i.e., if it has public charity status and public support). This isa separate schedule from the one associated with the political and lobbying activities described above.]

b. Schedule C. [This answer is correct. An organization fills out Schedule C if it answers “yes” on line3 (Political Campaign Activities) or line 4 (Lobbying Activities) of Form 990, Part IV.]

c. ScheduleE. [Thisanswer is incorrect. Anorganization fills outScheduleE if it is a school. Another scheduleis associated with political campaign and lobbying activities.]

d. Schedule H. [This answer is incorrect. If an organization operated (directly or indirectly through adisregarded entity or joint venture treated as a partnership for federal tax purposes) one or more hospitalfacilities at any time during the tax year, it needs to fill out Schedule H. The political and lobbying activitiesdescribe above are associated with a different schedule.]

11. Which of the following would be considered a Section 170(c) organization? (Page 308)

a. A trust that provides athletic equipment for amateur sports. [This answer is incorrect. A corporation, trust,or community chest, fund, or foundation can be a Section 170(c) organization if it meets certainqualifications. One of those qualifications is that it be organized and operated exclusively for religious,charitable, scientific, literary, or educational purposes; or to foster national or international amateur sportscompetition; or for the prevention of cruelty to children or animals. However, entities whose activitiesinclude providing athletic facilities or equipment are excluded from the Section 170(c) designation.]

b. An organization that benefits both veterans and a private individual. [This answer is incorrect. Section170(c) organizations include a post or organization of war veterans; or an auxiliary unit or society of, or atrust or foundation for, any such post or organization that is organized in the U.S. or one of its possessionsand in which no part of the net earnings inures to the benefit of a private shareholder or individual.]

c. A fraternal society thatmeets for social reasons. [This answer is incorrect.Oneexampleof aSection170(c)organization is a domestic fraternal society, order, or association operating under the lodge system; butonly if such an entity is soliciting contributions to be used exclusively for religious, charitable, scientific,literary, or educational purposes; or for the prevention of cruelty to children or animals. A socialorganization would not qualify.]

d. A state or a possession of the United States of America. [This answer is correct. A state or U.S.possession, or any political subdivisions of these, will qualify as a Section 170(c) organization.]


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12. The Garden Club is a nonprofit social club under Section 501(c)(7). To maintain its tax-exempt status, it mustdo which of the following? (Page 308)

a. Ensure at least 75% of its activities must be for the pleasure and recreation of its members. [This answeris incorrect. For a social club like the Garden Club to maintain its tax exemption, substantially all of itsactivities (not 75%)mustbe for thepleasure, recreation, andothernonprofitablepurposesof itsmembers.]

b. Limit income from the general public plus investment income to no more than 50% of its gross receipts.[This answer is incorrect. Nonmember revenue (i.e., income from the general public) plus investmentincome must be no more than 35% of gross receipts. The Garden Club would fail the gross receipts testif this income was 50% of its gross receipts.]

c. Limit nonmember revenue to 15% or less of its gross receipts. [This answer is correct. One of thegross receipts tests that social clubs have to pass is that nonmember revenuemust benomore than15% of gross receipts. Therefore, if the Garden Club keeps to this limitation, it will meet thiscondition for retaining its tax-exempt status.]

d. Ensure that all of its income is derived from its members instead of the general public. [This answer isincorrect. It is possible for a social club to receive income from the general public without losing itstax-exempt status, assuming the proper gross receipts tests are met.]


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Governance, Management, and Disclosure (Part VI)

Part VI requests information regarding an organization’s governing body and management, governance policies,and disclosure practices. Although federal tax law generally does not mandate particular management structures,operational policies, or administrative practices, every organization is required to answer each question in Part VI.For example, all organizations must answer lines 11a and 11b, which ask about the organization’s process, if any,it uses to review the Form 990, even though the governing body is not required by federal tax law to review the Form990.

The instructions further explain that even though the information on policies and procedures requested in SectionB generally is not required under the Internal Revenue Code, the IRS considers such policies and procedures togenerally improve tax compliance. The absence of appropriate policies and procedures can lead to opportunitiesfor excess benefit transactions, inurement, operation for nonexempt purposes, or other activities inconsistent withexempt status. Whether a particular policy, procedure, or practice should be adopted by an organization maydepend upon the organization’s size, type, and culture. Accordingly, it is important that each organization considerthe governance policies and practices that are most appropriate for that organization in assuring sound operationsand compliance with the tax law. For IRS governance training materials relating to exempt organizations, seewww.irs.gov and search for “IRS Training Materials—Governance.”

Section A—Governing Body and Management

The questions in Section A, Part VI, relate to the policies and procedures of the organization’s governing body andmanagement. If the organization answers “Yes” to questions 2–7b, or 9, or “No” to question 8a, 8b, or 10b attachSchedule O describing the circumstance, process, or change.

Line 1a—Number of Voting Members of Governing Body. The governing body is the group of one or more personsauthorized under state law to make governance decisions on behalf of the organization and its shareholders ormembers, if applicable. Typically, the governing body is the board of directors or the board of trustees (or trustee,if only one trustee). State the number, as of the tax year end, of members of the organization’s governing body withpower to vote on all matters that may come before the governing body (other than when disqualified from voting bya conflict of interest). Explain any material differences in the members’ voting rights in Schedule O.

If at any time during the organization’s tax year the governing body or governing documents delegated authority toact on its behalf to another committee (e.g., executive committee, finance committee), describe in Schedule O thecomposition of the committee and the scope of its authority, and indicate whether those committee members arealso members of the governing body. Limited scope delegations (i.e., an audit committee, investment committee,or compensation committee) do not need to be described in Schedule O.

Line 1b—Independent Voting Members. Enter the number of independent voting members of the governing bodyas of the organization’s tax year end. Members of the governing body are considered independent only if all of thefollowing applied at all times during the tax year:

1. Theywere not compensated as anofficer or other employee of the organization (or a related organization).In addition, the member was not compensated by an unrelated organization or individual for servicesprovided to the filing organization (or a related organization) if the compensation is required to be reportedin Part VII, Section A.

2. They did not receivemore than $10,000 of total compensation or other payments from the organization (ora related organization) as an independent contractor (other than expense reimbursements under anaccountable plan or reasonable compensation for services performed in the capacity as a member of thegoverning body). The $10,000 threshold is based on the organization’s tax year (including a short year,regardless of whether the compensation is reported in Part VII of Form 990). For example, the receipt of$7,500 from the organization for contractor services, plus reasonable expense reimbursements andreasonable director’s fees (regardless of amount) does not preclude independence.


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3. They (or a family member) were not involved in a transaction with the organization (whether directly orindirectly through an affiliated organization) that is required to be reported in the organization’s current taxyear Schedule L.

4. They (or a family member) were not involved in a transaction with a taxable or tax-exempt relatedorganization (whether directly or indirectly, through affiliation with another organization) of a type andamount that would be reported in Schedule L if required to be filed by the related organization.

A member of the governing body is not considered to lack independence merely because the member—

1. is a donor to the organization, regardless of the amount of the contribution;

2. has taken a bona fide vow of poverty and either (a) receives compensation as an agent of a religious orderor a Section 501(d) organization, but only under circumstances in which the individual does not receivetaxable income, or (b) belongs to a religious order that receives payments from the organization that arenot taxable income to the member (i.e., religious exception); or

3. receives financial benefits from theorganizationsolely in thecapacityofbeingamemberof theclassservedby the organization in the exercise of its exempt function [i.e., being a member of a Section 501(c)(6)organization], so long as the financial benefits comply with the organization’s terms of membership.

Organizations that prefer not to have amajority of independent boardmembers should strongly consider having anindependent audit committee in order to demonstrate that the organization is concerned about accountability andproper governance.

Example 3C-1 Legal fees paid to a board member’s law firm.

Bob is a voting member of the Homeless Shelter (HS) board of directors. Bob is also a partner with a profitsand capital interest greater than 5% in a law firm, Carter and Carter, LLP (CC) that charged $120,000 to HS forlegal services in a court case. The transaction between CC and HS must be reported on Schedule L becauseit is a transaction between HS and an entity of which Bob is a more than 5% owner, and because the paymentfrom HS to CC exceeded $100,000. Accordingly, Bob is not an independent member of the governing bodybecause the $120,000 paymentmust be reported on Schedule L as an indirect business transaction with Bob.

Variation: If Bob were an associate attorney (an employee) rather than a partner with a greater than 5%interest and not an officer, director, trustee, or owner of the CC, then the transaction would not affect Bob’sstatus as an independent member of the organization’s governing body.

Example 3C-2 Compensation paid to a family member of a board member.

Darrell is a votingmember of both Philanthropy’s governing body and the governing body of Charity, a relatedorganization. Darrell’s daughter, Emily, received $40,000 in taxable compensation as a part-time employee ofCharity. Darrell is not an independent member of the governing body because Emily received compensationfrom Charity, an organization related to Darrell, and the compensation was of a type (compensation to familymember of a member of Charity’s governing body) and amount (over $10,000) that would be reportable onSchedule L if the related organization, Charity, were required to file Schedule L.

Example 3C-3 Effect of compensation paid to board member on independence.

Charles (C) was Chairman of the Board for Xcel School (X) during the tax year. X’s bylaws designate thefollowing as officer positions: board chair, secretary, and treasurer. C set the agenda and officiated at boardmeetings, coordinated development of board policy and procedure, was an ex officio member of all boardcommittees, conducted weekly staff meetings, and performed teacher and staff evaluations. X compensatedC during the tax year for C’s board and committee activities and for C’s non-director services involving staffmeetings and performance evaluations. Because X compensated C for services as an officer/employee, C isnot an independent member of the governing body.


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Variation 1: Assume the Board Chair position was not designated as an officer position under X’s bylaws,board resolutions, or state law. However, because X compensated C for non-director services (e.g., staffmeetings and performance evaluations), C is deemed to have received compensation as an employee (not asa governing body member) for those activities. Therefore, C is not an independent member of the governingbody.

Variation 2: Assume C conducted only director and committee activities during the tax year and did notconduct staff meetings and evaluations. X paid C a reasonable amount for C’s Board Chair services during thetax year, but did not provide any other compensation to C. C’s board member independence is not impairedby receiving compensation from X as a board member (and not as an officer or employee).

Reasonable Effort Standard. An organization is not required to exert more than a reasonable effort to obtain thenecessary information to determine the number of independent voting members of its governing body and can relyon information provided by such members. For example, the organization can rely on information it obtains inresponse to a questionnaire sent annually to each member of the governing body that includes the member’sname, title, and blank lines for the member’s signature and date, and contains the necessary instructions anddefinitions for line 1b to determine whether the member is (or is not) independent.

Line 2—Relationships among Officers, etc. Answer “Yes” if any of the organization’s current trustees, directors,officers, or key employees (TDOKEs) had a family or business relationship with another of the organization’scurrent TDOKEs at any time during the organization’s tax year. For each family and business relationship, identifythe individuals and describe their relationship in Schedule O. Stating family relationship or business relationshipwithout greater detail is sufficient.

In determining whether a family relationship exists, the family of an individual (unless specified otherwise) includesonly his or her spouse, ancestors, brothers and sisters (whether whole or half blood), children (whether natural oradopted), grandchildren, great-grandchildren, and spouses of brothers, sisters, children, grandchildren, andgreat-grandchildren.

For Part VI, line 2, business relationships between two persons include the following:

1. One person is employed by the other in a sole proprietorship or by an organization with which the otherisassociatedasa trustee,director,officer,orgreater-than-35%ownereven if thatorganization is taxexempt.

2. One person is transacting business with the other (other than in the ordinary course of either party’sbusiness on the same terms as are generally offered to the public), directly or indirectly, in one or morecontracts of sale, lease, license, loan, performance of services, or other transaction involving transfers ofcash or property valued in excess of $10,000 in the aggregate during the organization’s tax year. Indirecttransactions are transactions with an organization with which the one person is associated as a trustee,director, officer, or greater-than-35% owner. These transactions do not include charitable contributions totax-exempt organizations.

3. The two persons are each a director, trustee, officer, or greater-than-10% owner in the same business orinvestment entity (but not in the same tax-exempt organization).

Ownership is measured by stock ownership (either voting power or value, whichever is greater) of a corporation,profits or capital interest in a partnership or limited liability company, membership interest in a nonprofit organiza-tion, or beneficial interest in a trust. Ownership includes indirect ownership (e.g., ownership in an entity that hasownership in the entity in question); there can be ownership through multiple tiers of entities.

Privileged Relationship Exception. For this line, a business relationship does not include a relationship between (1)attorney and client, (2) medical professional (including psychologist) and patient, or (3) priest/clergy and penitent/communicant.

Example 3C-4 Trustee’s business transactions at terms generally offered to the public.

Frank and Ginger are trustees of Good Cause, a Section 501(c)(3) organization. Frank is the owner and CEO ofa motorcycle dealership. Ginger purchased a $35,000 motorcycle from the dealership during the organization’s


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tax year in the ordinary course of the dealership’s business, on terms generally offered to the public. Therelationship between Frank and Ginger is not a reportable business relationship because the transaction was inthe ordinary course of business on terms generally offered to the public.

Example 3C-5 Board member’s business relationships.

Harvey and Julie are members of the Food Pantry’s board of directors. Both are CEOs of publicly tradedcorporations and serve on each other’s boards. The relationship between Harvey and Julie is a reportablebusiness relationship because each is a director or officer in the same business entity.

Example 3C-6 Privileged legal services performed for organization’s key employee.

Ken is an officer of Children’s Advocacy (CA), a Section 501(c)(3) organization. Lauren is on CA’s board ofdirectors. Lauren is a greater-than-35% partner of a law firm that charged $60,000 during the CA’s tax year forlegal services provided to Ken that were worth $600,000 at the law firm’s ordinary rates (thus, the ordinarycourse of business exception does not apply). However, the relationship between Ken and Lauren is not areportable business relationship because of the privileged relationship of attorney and client.

Variation: If Lauren is a greater-than-35% partner in a CPA firm performing accounting services, the privi-leged relationship exception would not apply.

Reasonable Effort Standard. As discussed for line 1b, the reasonable effort standard also applies to obtaininginformation about relationships among TDOKEs (using the instructions and definitions for line 2).

Line 3—Delegation of Management to Management Company. Answer “Yes” if the organization at any time duringits tax year used a management company or other person (other than persons acting in their capacities asTDOKEs) to perform management duties customarily performed by or under the direct supervision of officers,directors, trustees, or key employees. Such management duties include, but are not limited to, hiring, firing, andsupervising personnel, planning or executing budgets or financial operations, or supervising exempt operations orunrelated trades or businesses of the organization. Management duties do not include administrative services(e.g., payroll processing) that do not involve significant managerial decision-making. They also do not includeinvestment management unless the filing organization conducts investment management services for others.

A “Yes” answer requires an explanation in Schedule O of the circumstances and/or details of managementdelegation that should include a list of the name(s) of the management company or companies or other person(s)performing management duties, a description of the services it provided to the organization; and a list of theorganization’s current or former TDOKEs or highly compensated employees listed in Part VII, Section A, who werecompensated by the provider(s) of management services for services provided to the filing organization andrelated organizations during the calendar year ending with or within the organization’s tax year, including theamount of reportable and other compensation received.

Line 4—Changes to Organizational Documents. The organization must report significant changes to its organizingdocument (i.e., articles of incorporation, association, or organization; trust instrument; constitution; or similardocument) and to its rules governing its affairs (i.e., bylaws, regulations, operating agreement, or similar docu-ment). Report changes made since the prior Form 990 was filed, or that were not reported on any prior Form 990,and that were made before the end of the tax year. Do not report changes to policies described or establishedoutside of the organizing document and bylaws (or similar documents), such as adoption of, or change to, a policyadopted by resolution of the governing body that does not include a change to the organizing document or bylaws.

Examples of significant changes to the organizing or enabling document or bylaws include changes to the—

1. organization’s exempt purposes or mission;

2. organization’s name;

3. number, composition, qualifications, authority, or duties of the governing body’s voting members;


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4. number, composition, qualifications, authority, or duties of the organization’s officers or key employees;

5. role of the stockholders or membership in governance;

6. distribution of assets upon dissolution;

7. provisions to amend the organizing or enabling document or bylaws;

8. quorum, voting rights, or voting approval requirements of the governing body members or theorganization’s stockholders or membership;

9. policies or procedures contained within the organizing documents or bylaws regarding compensation ofTDOKEs, conflicts of interest, whistleblowers, or document retention and destruction; and

10. composition or procedures of an audit committee.

Insignificant changes made to organizing documents or bylaws that are not required to be reported here includechanges to the organization’s registered agent with the state and to the required or permitted number or frequencyof governing body or member meetings.

Example 3C-7 Organization changes conflicts of interest policy.

Emergency Assistance (EA), a Section 501(c)(3) organization, has a written conflicts of interest policy. Thepolicy is not included within EA’s organizing document or bylaws. The policy is changed during EA’s tax yearby board resolution. The policy change does not need to be reported in line 4.

Summarize significant changes in Schedule O, but do not attach a copy of the amendments or amended documentto Form 990 unless such amended documents reflect a change in the organization’s name.

If the organization changes its name during the year, attach the following documents to Form 990.

If the organization is Then attachA corporation Amendments to the articles of incorporation with proof of filing with the

incorporating state.

A trust Amendments to the trust agreement signed by the trustee.

An unincorporated association Amendments to the articles of association, constitution, bylaws, or otherorganizing documents, with the signatures of at least two officers/members.

Line 5—Significant Diversion of Assets. Answer “Yes” if the organization became aware during the year of asignificant diversion of its assets, whether or not the diversion occurred during the year. If “Yes,” explain the natureof the diversion, dollar amounts and/or other property involved, corrective actions taken to address the matter, andpertinent circumstances in Schedule O. Do not include the names or otherwise identify those who diverted theassets.

A diversion of assets includes any unauthorized conversion or use of the organization’s assets including but notlimited to an embezzlement or theft. Report diversions by the organization’s officers, directors, trustees, employ-ees, volunteers, independent contractors, grantees (diverting grant funds), or any other person, even if notassociated with the organization (other than by the diversion). A diversion of assets does not include an authorizedtransfer of assets for FMV consideration, such as to a joint venture or for-profit subsidiary in exchange for an interestin the joint venture or subsidiary. For this purpose, a diversion is considered significant if the gross value of alldiversions before recoveries discovered during the organization’s tax year exceeds the lesser of (1) $250,000, (2)5% of the organization’s gross receipts for its tax year, or (3) 5% of the organization’s total assets as of the end ofits tax year.

Line 6—Members or Stockholders. Answer “Yes” if the organization is (1) organized as a stock corporation, ajoint-stock company, a partnership, a joint venture, or a limited liability company; or (2) organized as a non-stock,


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non-profit, or not-for-profit corporation or association with members. Answer “No,” if the organization is a trust forfederal tax purposes.

For Part VI, a member is any person who has the right under the organizing documents to participate in theorganization’s governance, or to receive distribution of income or assets from the organization. Members do notinclude governing body members. A membership organization includes members with the right to—

1. elect the members of the governing body (but not if the persons on the governing body are theorganization’s only members) or their delegates;

2. approve significant decisions of the governing body; or

3. receivea shareof theorganization’sprofits, excessdues, or net assets upon theorganization’sdissolution.

Describe in Schedule O the classes of members or stockholders with the rights described previously.

Line 7a—Election of Members of Governing Body. Answer “Yes” if during the organization’s tax year there were oneor more persons (other than the organization’s governing body itself, acting in such capacity) who had the right toelect or appoint one or more members of the organization’s governing body, whether periodically, as vacanciesarise, or otherwise. If “Yes,” describe in Schedule O the class or classes of such persons and the nature of theirrights.

Line 7b—Approval of Decisions of Governing Body. Answer “Yes” if, during the organization’s tax year, there wasone ormore persons (whethermembers, stockholders, or persons other than the governing body) who couldmakegovernance decisions or had the right to approve or ratify decisions of the governing body, such as approval of thegoverning body’s election or removal of members of the governing body, or approval of the governing body’sdecision to dissolve the organization. If “Yes,” describe in Schedule O the class or classes of such persons, thedecisions that require their approval, and the nature of their voting rights.

Line 8—Documentation of Meetings and Actions. Answer “Yes” to lines 8a and 8b if the organization contempora-neously documented by any means permitted by state law every meeting held and written action taken during theorganization’s tax year by its governing body and committees with authority to act on behalf of the governing body(which generally does not include advisory boards). Documentation may include approved minutes, emails, orsimilar writings that explain the action taken, when it was taken, and who made the decision. Contemporaneousmeans by the later of (1) the next meeting of the governing body or committee (e.g., approving the minutes of theprior meeting), or (2) 60 days after the date of the meeting or written action.

If “No,” explain in Schedule O the organization’s practices or policies, if any, regarding documentation of meetingsand written actions of its governing body and committees with authority to act on its behalf.

Line 9—Addresses of Officers, Directors, etc. If any of the organization’s officers, directors, trustees, and keyemployees cannot be reached at the organization’s mailing address stated on the first page of Form 990, providetheir mailing addresses on Schedule O.

Section B—Policies

Section B specifically asks if the organization has adopted certain policies by the end of its tax year and, in somecases, what procedures exist for monitoring compliance with these policies. The policies mentioned in this sectionare not required by the IRS, but the information provided will be used to assess the risk of noncompliance withfederal tax law.

Line 10a—Local Chapters, Branches, or Affiliates. Answer “Yes” if the organization had, during its tax year, any localchapters, disregarded entities, branches, lodges, units, or similar affiliates. These terms include organizations overwhich the organization has the legal authority to exercise supervision and control (whether or not in a groupexemption), and local units that are not separate legal entities under state law.

Line 10b—Policies and Procedures Governing Chapters. Written policies and procedures governing the activitiesof chapters, branches, and affiliates to ensure their consistency with the organization’s tax-exempt purpose are


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documents used by the organization and its local units to address the policies, practices, and activities of the localunit. Such policies and procedures can include policies and procedures similar to those described in lines 11–16of this section, whether separate or included as required provisions in the chapter’s articles of organization orbylaws, a manual, a constitution, or similar documents.

If “No,” explain in Schedule O how the organization ensures that the local unit’s activities are consistent with its ownor are consistent with its tax-exempt purposes.

Line 11a—Copy of Form 990 to Governing Body. Answer “Yes” only if a complete written or electronic copy of theorganization’s Form 990 (including required schedules), as ultimately filed with the IRS, was provided to eachvoting member of the organization’s governing body (at the time the Form 990 was furnished) prior to its filing withthe IRS (even though no review occurred). The organization can also answer “Yes” if it emails its governing bodymembers a link to a website where the entire Form 990 can be viewed and notes in the email when the form will beavailable to review. Answer “No” if (1) the organization merely informed its governing body members that a copy ofthe Form 990 is available upon request, or (2) any information was redacted or removed from the final copy of Form990 provided to governing body members prior to filing. For example, if the organization, at the request of a donor,removed the name and address of that donor from the copy of the Form 990, Schedule B provided to the governingbody, the organization must answer “No” to line 11a and may explain why on Schedule O.

Line 11b—Schedule O Description of Organization’s Review of Form 990. Describe in Schedule O the process, ifany, by which any of the organization’s officers, directors, trustees, board committee members, or managementreviewed Form 990, whether before or after it was filed with the IRS, including specifics about who conducted thereview, when they conducted it, and the extent of any such review. If no review was or will be conducted, state “Noreview was or will be conducted.”

Example 3C-8 Providing a copy of Form 990 to board members.

The return preparer emails a copy of the final version of the Form 990 to each board member before it is filed.However, no board member undertakes any review of the form either before or after filing. Because a copy ofthe final version of the return was provided to each voting member of the organization’s governing bodybefore it was filed, the organization may answer “Yes” to line 11a even though no review took place. Theorganization must describe its internal Form 990 review process, if any, in Schedule O. If there is no internalreview process, it must state on Schedule O, “No review was or will be conducted.”

The organization should consider documenting in board minutes the directors who reviewed the Form 990.Additionally, for many board members, reviewing the organization’s Form 990 may seem like an overwhelmingtask. The organization should consider distributing information to each board member that can assist them inperforming a meaningful review along with his or her copy of Form 990. PPC’s 990 Deskbook provides a checklistthat can be used for this purpose.

Line 12a—Conflict of Interest Policy. Answer “Yes” if the organization had a written conflict of interest policy in placeas of the end of the organization’s tax year. A conflict of interest arises when a person in a position of authority overan organization, such as an officer, director, manager, or key employee, can benefit financially from a decision heor she couldmake in such capacity, including indirect benefits such as to family members or businesses with whichthe person is closely associated. For this purpose, a person’s competing or respective duties to the organizationand to another organization, such as by serving on the boards of both organizations, is not a conflict of interestprovided the dual service does not involve a material financial interest of, or benefit to, such person.

Example 3C-9 Vote on legislative proposal not a conflict of interest.

Bill is a member of the governing body of Help Now (HN) and of Food Bank (FB), which are Section 501(c)(3)public charities with different charitable purposes. HN publicly opposes a specific legislative proposal. At anupcoming boardmeeting, FB will consider whether to publicly endorse the same specific legislative proposal.While Bill may have a conflict of interest in this decision, the conflict does not involve a material financialinterest of Bill’s merely as a result of FB’s position on the legislation.

Line 12b—Annual Disclosure of Interests. Answer “Yes” if the organization’s TDOKEs are required to disclose orupdate annually (or more frequently) information regarding their interests and those of family members that could


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give rise to conflicts of interest, such as a list of family members, substantial business or investment holdings, andother transactions or affiliations with businesses and other organizations. See PPC’s Nonprofit Tax and GovernanceGuide: Helping Organizations Comply for additional information including a sample disclosure request.

Line 12c—Enforcement of Conflicts Policy. If “Yes,” describe in Schedule O the organization’s practices formonitoring proposed or ongoing transactions for conflicts of interest and dealing with potential or actual conflicts,whether discovered before or after the transaction has occurred. The description should include an explanation ofpersons covered under the policy, the level at which determinations of whether a conflict exists are made, and thelevel at which actual conflicts are reviewed. Also explain any restrictions imposed on persons with a conflict, suchas prohibition from participating in the governing body’s deliberations and decision in the transaction.

Lines 13 and 14—Whistleblower and Document Retention Policies. A whistleblower policy encourages staff andvolunteers to come forward with credible information on illegal practices or violations of adopted policies of theorganization, specifies that the organization will protect the individual from retaliation, and identifies those staff orboard members or outside parties to whom such information can be reported.

A document retention and destruction policy identifies the record retention responsibilities of staff, volunteers,board members, and outsiders for maintaining and documenting the storage and destruction of the organization’sdocuments and records. The policy should provide guidance on the length of time electronic and hard copy filesmust be stored, backup procedures to be used, and network maintenance to ensure reliability of the system. Anorganization should consider both state law and tax statutes of limitations when drafting a retention policy.

Line 15—Process for Determining Compensation. For a compensation package to be reviewed, there should be awritten job description and employment contract or other agreement describing the duties, hours, and responsibili-ties of the disqualified person. All types of compensation (both cash and noncash) including salary, fees, bonuses,severance payments, fringe benefits, and deferred compensation must be considered in total annual compensa-tion. Any incentive pay must also be documented and reviewed.

Answer “Yes” to line 15a if, during the tax year, the organization used a process for determining compensation(reported in Part VII or Schedule J) of the CEO, executive director, or other person who is the top managementofficial, that included all of the following elements:

1. Review and approval by a governing body or compensation committee, provided that persons with aconflict of interest regarding the compensation arrangement at issue were not involved. For this question,a member of the governing body or compensation committee has a conflict of interest regarding acompensation arrangement if any of the following circumstances apply:

¯ Themember or a familymember is participating in or economically benefiting from the compensationarrangement.

¯ The member is in an employment relationship subject to the direction or control of any personparticipating in or economically benefiting from the compensation arrangement.

¯ The member receives compensation or other payments subject to approval by any personparticipating in or economically benefiting from the compensation arrangement.

¯ The member has a material financial interest affected by the compensation arrangement.

¯ The member approves a transaction providing economic benefits to any person participating in thecompensation arrangement, who in turn has approved or will approve a transaction providingeconomic benefits to the member.

2. Use of data as to comparable compensation for similarly qualified persons in functionally comparablepositions at similarly situated organizations.

3. Contemporaneous documentation and recordkeeping of the deliberations and decisions regarding thecompensation arrangement.


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Answer “Yes” to line 15b if the process for determining compensation of one or more officers or key employeesother than the top management official included all of the elements listed previously.

Answer “No” to line 15a if the organization did not compensate its CEO, executive director, or top managementofficial during the tax year. Similarly, answer “No” to line 15b if the organization did not compensate any of its otherofficers or key employees during the tax year.

An organization must be able to demonstrate that the data used is from organizations that are in fact comparablein terms of geographical location, size, revenues, total net assets, and other relevant factors. Also, the compensa-tion surveys relied on for comparable data should specify whether amounts reported include only salary or othertypes of compensation as well.

Example 3C-10 Conflict of interest in setting compensation.

John Appleseed is a voting director of People for Charity (PC) and is the president of Big Wireless. Inc. (BWI),a corporation wholly owned by Barry Blackberry. Barry is also a salaried executive of PC.

Barry’s control of John’s employment at BWI means John has a conflict of interest if he participates in thesetting of Barry’s compensation at PC.

Line 16—Joint Venture Policy. Answer “Yes” to line 16a if at any time during its tax year the organization invested in,contributed assets to, or otherwise participated in a joint venture (or any similar arrangement) with one or moretaxable persons. For line 16 reporting, a joint venture or similar arrangement includes any joint ownership orcontractual arrangement through which there is an agreement to jointly undertake a specific business enterprise,investment, or exempt purpose activity (regardless of control, or legal or tax structure). Disregard ventures thatmeet both of the following conditions:

1. Ninety-five percent or more of the venture’s income for its tax year ending with or within the organization’staxyear ispassive incomedescribed in IRCSec.512(b)(1)–(5) (includingunrelateddebt-financed income).

2. The primary purpose of the organization’s contribution to, or investment or participation in, the venture isthe production of income or appreciation of property.

Line 16b must be answered if line 16a is answered “Yes.” Answer “Yes” to line 16b if the organization at the end ofthe tax year has both (1) followed a written policy or procedure that requires the organization to negotiate in itstransactions or arrangements with other members of the venture (or arrangement) such terms and safeguardsadequate to ensure that the organization’s exempt status is protected, and (2) taken steps to safeguard theorganization’s exempt status with respect to the venture.

Examples of safeguards include the following:

1. Control over the venture sufficient to ensure that it furthers the exempt purpose of the organization.

2. A requirement that the venture give priority to exempt purposes over maximizing profits for the otherparticipants.

3. The venture not engage in activities that would jeopardize the organization’s exemption (i.e., lobbying orpolitical intervention).

4. All contracts entered into with the organization be on terms that are arm’s length or more favorable to theorganization.

Section C—Disclosure

Line 17—Form 990 Filings with States. List each state with which a copy of the Form 990 is required to be filed, evenif not yet filed. Use Schedule O if additional space is necessary.


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Line 18—Public Availability of Forms 1023, 1023-EZ, 1024, 990, and 990-T. Exempt organizations must makepublicly available their Form 1023 [Application for Recognition of Exemption Under Section 501(c)(3) of the InternalRevenue Code], 1023-EZ [Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of theInternal Revenue Code], or 1024 [Application for Recognition of Exemption Under Section 501(a)]. Applicationsfiled before July 15, 1987, need not bemade publicly available unless the organization had a copy on July 15, 1987.Organizations that file Form 990 must make it publicly available for a period of three years from the date it isrequired to be filed (including extensions) or, if later, is actually filed. Organizations are not required tomake publiclyavailable the names and addresses of contributors (reported in Form 990, Schedule B and in Form 1023, 1023-EZ,or 1024).

Section 501(c)(3) organizations that file Form 990-T also are required to make their Form 990-T publicly availablefor the corresponding three-year period (unless the form was filed solely to request a refund of telephone excisetaxes).

Check the “Own website” box only if the organization posted an exact reproduction (other than the informationpermitted to be withheld such as donor information on Schedule B) of its Form 990, Form 990-T, or application forexemption (i.e., Form 1023, 1023-EZ, or 1024) on its website during its tax year.

Check the “Another’s website” box only if the organization provided, and another person or organization posted onits website, an exact reproduction (other that the information permitted to be withheld) of any such forms during thetax year.

Explain in Schedule O if “Other” is checked or if the organization does not make publicly available upon requestany form that is subject to public inspection as discussed previously.

Line 19—Public Availability of Other Documents. Explain in Schedule O whether the organization makes itsgoverning documents (e.g., articles of incorporation, constitution, bylaws, trust instrument), conflict of interestpolicy, and financial statements (whether or not audited) available to the general public during the tax year, and ifso, how it made them available (e.g., posting on the organization’s website, posting on another website, providingcopies on request, inspection at an office of the organization). State “No documents available to the public” if theorganization did not make any of these documents publicly available. Federal tax law does not require that suchdocuments be made publicly available unless they were included in a form that is publicly available (such as Form1023, 1023-EZ, or 1024).

Line 20—Location of Books and Records. Provide the name of the individual who possesses the organization’sbooks and records, and the business address and telephone number of the individual, or use the address andtelephone number of the organization if the books and records are kept by the individual at a personal residence.If the books and records are kept at more than one location, provide the name, business address, and telephonenumber of the person responsible for coordinating the maintenance of the books and records. The organization isnot required to provide the address or telephone number of an individual’s personal residence.


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SELF-STUDY QUIZ


13. Assuming all other qualifications are met, individuals can be considered an independent member of anorganization’s governing body under which of the following circumstances?

a. They do not make donations to the organization that they serve.

b. They receive a fair amount of compensation from the organization for providing governing services.

c. They receive financial benefits from the organization as a member of the class it serves under the termsof membership.

d. They were involved in transactions with the organization that must be reported on the organization’sSchedule L for the tax year in question.

14. Which of the following would be considered an insignificant change to an organizational document (i.e., achange that does not have to be reported)?

a. A name change.

b. A change in the number of annual meetings.

c. Changes to the exempt purpose.

d. Changes in roles played by governing members.


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SELF-STUDY ANSWERS


13. Assuming all other qualifications are met, individuals can be considered an independent member of anorganization’s governing body under which of the following circumstances? (Page 320)

a. They do not make donations to the organization that they serve. [This answer is incorrect. A member ofthe governing body is not considered to lack independencemerely because themember is a donor to theorganization, regardless of the amount of the contribution.]

b. They receive a fair amount of compensation from the organization for providing governing services. [Thisanswer is incorrect. To be considered independent, at all times during the year, individuals must not becompensated as an officer or other employee of the organizations.]

c. They receive financial benefits from the organization as a member of the class it serves under thetermsofmembership. [Thisanswer is correct.Amemberof agoverningbodycanstill beconsideredindependent if he or she receives financial benefits from the organization solely in the capacity ofbeing a member of the class served by the organization in the exercise of its exempt function, solong as the financial benefits comply with the organization’s terms of membership.]

d. They were involved in transactions with the organization that must be reported on the organization’sSchedule L for the tax year in question. [This answer is incorrect.Members’ independencewill be impairedif they (or family members) were involved in a transaction with the organization (whether directly orindirectly through an affiliated organization) that is required to be reported in the organization’s current taxyear Schedule L.]

14. Which of the following would be considered an insignificant change to an organizational document (i.e., achange that does not have to be reported)? (Page 320)

a. A name change. [This answer is incorrect. Changes to an organization’s name are considered significantchanges and, therefore, must be reported.]

b. A change in the number of annual meetings. [This answer is correct. Insignificant changes madeto organizing documents or bylaws that are not required to be reported include changes to theorganization’s registered agent with the state and to the required or permitted number or frequencyof governing body or member meetings.]

c. Changes to theexemptpurpose. [Thisanswer is incorrect.Achange toanorganization’sexemptpurposesor mission is considered significant. This type of change would have to be reported.]

d. Changes in roles played by governing members. [This answer is incorrect. Changes in the role of thestockholders or membership in governance are considered significant changes and are required to bereported.]


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Lesson 4: Reporting Functional ExpensesIntroduction

Part IX provides the IRS and donors with information to use in determining if an appropriate amount of expendituresis being directed to activities that further an entity’s exempt purpose. The IRS is interested in ensuring that theorganization’s financial resources are focused on performing its tax-exempt programs. Also, since Form 990 ispublicly disclosed, the general public can see howmuch of the organization’s funds are spent on program services(compared to fundraising and management and general expenses) and consequently form opinions about anorganization’s stewardship.


Completion of this lesson will enable you to:¯ Identify generalmethods for reporting functional expenses on Form990 and how to allocate expenses tomorethan one function, report grants and other assistance (Part IX and Schedule I), report benefits paid to or formembers, and report compensation and related benefits (Part IX).

¯ Determine the bestmethods for dealingwith fees for services paid to independent contractors, other expenses(advertising, travel, etc.), and payments to affiliates.

The General Reporting of Functional Expenses

Total Expenses—Column (A), Part IX

All organizations must determine the natural classification (e.g., grants, compensation, fees for services, and officeexpenses) of each expenditure and report it in column (A) on the appropriate line. The four largest non-listedexpenses are reported on lines 24a–24d, and all other expenses can be combined on line 24e.

Exceptions include the following:

¯ Expenses directly related to rental income from real or personal property, reportable on Part VIII, line 6b.

¯ Expenses directly related to the sale of securities or other non-inventory assets, reportable on Part VIII, line7b.

¯ Expenses directly related to fundraising events, reportable on Part VIII, line 8b.

¯ Expenses directly related to gaming, reportable on Part VIII, line 9b.

¯ Cost of goods sold directly related to the sale of inventory, reportable on Part VIII, line 10b.

¯ Donated services including the free use of materials, equipment, or facilities, not reportable on either PartVIII or Part IX.

Section 501(c)(3) and (c)(4) organizations must also complete columns (B) through (D). These columns areoptional for all other exempt organizations. Generally accepted accounting principles (GAAP) may be used as aguide for distinguishing between the different types of functional costs. (See PPC’s Guide to Nonprofit Expenses forinformation on GAAP accounting for expenses.)

The three functional classifications are programmatic, administrative, and fundraising. Expenditures directly relatedto a specific function should be reported in the appropriate column. An organization may use any reasonable andconsistent method for allocating shared expenditures across multiple functional columns.

Report expenses using the same method of accounting used in the organization’s books and records. If ScheduleO is used to provide required details, such as for line 11g or line 24e, check the box in the heading of Part IX.


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Program Service Expenses—Column (B)

Every tax-exempt organization must be organized and operated for an exempt purpose. Expenses directlyassociated with accomplishing that exempt purpose are reported in column (B).

Because the mission and exempt purpose of each organization is different, the program services must bedetermined by the facts and circumstances. A thorough understanding of the organization’s exempt purpose isrequired, including a review of the original exemption application (Form 1023), subsequent correspondence withthe IRS, current governing documents (e.g., Articles of Incorporation and Bylaws), and any disclosure of new anddiscontinued programs on previously filed Forms 990.

Form 990 is a public document. Therefore, it is important to carefully and fully document program expenses in PartIX, column (B). The public’s analysis of an organization’s efficiency and effectiveness may be based on analyzingthe portion of expenditures made to accomplish the organization’s programs.

Do not report fundraising expenses, the expenditures made by the organization to raise charitable donationrevenue, as program service expenses even if one of the organization’s purposes is to solicit contributions.However, lobbying expenditures should be reported as program service expenses if the organization’s exemptpurpose includes lobbying or similar advocacy activity.

Example 4A-1 Lobbying directly related to exempt purpose.

Save the Snails Foundation (SSF), a Section 501(c)(3) organization, has the exempt purpose of preservingthe natural habitat for endangered snails. The U.S. Congress is considering legislation to build a natural gaspipeline through a wetland where endangered snails are known to reside. SSF engages in direct andgrassroots lobbying activities opposing the bill authorizing the pipeline. Since this lobbying is directly relatedto SSF’s exempt purpose, it is considered an exempt function expense and reported under column (B).

Expenses that are deductible against unrelated business income (UBI) and reportable on Form 990-T are includedin column (B) if they relate to one of the organization’s programs, as opposed to its administrative or fundraisingactivities. For example, all expenses of a magazine that contains both advertising and exempt-function editorialcontent are program expenses, even if the advertising expenses are classified as management and generalexchange transaction expenses for financial statement purposes.

Costs associated with securing a grant must be classified based on the nature of the grant. If the grant revenue willbe classified as a contribution, then the solicitation expenses are reported as fundraising expenses. If the grantrevenue will be treated as program service revenue from an exchange transaction, then the expenses incurred inseeking the grant are reported as program service expenses (although for GAAP purposes, they would beclassified as management and general expenses).

Management and General Expenses—Column (C)

Report in column (C) those expenses that are not identifiable with a specific program or fundraising activity but arenonetheless necessary for the operation of the organization. Such expenditures should not be confused with thegeneral term overhead, which may be partially allocable to programs and fundraising. Since an organization’sefficiency and effectiveness may be judged, fairly or unfairly, on the proportion of management and generalexpenses over total expenses, the organization should follow reasonable and consistent procedures to allocateshared and indirect expenses.

The extent to which certain salaries and related payroll costs, occupancy and related costs, and other expenses areidentified as management and general costs varies widely among organizations. In a large national organization,overall planning and coordination of activities may require the full-time attention of several executives and theirstaffs. However, in a small organization, if the executive director functions as the organization’s CEO and spendstime directly supervising program or fundraising staff, his or her time may be divided between managementfunctions, program activities, and fundraising efforts.


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Management and general expenses are normally identified in the same manner as those related to programservices or fundraising—by identifying the organization’s activities and then determining the direct and indirectexpenses of those activities. Examples of management and general expenses include the following:

1. Meetings of the board of directors, committees, and staff unless the meeting relates to fundraising or to aspecific program.

2. Executive strategy, direction, and planning.

3. Business management (e.g., determining the need for and helping to establish new local chapters of thenational organization).

4. Office management (e.g., negotiating lease agreements for office space or office equipment rentals andsetting policies for office procedures).

5. General office support activities, including the receptionist, mail room, and other administrative functions.

6. Personnel administration (i.e., human resources).

7. Management of the organization’s investment portfolio.

8. External accounting, auditing, and legal services unless related to accomplishing a specific program.

9. Internal accounting, auditing, budgeting, and financial reporting.

10. Lobbying expenses if the organization’s exempt purpose does not include lobbying or similar advocacyactivity.

11. Provision of general liability and director and officer liability insurance.

Example 4A-2 Reporting management and general expenses.

The Giraffe Preservation Council (GPC), a Section 501(c)(3) public charity, classifies 100% of its expenses asprogram service expenses. The CEO argues that all the expenses are mission-related, reasoning that if therewere no programs, there would be no expenses. In his view, every pen, light bulb, and dollar spent by theorganization is incurred to preserve giraffes.

GPC is not using a reasonable method of allocating expenses. While it is true that the organization’s activitiesdrive all of the direct costs, there are indirect costs that exist independently of the mission. For example, theaccounting, marketing, and human resources departments would still need payroll, benefits, office space,and supplies even if the organization discontinued all of its giraffe preservation activities. Once anorganization identifies its expenses that are directly related to its programs, it must use a reasonable andconsistent method to allocate its indirect costs.

Fundraising Expenses—Column (D)

Report in column (D) those expenses that are identifiable with fundraising (including allocable overhead:

1. Solicitation of cash and noncash contributions, gifts, and grants from individuals, foundations, and otherorganizations.

2. Obtaining government grants reportable on Part VIII, line 1e [however, expenses for government grantsreportable on Part VIII, line 2, are reported as program service expenses in Part IX, column (B), rather thanas fundraising expenses in column (D)].

3. Preparation and distribution of fundraising manuals, instructions, and other materials.


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4. Maintenance of donor mailing lists.

5. Indirect expenses of fundraising events such as advertising, promotion, and expenses related to solicitingsponsors.

6. Fees paid to professional fundraisers.

7. Expenses of participating in federated fundraising campaigns (e.g., United Way campaigns).

8. Expenses of attending clinics, workshops, and other activities for improving fundraising techniques.

9. Costs of radio and television material (to the extent it is not program related).

10. Expenses of campaign kick-off events for an organization’s fundraising volunteers (e.g., postage, printing,meals, and entertainment).

11. Overhead costs allocable to fundraising activities.

The Allocation of Expenses Related to More Than One Function

Joint or indirect expenses that are applicable to more than one activity or function must be properly allocatedbetween program service, management and general, and fundraising expenses. For Form 990, Part IX, purposes,consider the following:

¯ Joint Costs. These are costs from a combined educational campaign and fundraising solicitation. Thedefinition of joint costs for generally accepted accounting principles (GAAP) may differ, as discussed laterin this lesson.

¯ IndirectExpenses.Thesearecosts that cannotbe identifiedwithaspecificactivityorproject (e.g., thesalaryof an employee whose work affects several functional categories).

Expenses that are applicable to more than one activity or function (joint or indirect expenses) must be properlyallocated. The allocationmethods and procedures are important for several reasons. The amount of funds spent onprogram services, as a percentage of total expenses, is often viewed as a measurement of the organization’seffective stewardship of its assets. Donors want to know the extent to which their contributions are used primarily forcharitable purposes. The IRS and state governments examine expense classifications to verify that the organizationis operating primarily for an exempt purpose (and therefore continuing to qualify for its tax exemption). Some statesare especially focused on an organization’s fundraising activities and the related fundraising costs.

Expensesmust also be allocated to unrelated business income (UBI) activities (although such expenses are not setout separately on Part IX.

The allocation must be reasonable, consistent, and thoroughly documented.

Example 4B-1 Allocating salary to more than one function.

Sally spends 40% of her time on fundraising and 60% on program management for Good Cause (GC), aSection 501(c)(3) organization. GC must allocate Sally’s salary 40% to fundraising and report that portion incolumn (D) and 60% to program service expenses and report that portion in column (B). GC may not reportthe 100% of salary as program expenses simply because the employee spent over 50% of her time onprogram management.

Accounting System and Chart of Accounts for Expense Allocation

Whenever possible, charge expenses directly to a particular function. Establish an organization’s accountingsystem and chart of accounts to facilitate this. For example, in addition to recording expenses by object code (i.e.,


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salaries, supplies, and rent), expenses can be recorded by function. Therefore, if an individual spends 50% of thetime on program related activities, 30% on management and general activities, 10% on unrelated businessactivities, and 10% conducting fundraising activities, salary and related expenses for the individual are recordedaccordingly when entered in the accounting system. Without an on-the-spot allocation, an organization may facelarge accounting fees for the hours required to determine the proper allocation of expenses among functions.

Allocating Indirect Expenses

Allocating to More Than One Function. It can be difficult to properly allocate expenses that are common to morethan one function (i.e., indirect expenses). For example, if an organization incurs costs for program service activitiesthat also include a fundraising appeal (such as newsletters, massmailings, or telethons), the allocation of the costsbetween the program service activity and fundraising may not be clear. The IRS provides little guidance concerningthe allocation of these expenses. While total expenses should be reported in column (A) using the same methodthe organization uses for its books and records, those expenses may be segregated into columns (B), (C), and (D)using any method that is consistent and reasonable. Thus, the functional expense totals will not always match theallocation used in the organization’s financial statements.

Allocating indirect expenses based on the portion of an activity’s content that relates to one function (e.g., aprogram service) versus another (e.g., fundraising) may be appropriate, but difficult to do in practice. Possibleallocation methods may include staff time devoted to the activities, or the square footage dedicated to the activity.Allocating expenses based on the revenue generated is not an appropriate method. Some activities consume agreat deal of time and resources without generating significant revenue, while other activities may generate a greatdeal of revenue without consuming a significant amount of time or space. Therefore, an organization should notallocate its indirect labor costs based on program revenue as a percentage of total revenue. (See Example 4B-4 forinformation on the direct-cost method.)

Reporting Indirect Costs. Some organizations (e.g., colleges, universities, and hospitals) accumulate indirect costsin cost centers such as the physical plant, communication costs, books and subscriptions, or cost centers set upto track the expenses associated with grants from various funding sources. The total expense in a particular costcenter is then reallocated among the functions. When preparing Part IX of Form 990, the cost center’s expenses arereported on lines 5 through 24 of the “Management and general” column [column (C)], and then reallocated in asingle step on line 24 (in lieu of reallocating each of the cost center’s expenses on a line-by-line basis) as shown inExample 4B-2. On line 24, enter the description, “Allocation of (name of indirect cost center) expenses.”

As long as all of the reallocated expenses are included in Part IX, reallocation will result in a negative amount incolumn (C), offsetting positive amounts in columns (B) and (D), and column (A) will be $0. However, if thereallocated expenses were reportable in Part VIII (such as rent expense, fundraising expenses, or losses on sale ofassets), then a negative amount in column (C) will require an equal negative amount in column (A), and columns(B) and (D) will be unaffected.

Example 4B-2 Reporting indirect costs.

Main State University (MSU) reallocates to its program services and other functional areas indirect expensesit accumulates in the physical plant cost center. In the current year, it has $50,000 of management and generalexpenses and $150,000 of expenses in the physical plant cost center that are allocable in part to otherfunctions ($25,000 to fundraising, $100,000 to program services, $10,000 to management and general, and$15,000 to special events and activities).

The following steps may be followed to allocate these items:

1. Report the expenses on lines 5–24 in Part IX, column (C) (Management and general), alongwith the otherexpenses that should properly be reported in that column.

2. Allocate the expenses for each cost center to columns (B) (Program services), (C) (Management andgeneral), and (D) (Fundraising) of Part IX as a separate item on line 24 (Other expenses). Enter the nameof the cost center from which the amount is allocated in the blank on the left side of Part IX on the line onwhich the amount is entered.


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3. If any expense is to be allocated to the expenses listed on Part VIII of the Form 990 (e.g., fundraisingevents), enter that expense as a negative amount in columns (A) (Total) and (C) (Management andgeneral) of Part IX to avoid duplicating the expense amount.

4. If any expense is to be allocated to either column (B) (Program services) or (D) (Fundraising), enter theamount as a positive amount in column (B) or (D) and a negative amount in column (C) (Management andgeneral). No offsetting entries should be made in Column (A) (Total) for these expenses.

Approaches to allocating other types of indirect costs, such as occupancy and interest, are discussed later in thislesson.

Allocating Joint Costs. GAAP’s guidance on how to allocate costs that include elements of both program servicesand a fundraising appeal is found in the Financial Accounting Standards Board Codification (FASB ASC) 958-720.Organizations that report joint costs from a combined educational campaign and fundraising solicitation in column(B) must complete line 26. FASB ASC 958-720 requires three criteria (purpose, audience, and content) to besatisfied before any costs of joint activities can be allocated between fundraising and program service or manage-ment and general expenses. If any of the criteria are not met, all costs of the activity (with one exception) must bereported as fundraising costs, even though some of the costs might be considered program or management andgeneral costs if they had been incurred in a different activity. The single exception is that costs of goods or servicesprovided in an exchange transaction that is part of the joint activity [such as costs of direct donor benefits of aspecial event (e.g., a meal)] are not reported as fundraising costs but rather as costs of goods sold.

FASB ASC 958-720-45-29’s detailed discussion of the purpose, audience, and content criteria can be summarizedas follows:

1. Purpose. Accomplishing the organization’s mission(s) or its management and general functions must beoneof the reasons for the joint activity. If the reason relates to theorganization’smission, the audiencemustbe requested to take specific action (other than simply providing financial support) to achieve thatobjective. In addition to thecall to action, certain factors areparamount indeterminingwhether thepurposecriterion is satisfied. For example, the joint activity will fail the purpose test if amajority of the compensationpaid to a participant in the activity is contingent upon contributions raised. On the other hand, the fact thatthe organization already separately conducts a similar program or management and general activity (thatdoes not include a fundraising component) on the same or greater scale will be sufficient to satisfy thepurpose test as long as the call to action and compensation tests are met.

The call to action must satisfy two conditions. First, it must request the audience to act in a specific wayor to influence others to act in a specific way. Second, the requested action must help to advance theorganization’s mission by either benefitting the recipient (e.g., improving his or her physical or mentalwell-being) or benefitting society (by addressing societal problems). The call to action test is not met byeither of the following activities that are considered in support of fundraising: (a) educating the audienceabout causes or motivating the audience to otherwise engage in specific activities that will educate themabout the causes; or (b) asking the audience to make contributions.

However, someeducational activities thatmight otherwisebe consideredas educating the audienceaboutcauses may implicitly call for specific action by the audience that will help accomplish the organization’smission. For example, activities that educate the audience about environmental problems caused by notrecycling implicitly call for that audience to increase recycling. If the need for, and benefits of, the specificaction is clearly evident from the educational message, the message is considered to include an implicitcall for specific action by the audience.

2. Audience. The audience criterion ismet, generally, if themembers of the audiencewere selected primarilybecause of either their need for the action called for, their ability to take specific action to help theorganizationaccomplish itsgoals for theactivity, or their need for themanagementandgeneral componentof the joint activity. Audience selection based on prior financial support or on their ability or likelihood tocontribute to the organization raises a rebuttable presumption that the audience criterion is not met.However, the organization may be able to overcome that presumption if it primarily selects the audiencefor one of the reasons mentioned in the first sentence.


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3. Content. The content criterion is satisfied if the need for, and benefits of, the action the audience is calledupon to undertake in support of the organization’s mission is explained in the information presented.Alternatively, the test is met if an element of the joint activity fulfills one or more of the organization’smanagement and general responsibilities.

Example 4B-3 Brochure content includes a call to action.

Healthier Lifestyle, Inc. (HLI) is a Section 501(c)(3) organization whose mission is to improve individuals’physical health. HLI sends its audience a brochure that urges them to stop smoking and suggests specificmethods, instructions, references, and resources that they can use to stop smoking. The audience is selectedbased on the individuals’ expressed interest in smoking-cessation programs, not on their likelihood to donate.However, the brochure does include a fundraising appeal.

The expenses attributable to the brochure are joint costs from an educational campaign and a fundraisingappeal, and they can be allocated between program service, management and general, and fundraisingexpense. The organization must also complete Form 990, Part IX, line 26.

FASB ASC 958-720 also illustrates some commonly used and acceptable (at least for GAAP purposes) methods ofallocating costs of joint activities (including the direct-cost method shown in Example 4B-4) without requiring orprohibiting any particular method.

Example 4B-4 Using the direct-cost method to allocate joint costs.

The National Wildlife Association (NWA) is a tax-exempt organization devoted to protecting wildlife. NWA senta package of materials to individuals included in lists rented from various organizations that support causesNWA believes are similar to its own. In addition to donor response cards and return envelopes, the packageincluded a bumper sticker urging the public to protect native animals and a letter asking the reader to takespecific action to further NWA’s goals.

The following costs were incurred in connection with distributing this material:

Expenses directly related to fundraising (e.g., printing the donorresponse cards and return envelopes) $ 3,500Expenses directly related to program service activity(e.g., printing the bumper stickers) 5,000Joint costs (e.g., list rentals, outbound postage, and consultingand design costs) 25,000

Based on the content of the mailout, the audience to which it was mailed, and the call to action contained inthe letter, NWA should allocate the expenses of the mailout between fundraising and program services. Thedirectly related expenses should be listed in the appropriate function’s column. The $25,000 of joint costsshould be allocated between the two functions using a reasonable method.

Although not the only reasonablemethod, onemethod of allocating the joint costs is to use what is sometimesreferred to as the direct-costmethod. Using thismethod, the portion of total joint costs allocated to fundraisingequals the ratio of direct fundraising expenses to total direct expenses for the activity [$25,000 × $3,500 ÷($3,500 + $5,000) = $10,294]. Using this same method, the portion of joint costs allocated to programservices is $14,706 [$25,000 × $5,000 ÷ ($3,500 + $5,000)].

NWA is including joint costs from a combined program service and fundraising campaign in column (B) ofForm 990, Part IX. Therefore, it must complete the information below line 26 of Part IX.

Reporting Grants and Other Assistance in Part IX of Form 990

The IRS is interested in the payments to other organizations for at least three reasons. First, the payments couldsuggest that there is private inurement (i.e., payments benefiting an individual because of that individual’s


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relationship with the organization, rather than to fulfill an exempt purpose). Second, the IRS is concerned that someorganizations may be inflating the public contributions they receive by participating in a plan that transfers title tovarious noncash property from entity to entity (with the receiving entity showing the property as a contribution onPart VIII, line 1 and the transferring entity reporting it as a grant on Part IX, line 1, 2, or 3). Third, the IRS is particularlyinterested in foreign grants reported on Part IX, line 3.

Grants

Form 990, Part IX, lines 1 through 3 report voluntary gifts, whether in cash or property, from the organization to anoutside recipient where the organization received nothing of value in return, including grants, awards, prizes,contributions, noncash assistance, cash allocations, stipends, scholarships, fellowships, research grants, andsimilar payments and distributions made during the tax year.

Line 1—Grants and Other Assistance to Domestic Governments and Organizations. Report grants and otherassistance paid to domestic organizations and governments, including United Way and similar federatedfundraising organizations, and discretionary payments to affiliates, even if for a specific (restricted) purpose orproject. If the organization reports more than $5,000 to any single organization, then answer “Yes” to Part IV, line 21and complete Schedule I, Parts I and II.

Line 2—Grants and Other Assistance to Domestic Individuals. Report grants and other assistance paid to domesticindividuals, including assistance paid to third-party providers for the benefit of specified domestic individuals. Forexample, report a grant payment to a hospital to cover the medical expenses of a particular patient on line 2.However, report a grant to the same hospital to provide services to the general public or to unspecified charitypatients on line 1.

Domestic refers to the location of the recipient, not the citizenship of the recipient. Therefore, any individual residingin the U.S. at the time of the grant is a domestic individual, regardless of whether he or she is a U.S. citizen. If theorganization reports more than $5,000 in the aggregate to all domestic individuals, then answer “Yes” to Part IV, line22 and complete Schedule I, Parts I and III.

Line 3—Grants and Other Assistance to Foreign Governments, Organizations, and Individuals. Report grants andother assistance paid to foreign organizations, governments, and individual, including amounts paid to domesticorganizations or domestic individuals for the purpose of providing grants or other assistance to designated foreignorganizations or foreign individuals. For example, a grant made to a domestic charity that is earmarked for a foreigngrantee is reported on line 3 rather than line 1. Foreign refers to the location of the recipient, not the citizenship ofthe recipient. Therefore, any individual residing outside the U.S. at the time of the grant is a foreign individual,regardless of whether he or she is a U.S. citizen. If the organization reports more than $5,000 to any single foreignorganization, then answer “Yes” to Part IV, line 15, and complete Schedule F, Part II. If the organization reports morethan $5,000 in the aggregate to all foreign individuals, then answer “Yes” to Part IV, line 16, and complete ScheduleF, Part III.

Pledges

An unconditional promise to give is recognized as an expense when the pledge is made. FASB ASC 958(acceptable but not required) instructs that the pledge should be reported as grant expense at its present value,and accruals of present value increases to the unpaid balance should be reported as grant expense in future years.A payable is reported on Part X, line 18, until the pledge is fulfilled.

Administrative Expenses

Report expenses incurred in selecting recipients or monitoring compliance with the terms of a grant or award onlines 5 through 24.

Nondiscretionary Payments to Affiliates

These include amounts such as a contractual obligation to pay a specific portion of revenue to a relatedorganization and are reported on line 21.


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Exchange Transactions

If the payment is for goods and services that benefit the organization, then it is an exchange transaction and shouldbe reported on lines 5 through 24.

Grants and Other Assistance to Organizations, Governments, andIndividuals in the U.S (Schedule I)

An organization must complete Form 990, Schedule I if—

¯ it answered “Yes” on Form 990, Part IV, line 21 because it reportedmore than $5,000 to any single domesticorganization (Parts I and II) or

¯ it answered “Yes” on Form 990, Part IV, line 22 because it reported more than $5,000 in the aggregate toall domestic individuals (Parts I and III).

Domestic organizations include nonprofits or other exempt organizations, partnerships, corporations, or otherbusiness entities that are created or organized in the U.S. (or under the laws of the U.S.) or of any state, the Districtof Columbia, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, Guam,American Samoa, and the U.S. Virgin Islands, and an estate or trust other than a foreign estate or trust.

Domestic governments include the federal government and any state or political subdivisions thereof, including theDistrict of Columbia and any possession or political subdivision of the U.S. Include a grant to a U.S. governmentagency on this schedule regardless of where the agency is located or operated.

Domestic individuals include individuals residing in the U.S. at the time of the grant, regardless of whether they areU.S. citizens. U.S. citizens residing outside the U.S. at the time of the grant are not considered domestic individualsfor Schedule I purposes, but must be reported on Schedule F.

Report voluntary gifts, whether in cash or property, from the organization to outside domestic recipients where theorganization received nothing of value in return, including grants, awards, prizes, contributions, noncashassistance, cash allocations, stipends, scholarships, fellowships, research grants, and similar payments anddistributions made during the tax year. Include indirect activities conducted through a disregarded entity or a jointventure treated as a partnership. Do not include salaries or other compensation to employees or payments toindependent contractors that serve the direct needs of the organization (exchange transactions). In addition,certain payments by a Section 501(c)(9) VEBA do not qualify.

Grants to foreign organizations, governments, and individual, including amounts paid to domestic organizations ordomestic individuals for the purpose of providing grants or other assistance to designated foreign organizations orforeign individuals, are reportable on Schedule F.

Example 4D-1 Grants designated for foreign beneficiaries.

The Blue America Society (BAS) awards a grant of $10,000 to the Helpful Americans Foundation (HAF), adomestic nonprofit organization that provides relief to victims of natural disasters around the world. If BASawards the grant to support HAF’s general activities, then BAS should report the grant on Form 990, Part IX,line 1 and on Schedule I (Grants and Other Assistance to Organizations, Governments, and Individuals in theU.S.), Part II.

Variation: If BAS awards the grant specifically to support HAF’s own grantmaking program to assist victimsof an earthquake in the Middle East, then BAS should report the grant on Form 990, Part IX, line 3 and onSchedule F (Statement of Activities Outside the United States), Parts II and IV.

Part I—General Information on Grants and Assistance.

Complete this part if the organization answered “Yes” on Form 990, Part IV, line 21 or 22.


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Line 1. Indicate whether the organization retains written documentation regarding how grant recipients wereidentified, reviewed, selected, and monitored.

Line 2. Explain in Part IV how the organization ensures that the awards were used for the intended purpose andwere not diverted. For example, describe periodic reports required or field investigations conducted.

Part II—Grants and Other Assistance to Domestic Organizations and Domestic Governments

Line 1. List each domestic organization or government entity that receivedmore than $5,000 aggregate of grants orassistance from the organization during the tax year. If there are more than twelve organizations or entities to reportin Part II, use duplicate copies of Schedule I, Part II, and number each page. Use Part IV if additional space isneeded for descriptions.

Column (a). State the complete legal name and mailing address of each recipient organization or governmententity.

Column (b). Enter the employer identification number (EIN) of the grant recipient. This information should begathered at the time the grant is made, as it can be surprisingly difficult to obtain the necessary information whenForm 990 is being prepared. If the grantee is a Section 501(c)(3) organization, the EIN may be obtainable throughwww.Guidestar.org or www.irs.gov (search “Exempt Organization Select Check”).

Column (c). If the recipient organization is tax-exempt, enter the IRC section that is the basis for its tax exemption.For example, enter 501(c)(3) for schools, hospitals, private foundations, and other public charities; enter 501(c)(4)for social welfare organizations; or enter 501(c)(6) for business leagues and trade associations. If the recipient is agovernment entity, indicate the name of the government entity in column (c). For example, if the recipient is the U.S.Army, enter Department of Defense. If a recipient is neither a tax-exempt nor a government entity, leave column (c)blank.

Column (d). Enter total amount of cash grants to each recipient organization or entity during the filing organization’stax year. Cash grants include grants and allocations paid by cash, checks, money orders, electronic fund or wiretransfers, and other charges against funds on deposit at a financial institution. Separate grants to a single recipientshould be combined, although the separate purposes can be explained in column (h).

Columns (e) and (f). Enter the value of noncash property and describe the method of valuation used. For mar-ketable securities registered and listed on a recognized securities exchange, use the average of the highest andlowest quoted selling prices or the average between the bona fide bid and asked prices, on the date the propertyis distributed to the grantee.

Fair market value is generally understood to be the price at which a willing buyer and a willing seller will agree toparticipate in a transaction. Since the act of donating an item involves neither a buyer nor a seller, the organizationmust report what method it used to determine the fair market value of the noncash grant amounts:

¯ ComparableSales.Thedegreeofsimilarity, the timing, thecircumstances,andmarketconditionscanaffectwhether the sale of similar items is a reasonable method to determine the fair market value of the donateditem.

¯ Replacement Cost. This is the cost of buying, building, or manufacturing similar property. Determine the“estimated replacement cost NEW,” and subtract for wear and tear, obsolescence, and factors of supplyand demand.

¯ Expert Opinions. These types of estimates and appraisals are useful if the facts support the opinion andif the expert is competent and knowledgeable.

Column (g). For noncash property or assistance distributed, enter a description of the property or assistancedistributed (e.g., medical supplies or equipment, pharmaceuticals, blankets, books or other educational supplies).

Column (h). Describe the purpose or ultimate use of the grant funds or other assistance in terms that will bemeaningful and useful to readers of the Form 990. Remember that Schedule I is open to public disclosure, and that


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donors and other interested parties will benefit from knowing not only who the grant recipients are, but what theorganization’s reasons were for making the donation. Do not use broad terms such as charitable, educational,religious or scientific. Instead, use more specific descriptions such as payments for nursing services, laboratoryconstruction, food, medical care, or free care for indigent hospital patients. General support is a permissibledescription in cases where the purpose of the grant is obvious or where there is no specific program or projectbeing supported. In the case of disaster assistance, include a description of the disaster and the assistanceprovided (e.g., food and clothing for Organization A’s assistance to California wildfire victims). Use Part IV ifadditional space is needed for descriptions.

Line 2. Enter the total number of recipient organizations listed in line 1 that are (1) tax-exempt under IRC Sec.501(c)(3), (2) domestic government units or entities, or (3) churches, including synagogues, temples, andmosques (or integrated auxiliary thereof). (See Lesson 1 for more information on churches and integrated auxil-iaries.)

Line 3. Enter total number of recipient organizations that are exempt under IRC Sec. 501(c) other than IRC Sec.501(c)(3) and organizations that are not tax-exempt.

Part III—Grants and Other Assistance to Domestic Individuals

Column (a). Do not enter the names, addresses, or any other type of personal identifying information for theindividual grant recipients. Instead, list the types of assistance provided, or describe the purpose or use of grantfunds made to or for the benefit of individual recipients. Do not use broad terms such as charitable, educational,religious, or scientific. Rather, use more specific descriptions, such as scholarships for students attending aparticular school; provision for books or other educational supplies; food, clothing, shelter for indigents or directcash assistance to indigents. In the case of specific disaster assistance, the type of assistance provided andidentification of the disaster should be included (e.g., food, shelter, and clothing for immediate relief for Californiawildfire victims).

Include grants or assistance provided to an organization if they are earmarked for a specific individual. Forexample, if the organization selects an individual to receive a scholarship but makes the payment directly to theuniversity, then include the payment in Part III. However, if the organizationmakes the payment to the university andthe university selects the individual recipient, then include the payment to the university in Part II. Likewise, reportpayments to a hospital to support a specific patient in Part III, but report a contribution to a hospital to provideservices to the general public or to unspecified charity patients in Part II.

If there are more types of assistance than space available, report the additional assistance transactions onduplicate copies of Schedule I, Part III, and number each page. Use Part IV if additional space is needed fordescriptions.

Column (b). Enter the number of recipients for each type of assistance. If an actual number is not available, providean estimate of the number and explain in Part IV how the estimate was determined. For example, an organizationwould normally know the precise number of scholarships it awarded during the year, but might need to estimate thenumber of disaster victims who received blankets and water.

Column (c). For grants paid by cash, checks, money orders, electronic fund or wire transfers, and other chargesagainst funds on deposit at a financial institution, enter the aggregate amount for each type.

Columns (d) and (e). Enter the value of noncash property and describe the method of valuation used. Formarketable securities registered and listed on a recognized securities exchange, use the average of the highestand lowest quoted selling prices or the average between the bona fide bid and asked prices, on the date theproperty is distributed to the grantee.


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Fair market value is generally understood to be the price at which a willing buyer and a willing seller will agree toparticipate in a transaction. Since the act of donating an item involves neither a buyer nor a seller, the organizationmust report what method it used to determine the fair market value of the noncash grant amounts:

¯ Comparable Sales.Thedegreeof similarity, the timing, the circumstances, andmarket conditions canaffectwhether the sale of similar items is a reasonable method to determine the fair market value of the donateditem.

¯ Replacement Cost. This is the cost of buying, building, or manufacturing similar property. Determine the“estimated replacement costNEW,”andsubtract forwearand tear, obsolescence,and factorsof supplyanddemand.

¯ Expert Opinions. These types of estimates and appraisals are useful if the facts support the opinion and ifthe expert is competent and knowledgeable.

Column (f). For noncash property or assistance distributed, enter a description of the property or assistancedistributed (e.g., medical supplies or equipment, pharmaceuticals, blankets, books, or other educational supplies).

Example 4D-2 Grants to individuals.

The Blue America Society (BAS) awards a grant in the form of a $6,000 scholarship to a graduating highschool student it selects based on merit and financial need. The student elects to attend Red State University(RSU). BAS does not provide the funds directly to the student. Instead, BAS sends the payment directly toRSU to cover the student’s tuition.

BAS reports the payment as a scholarship on Form 990, Part IX, line 2 and on Schedule I (Grants and OtherAssistance to Organizations, Governments, and Individuals in the U.S.), Part III.

Variation: If BAS does not select the student, but instead sends $6,000 to RSU and allows RSU to select therecipient, then the grant to RSU is reported on Form 990, Part IX, line 1 and on Schedule I (Grants and OtherAssistance to Organizations, Governments, and Individuals in the U.S.), Part II.

Example 4D-3 Recording payments to specific individuals.

Tri-County Charities, Inc. (TCCI), annually awards two $20,000 scholarships. The awards allow the recipientsto devote full time to obtaining an advanced degree in social services. To be eligible to receive one of thescholarships, an individual must have completed a four-year degree (or be in the final year of completing one)and attend one of the two universities in the counties where TCCI operates.

TCCI also conducts a public assistance program for indigent families. In addition to maintaining a food pantryand clothing closet for the needy, TCCI occasionally makes direct payments to service providers to assistspecific individuals with housing or medical needs. During the current year, the following amounts wereexpended for direct public assistance:

1. Cost or other basis (e.g., fair market value at date of donation to TCCI) of fooddistributed to needy individuals through the food pantry $ 234,300

2. Cost or other basis of clothing distributed to needy individuals 9,7003. Payments to various apartment owners to assist five specific individuals with theirmonthly rent payment 1,500

4. Payments to the Tri-County Community Hospital for a portion of the hospital costsof six specified indigent individuals 3,200

Total payments $ 248,700

The $40,000 expended for scholarships is reported on Form 990, Part IX, line 2. In addition, the $248,700distributed in direct public assistance is reported on line 2. Since TCCI reported more than $5,000 of grantsand other assistance to individuals on Part IX, line 2, the organization must answer “Yes” on line 22 of Part IVand attach Schedule I (Form 990) with Parts I and III completed.


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Part IV—Supplemental Information (Schedule I)

Use Part IV to provide narrative information required by Part I, line 2, regarding monitoring of funds, and by Part III,column (b), regarding how the organization estimated the number of recipients for each type of grant or assistance.Also use Part IV to provide other narrative explanations and descriptions. Identify the specific part and line(s) thatthe response supports. Duplicate Part IV if needed for more space.

Benefits Paid to Members or for Members

Reporting Benefits Paid in Part IX of Form 990

Line 4. Certain tax-exempt organizations are designed to provide benefits for a specific class of members or theirdependents. For example, Sections 501(c)(8), 501(c)(9), and 501(c)(17) organizations report expenditures formembers’ insurance benefits on line 4 as would a Section 501(c)(12) organization paying a patronage dividend.Note that these organizations are not required to complete columns (B) through (D).

Do not report the cost of employment-related benefits (e.g., health, life, or disability insurance) provided to trustees,directors, officers, key employees (TDOKEs), and other employees on this line. Report these expenses on line 5 forTDOKEs, line 6 for disqualified persons, and lines 8 and 9 for other employees.

Example 4E-1 Reporting the costs of providing member benefits.

The Loyal Order of the Water Buffalos (LOWB), an organization described in IRC Sec. 501(c)(8), providessupplemental death, accident, and disability benefits for its members. It also provides the same benefits for itssole (nonofficer) employee, Joe Smiley. During the current year, LOWB paid the following amounts related toproviding these benefits:

Benefit Amount

Death $ 40,000Accident 18,000Disability 2,400

Total $ 60,400

Joe received $2,300 of the total benefits paid because of an accident his son had during the year. Benefitspaid to employees of the organization are not reported on line 4 of Part IX, even if the employee is also amember of the organization and receives the same benefits as other members. Instead, the $2,300 is reportedon line 9 of Part IX as an employee benefit. The remaining $58,100 ($60,400 – $2,300) is reported on line 4.

Reporting the Compensation and Related Benefits fromPart IX

Report compensation for Part IX of Form 990 based on the accounting method and tax year used by the organiza-tion, rather than the definitions and calendar year used to complete Part VII or Schedule J regarding compensationof certain officers, directors, trustees and key employees.

Compensation includes all forms of income and other benefits earned or received in return for services rendered tothe filing organization, whether paid by the organization, common paymaster, or a third-party payroll agent. Itincludes compensation reported on Forms W-2 and 1099, pension plan contributions and accruals, and otheremployee benefits, but does not include non-compensatory expense reimbursements or allowances.

Compensation of Current Trustees, Directors, Officers, and Key Employees

Line 5. Enter the total compensation paid to current trustees, directors, officers, and key employees (TDOKEs) forthe organization’s tax year. Current includes individuals who served for even a single day during the reporting year,


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regardless of whether they were still current at the end of the year. Report all compensation amounts relating toTDOKEs, including those related to services performed in a capacity other than as a TDOKE (e.g., services as anindependent contractor).

Example 4F-1 Reporting compensation of a key employee.

Cathy, is a key employee of HELP, a Section 501(c)(3) organization. The organization recorded $100,000 ofsalary expense, $25,000 of fringe benefits, $10,000 of non-compensatory travel reimbursements, and $7,500of pension plan contributions relating to Cathy. HELP reports $132,500 ($100,000 + $25,000 + $7,500) ascompensation on line 5 and reports the $10,000 of expense reimbursements related to travel on line 17. Theseamounts may differ from Cathy’s Form W-2 for a variety of reasons.

Compensation to Other Disqualified Persons

Line 6. Section 501(c)(3), 501(c)(4), and 501(c)(29) organizations must report the total compensation and otherdistributions to disqualified persons as defined under IRC Sec. 4958(f)(1) and persons related to a supportingorganization as defined in IRC Sec. 4958(c)(3)(B) (unless such amounts are being reported on line 5).

Other Salaries and Wages

Line 7. Enter the total amount of employee compensation (e.g., salaries, wages, fees, bonuses, severance pay-ments, and similar amounts paid or provided) not reported on line 5 or 6.

Once compensation and benefits have been entered in column (A) of the proper lines of Part IX, the next issue ishow to allocate expenses among the three functional areas in columns (B)–(D). [Only Section 501(c)(3) and501(c)(4) organizations are required to make this allocation.] The entire salary and related expenses of an individ-ual who works solely on activities related to one function are charged to that function. Alternatively, allocateexpenses of an individual performing tasks related to multiple functions among the functions based on the timespent on each activity. Allocate an individual’s salary and benefits, along with the organization’s share of relatedpayroll taxes (i.e., social security and medicare taxes, federal and state unemployment taxes, and any local payrolltaxes) using the same percentages.

Example 4F-2 Allocating personnel costs.

Gimbel Art Museum (GAM), a Section 501(c)(3) organization, paid compensation to three individuals. Theirsalaries and related payroll tax expenses for the current year are as follows:

Individual Position SalaryGAM’s Shareof Payroll Taxes

Albert Snow Executive Director $ 29,000 $ 2,662Jim Java Former Chief Financial Officer 23,000 2,203Judy Lemons Secretary/Bookkeeper 17,300 1,766

$ 69,300 $ 6,631

Each individual’s time is divided among program services, management and general, and fundraising, asfollows:

Percentage of Time Spent on:

IndividualProgramServices

Managementand General Fundraising

Albert Snow 60% 15% 25%Jim Java — % 5% 95%Judy Lemons 20% 80% — %


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GAM’s personnel related expenses should be allocated in Part IX based on the time spent by the individualson each of the three functions. Thus, GAM’s expenses are allocated as follows:

Line Number TotalProgramServices

Managementand General Fundraising

5—Compensation–Current TDOKEa $ 29,000 $ 17,400 b $ 4,350 $ 7,2506—Compensation–Disqualified personc 23,000 — 1,150 21,850 d7—Other salaries 17,300 3,460 13,840 e —10—Payroll taxes 6,631 1,951 f 1,922 2,758

Notes:

a Mr. Snow is an officer; therefore, his salary must be reported on line 5.

b $29,000 × 60% = $17,400.

c Jim Java retired from the position as Chief Financial Officer in the prior year; therefore, he is adisqualified person.

d $23,000 × 95% = $21,850.

e $17,300 × 80% = $13,840.

f ($2,662 × 60%) + ($1,766 × 20%) = $1,951.

Pension Plan Contributions

Line 8. Enter the employer’s share of contributions to, or accruals under, qualified and nonqualified pension plansfor the year. Include contributions made to Section 401(k) and 403(b) pension plans on behalf of employees.However, do not include amounts already reported on line 5 or 6, including contributions to qualified pension,profit-sharing, and stock bonus plans under IRC Sec. 401(a) solely for the benefit of current or former TDOKEs ordisqualified persons.

Other Employee Benefits

Line 9. Report the employer’s expense for providing nontaxable benefits, such as health, life, disability, dental, andvision insurance coverage. Report such benefits as an expense of the organization even if the employees are paidby another organization, such as a common paymaster or third-party payroll administrator, if the organizationultimately recognizes the expense of providing the benefits. Also include other nontaxable benefits such asexpenditures for an employee picnic or holiday party. Do not include amounts already reported on line 5 or 6.

Payroll Taxes

Line 10. Enter the employer’s share of federal, state, and local payroll taxes for the year, including social security(FICA) andMedicare, the federal unemployment tax (FUTA), state unemployment compensation taxes (SUTA), andother state and local payroll taxes. Do not report the employee’s portion of such taxes, which are included ascompensation on line 5 or 7. (See Example 4F-2.)


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SELF-STUDY QUIZ


15. Expenses related to executive strategy and personnel administration should be reported as what type ofexpenses?

a. Fundraising expenses.

b. Program service expenses.

c. Total expenses.

d. Management and general expenses.

16. Literacy Now puts on a combined educational and fundraising campaign to support its exempt purpose,combatingchildhood illiteracy.Thematerials included in thecampaignurge recipients tovolunteerasa readingbuddy at a local school. This is an example of which of the following?

a. Call to action.

b. Purpose.

c. Audience.

d. Content.

17. Where in Part IX would an organization report compensation for regular employees?

a. Line 5.

b. Line 6.

c. Line 7.

d. Line 8.


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SELF-STUDY ANSWERS


15. Expenses related to executive strategy and personnel administration should be reported as what type ofexpenses? (Page 333)

a. Fundraising expenses. [This answer is incorrect. Fundraising expenses, reported in column (D), are thosethat are identifiable with fundraising (including allocable overhead). They include expenses related tosolicitation of contributions, maintenance of donor mailing lists, and more. However, the expenses listedabove do not fall into this category as they are not specifically related or always allocable to fundraising.]

b. Program service expenses. [This answer is incorrect. Every tax-exempt organization must be organizedand operated for an exempt purpose. Expenses directly related to this purpose are reported in Column(B). Because themission andexempt purposeof eachorganization is different, theprogramservicesmustbe determined by facts and circumstances. However, the expenses listed above do not fall into thisprogram-specific category.]

c. Total expenses. [This answer is incorrect. All organizations must determine the natural classification ofeach expenditure and report it in Column (A) on the appropriate line. The four largest non-listed expensesare reported on lines 24a–24d, and all other expenses can be combined on line 24e. However, totalexpenses include more than just those expenses listed above. Therefore, there is a better, more specificanswer to this question.]

d. Management and general expenses. [This answer is correct. Report in column (C) those expensesthat are not identifiable with a specific program or fundraising activity, but are nonethelessnecessary for the operation of the organization. Examples of management and general expensesinclude executive strategy, direction, and planning; business management; office management;general office support activities; and personnel administration.]

16. Literacy Now puts on a combined educational and fundraising campaign to support its exempt purpose,combatingchildhood illiteracy.Thematerials included in thecampaignurge recipients tovolunteerasa readingbuddy at a local school. This is an example of which of the following? (Page 336)

a. Call to action. [This answer is correct. To pass thepurpose test under FASBASC958-720-45-29, thecall to actionmust satisfy two conditions. First, it must request the audience to act in a specific wayor to influence others to act in a specific way. Second, the requested action must help to advancethe organization’s mission by either benefitting the recipient (e.g., improving his or her physical ormental well-being) or benefitting society (by addressing societal problems). By calling for readingbuddies, Literacy Now’s campaign includes a call to action.]

b. Purpose. [This answer is incorrect. Accomplishing the organization’s mission(s) or its management andgeneral functions must be one of the reasons for a joint activity. Two specific tests must be met for a jointactivity to be deemed to have purpose under FASBASC958-720-45-29, one of which is the compensationtest. As the compensation test is not mentioned in this scenario, there is a better answer to this question.]

c. Audience. [This answer is incorrect. The audience criterion in FASB ASC 958-720-45-29 is met, generally,if the members of the audience were selected primarily because of either their need or the action calledfor, their ability to take specific action to help the organization accomplish its goals for the activity, or theirneed for the management and general component of the joint activity. Because audience selection wasnot discussed in the above scenario, the activity described does not fulfill this test.]

d. Content. [This answer is incorrect. The content criterion in FASBASC958-720-45-29 is satisfied if the needfor, andbenefitsof, theaction theaudience iscalledupon toundertake insupport of theaudience’smissionis explained in the information presented. As the information in the scenario above does not go into detailabout the content presented, it is unclear from this scenario whether the content test is met.]


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17. Where in Part IX would an organization report compensation for regular employees? (Page 345)

a. Line 5. [This answer is incorrect. Line 5 is used to record total compensation paid to current trustees,directors, officers, and key employees (TDOKEs) for the organization’s tax years. Compensation forregular employees who do not meet these distinctions is reported elsewhere.]

b. Line 6. [This answer is incorrect. Section 501(c)(3), 501(c)(4), and 501(c)(29) organizations report the totalcompensation and other distributions to disqualified persons and persons related to a supportingorganization on line 6. Compensation for regular employees who do not fall into these categories isreported on a different line of Part IX.]

c. Line 7. [This answer is correct. The total amount of employee compensation (e.g., salaries, wages,fees, bonuses, severance payments, and similar amounts paid or provided) that is not reported onlines 5 or 6 is reported on line 7. Therefore, compensation amounts for employees who do not fitthe specific categories listed for lines 5 and 6 would be recorded here.]

d. Line 8. [This answer is incorrect. Line 8 is used to record the employer’s share of contributions to, oraccruals under, qualified and nonqualified pension plans for the year. This includes contributions madeto Section 401(k) and 403(b) pension plans on behalf of employees.]


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Fees for Services Paid to Independent Contractors

Expenditures for services provided by outsiders who are not employees are reportable on lines 11a through 11g.Specified services include management, legal, accounting, lobbying, professional fundraising, investment man-agement, and other. Many of these independent contractorsmay have received a Form 1099 from the organization,but the expenditures are reportable here regardless of whether a Form 1099 was issued to the independentcontractor. Amounts paid to or earned by the reporting organization’s employees for these types of services mustbe reported on lines 5 through 7, and not on line 11.

The IRS places a high priority on the proper classification of workers (i.e., whether they are employees or indepen-dent contractors). IRS Announcement 2012-452012-51 IRB 724 gives certain qualifying employers an opportunityto correct worker misclassification on a prospective basis by making a relatively small payment and filing Form8952 (Application for Voluntary Classification Settlement Program).

Management Fees

Line 11a—Management. Enter the fees for management services provided by outside firms and non-employeeindividuals.

Legal and Accounting

Line 11b—Legal. Enter the amounts for legal fees charged by outside firms and non-employee individuals andallocate as management and general costs in column (C). However, legal expenses directly attributable to aprogram activity should be reported as a program service expense in column (B) (e.g., legal fees incurred inconnection with operating an adoption clinic). Report penalties, fines, settlements, or judgments imposed againstthe organization as a result of legal proceedings on line 24. Report any amounts for lobbying services provided byattorneys on line 11d. Report amounts paid to employees, such as the organization’s general counsel or internallegal department, on lines 5 through 10.

Line 11c—Accounting. Enter amounts for accounting and auditing services charged by outside firms and individu-als and allocate asmanagement and general costs in column (C). It seems logical that this would include situationswhere such services relate to a specific program. However, if the accounting firm is also providing consultingservices for a particular program (e.g., to improve the efficiency of the program’s operations), then report the feesapplicable to those services as a program service expense in column (B). Report amounts paid to employees, suchas the organization’s internal accounting, auditing, budgeting, and financial personnel, on lines 5 through 10.

Lobbying

Line 11d. Enter amounts for activities intended to influence the passage or defeat of a specific piece of legislation,whether at the foreign, national, state, or local level. Include both direct lobbying (attempting to influence themembers of the legislature to vote for or against the legislation) and grassroots lobbying (encouraging the generalpublic to contact their legislators to vote for or against the legislation).

Professional Fundraising

Line 11e. Report expenditures to outside organizations and non-employees for the direct solicitation of contribu-tions, planning and managing solicitation campaigns, preparing grant applications and direct mail solicitations,and advice or other consulting services supporting in-house fundraising campaigns. If fundraising services andexpenses are distinguishable, report the payment of fundraising expenses (i.e., printing, paper, envelopes,postage, mailing list rental, and equipment rental) on line 24.

Professional fundraising does not include services provided by the organization’s employees in their capacity asemployees, nor does professional fundraising include purelyministerial tasks, such as printing, mailing services, orreceiving and depositing contributions to a charity, such as services provided by a bank or caging service.


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Investment Management Fees

Line 11f. Report expenditures to outside organizations and non-employees for investment advisory services,counseling, and portfolio management includingmonthly account service fees. Brokerage fees, commissions, andother transaction costs are sales expenses reportable on Part VIII, line 7b.

Other

Line 11g. Report expenditures to outside organizations and non-employees for services not listed on lines 11athrough 11f. Examples include payments for advocacy services other than lobbying, nonemployee health careprofessionals, payroll agents, common paymasters, and reimbursements to third parties for services that benefitthe organization. However, reimbursements to third parties for compensation paid to the filing organization’strustees, directors, or employees should be reported on lines 5 through 10, as appropriate. Report payments tocontractors for information technology services on line 14 rather than on line 11g.

If the amount exceeds 10% of the total expenses on line 25, column (A), provide a detailed breakout on ScheduleO so that no single amount is greater than 10% of total expenses.

Dealing with Other Expenses

Advertising and Promotion

Line 12. Include amounts for all forms of advertising, whether print or electronic, including web links, signage, andadvertising connected to special fundraising events. Amounts paid to professional fundraisers are reportable online 11e.

Advertising is differentiated from sponsorships, which are reportable on line 1. Advertising contains comparativeand qualitative language, price information, endorsements, and inducements to purchase goods and services.

Office Expenses

Line 13. Include expenditures for a variety of supplies, including telephone, cell phone, fax machines, postage,shipping, delivery, equipment rental, and general printing costs. However, printing costs that relate to conferencesor conventions are reported on line 19.

For organizations required to allocate the expense among different functions, the allocation should bemade basedon actual use. In many cases, the type of supplies or where they are used will indicate the function to which theyrelate. (For example, the cost of medical supplies used by an organization operating clinics for low-income familiesis easily identified as a program service expense, while office supplies consumed in the national headquarters of alarge organization are not readily identified.)

Information Technology

Line 14. Report expenditures for computer hardware and software and non-employee IT support services includingmaintenance, help desk, technical support services, website design and operations, virus protection, andinformation security to keep the organization’s website operational and secured against intrusions and otherinformation technology contractor services. Report amounts paid to employees, such as the organization’s ITdepartment, on lines 5 through 10.

Royalties

Line 15. Report amounts paid to license another organization’s intellectual property, including patents, copyrights,logos, taglines, and trademarks.

Occupancy

Line 16. Report all amounts paid to maintain the organization’s real property and office space, including utilitiessuch as electricity, heat, gas, and water. Also include expenditures for property insurance, real estate taxes,


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mortgage interest, and other occupancy-related expenses. Do not include office expenses such as telephoneexpenses reportable on line 13.

Do not allocate occupancy costs for office space based on employee salaries, which skew the allocation towardfunctions where higher paid employees spend their time. If each employee presumably uses approximately thesame space, allocate cost based on the number of people, not on salary expense. Then, allocate costs for aparticular person to each function based on the time he or she spends on each function.

Do not net any rental income received from leasing or subletting rented space against occupancy expenses. If thetenant’s activities are related to the organization’s exempt purpose, report rental income as program-servicerevenue on Part VIII, line 2, and allocable occupancy expenses on this line 16. However, if the tenant’s activities arenot program-related, report the rental income on Part VIII, line 6a, and related rental expenses on Part VIII, line 6b.

Depreciation expense is reportable on line 22.

Travel

Line 17. Report transportation costs, rental cars, fares, tickets, mileage allowances, automobile expenses, meals,lodging, and per diem payments. Include the expenses of leasing, operating, and repairing any vehicles owned bythe organization and used for the organization’s activities.

Travel, meal, and entertainment expenses should be properly documented in the organization’s records andaddress the who, what, where, when, and why the expenditures were necessary to conduct the organization’sbusiness. Reimbursed travel expenses of employees under an accountable plan should be reported on line 17, noton lines 5 through 9. Reimbursements under a non-accountable plan, such as an expense account, are treated astaxable compensation and are reportable on lines 5 through 7. Likewise, if the organization leases vehicles onbehalf of its executives or other employees as part of a compensation program, the leasing costs are consideredemployee compensation and reported on line 5 through 7.

Payments of Travel or Entertainment Expenses for Any Federal, State, or Local Public Officials

Line 18. Report amounts paid or reimbursed to federal, state or local public officials and their family members fortravel or entertainment expenses if the amount expended for a particular individual exceeds $1,000 for the tax year.If the expense is not specifically identifiable to a particular individual, then the organization may use a reasonableand consistent method to estimate the value of the expenditure on behalf of the particular individual. Keep recordsof all travel and entertainment expenses related to a government official regardless of whether it is reported on line18 or elsewhere.

Conferences, Conventions, and Meetings

Line 19. Report expenses incurred for board meetings, committee meetings, staff meetings, employee retreats,facility rentals, speakers’ fees and expenses, and printed materials. Include the registration fees (but not travelexpenses) paid for sending any of the organization’s staff to conferences, conventions, and meetings conductedby other organizations. Travel costs associated with such meetings is reportable on line 17.

Interest

Line 20. Report interest expense, except thatmortgage interest is reportable on line 16, and interest related to rentalincome is reportable on Part VIII, line 6b. Interest expense is generally allocated to management and generalexpenses unless the use of the borrowed funds can be traced to a specific program.

Payments to Affiliates

Line 21. This topic is discussed later in this lesson.

Depreciation, Depletion, and Amortization

Line 22. Report depreciation, depletion, amortization, or similar expenses including depreciation or amortization ofleasehold improvements and intangible assets. Maintain books and records to substantiate any amount reported.


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When completing Form 990, exempt organizations are not required to use the depreciation methods and rules thatapply to for-profit entities. Therefore, organizationswithout unrelated business activities usually record depreciationusing the straight-line method.

Insurance

Line 23. Report insurance expenses, except for the following:

¯ Property and occupancy-related insurance is reportable on line 16.

¯ Insurance benefits for employees are reportable on lines 5, 6, and 9.

¯ Insurance benefits formembers of an organization defined by IRCSec. 501(c)(8), (9), or (17) are reportableon line 4.

Other Expenses

Line 24. Enter the types and amounts of miscellaneous expenses which were not reportable on lines 1 through 23,such as medical supplies incurred by health care/medical organizations and fundraising expenses incurred by aprofessional fundraiser, such as printing, paper, envelopes, postage, mailing list rental, and equipment rental.Taxes on unrelated business income must appear on line 24a, even if not one of the four largest miscellaneousexpenses. After reporting UBI tax and the other largest expenses, combine all other miscellaneous expenses online 24e. Amounts labeled “other expenses,” “miscellaneous expenses,” or something similar cannot exceed 10%of the total expenses reported on line 25, column A. Therefore, if line 24e expenses exceed the 10% limit, detailthem by type and amount on Schedule O.

Total Functional Expenses

Line 25. Report the sum of lines 1 through 24e in each applicable column. For Section 501(c)(3) and (c)(4)organizations, the amount on line 25, column (B) must equal the total amount of expenses reported on Part III, lines4a through 4d.

Joint Costs

Line 26. If an organization included any joint costs from a combined educational campaign and fundraisingsolicitation in its program service expenses [column (B)], it must disclose on line 26 how the total joint costs of allsuch combined activities were reported in Part IX. For example, if an organization spent $100,000 on joint costs andallocated 10% to education, it would report $100,000 in line 26, column (A), $10,000 in column (B), and $90,000 incolumn (D).

A combined educational campaign and fundraising solicitation occurs when the organization solicits contributionsand, along with the solicitation, includes educational material that furthers an exempt purpose of the organization.Expenses related to providing information about the organization itself, its past use of contributions, or its planneduse of contributions should be reported in column (D) of line 26 as fundraising expenses, rather than in column (B)as program service expenses. However, costs reported on line 26 are not deducted from the other lines in Form990, Part IX, on which they are reported.

The organization should use any reasonable method under the facts and circumstances to allocate joint costsbetween columns (B) and (D). Most states with reporting requirements for charitable organization solicitationseither require or allow reporting of joint costs under FASB ASC 958-720 (A discussion about allocating joint costsappeared earlier in this lesson). If the organization reports joint costs following this method, it should check the boxon line 26.

Example 4H-1 Completing the Statement of Functional Expenses.

The Rocky Mountain Society (RMS) regularly conducts educational programs to inform the public about thedangers of RockyMountain Spotted Fever. Most of the seminars are conducted by volunteers, although all theplanning and arrangements are handled by the RMS staff. All of the seminars are provided free to the public.


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To raise money for its operations, RMS conducts a general fundraising campaign each fall using direct mailsolicitations. The educational programs and the fall fundraising effort are the staff’s only activities.

During the current year RMS incurred the following expenses related to its operations:

(1) Salaries for current employees:Executive director $ 27,000Program director 23,500Volunteer coordinator 17,500Secretary/bookkeeper 14,300 $ 82,300

(2) Benefits costs (55% payroll taxes, 45% health insurance costs) forcurrent employees:Executive director 4,320Program director 3,760Volunteer coordinator 2,800Secretary/bookkeeper 2,288 13,168

(3) Occupancy expenses:Rent 9,000Telephone 1,150Utilities 1,900Depreciation (furniture/fixtures) 600Supplies 550 13,200

(4) Insurance (general liability) 800(5) Professional and contract fees:

Audit 3,500Legal 1,400Mailing lists for fundraising effort 350 5,250

(6) Facility rental (for seminars) 5,500(7) Outside printing:

Brochures for educational seminars 800Fundraising brochures 550 1,350

(8) Postage and shipping ($315 for fundraising campaign, $140 for admin-istrative items, remainder for program service activities) 950

(9) Volunteers’ expense reimbursements (for seminars) 1,300(10) Miscellaneous ($125 related to fundraising campaign, balance to

program services) 900(11) Travel related to:

Conducting educational seminars 1,600Local miscellaneous travel for administrative purposes 500Other travel (workshop for employee to improve skills in arrangingand presenting educational seminars; includes $400 seminar fee) 600 2,700

$ 127,418

Assume 20% of the executive director’s time and 10% each of the program director’s and secretary/book-keeper’s time is spent on fundraising efforts. The executive director and secretary/bookkeeper also spend30% of their time on management and general activities. Also assume 8% of the occupancy expenses,telephone, and supplies are allocable to fundraising efforts and 19% to management and general activities.(The allocation of expenses to more than one function was discussed earlier in this lesson.)

Payments Made to Affiliates

Reporting Payments to Affiliates in Part IX

Line 21. Report nondiscretionary payments to organizations affiliated with (closely related to) the reportingorganization, including the following:

1. Dues paid by a local organization, chapter, subsidiary, or subordinate to its national headquarters parent.Include predetermined quota support and dues (excluding membership dues of the type described later


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by local agencies to their state or national organizations for unspecified purposes, such as general supportfor the national organization’s own program and support services).

2. Expenses for providing goods or services to affiliates unless—

a. the goods or services provided are related to the program services conducted by the organizationfurnishing them (e.g., when a local organization incurs expenses in the production of a solicitation filmfor the state or national organization); and

b. the costs involved are connected with the management and general or fundraising functions of thereportingorganization. For example,whena local organizationgivesa copyof itsmailing list to thestateor national organization, the expense of preparing the copy provided may be reported on line 21, butnot the expenses of preparing and maintaining the local organization’s master list.

3. Quota support payments from a federated fundraising agency to its state or national organization.

Line 21 does not include the following:

1. The purchase of goods or services from affiliates, reportable on the appropriate line 11 through 24.

2. Discretionary or voluntary awards or grants to affiliated state or national organizations for specifiedpurposes, reportable on line 1.

3. Grants by federated fundraising agencies (FFAs) in connection with a solicitation campaign they conductwhere donors designate specific agencies to receive part or all of their individual contributions, reportableon line 1.

4. Membership dues paid to obtain general membership benefits from other organizations (e.g., regularservices, publications, and other materials), reportable as miscellaneous expenses on line 24. This is thecase if a charitable organization pays dues to a trade association comprised of otherwise unrelatedmembers.


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359

SELF-STUDY QUIZ


18. Expenses for which of the following would be reported on line 13 of Part IX?

a. Computer software.

b. Postage and shipping.

c. Per diem amounts for business travel.

d. Print advertising.

19. Which of the following would a local organization report on line 21 of Part IX as a payment to an affiliate?

a. Purchasing goods from an affiliate.

b. Voluntary grants made to the state affiliate.

c. Membership dues paid to other organizations.

d. Dues paid to a national headquarters parent.


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SELF-STUDY ANSWERS


18. Expenses for which of the following would be reported on line 13 of Part IX? (Page 353)

a. Computer software. [This answer is incorrect. Amounts for information technology (including hardwareand software, among other things) are entered on line 14.]

b. Postage and shipping. [This answer is correct. Office expenses—including telephone, cell phone,fax machines, postage, shipping, delivery, and more—are recorded on line 13.]

c. Per diem amounts for business travel. [This answer is incorrect. Line 17 is used to report transportationcosts, rental cars, fares, tickets, mileage allowances, automobile expenses,meals, lodging, and per diempayments.]

d. Print advertising. [This answer is incorrect. Amounts for all formsof advertising,whether print or electronic,are reported on line 12.]

19. Which of the following would a local organization report on line 21 of Part IX as a payment to an affiliate?(Page 356)

a. Purchasing goods from an affiliate. [This answer is incorrect. The purchase of goods or services fromaffiliates is not reported on line 21. Instead, such purchases are reportable on the appropriate line 11through 24.]

b. Voluntary grants made to the state affiliate. [This answer is incorrect. Discretionary or voluntary awards orgrants to affiliated state or national organizations for specified purposes are specifically excluded frombeing reported on line 21.]

c. Membership dues paid to other organizations. [This answer is incorrect. Membership dues paid to obtaingeneral membership benefits from other organizations (e.g., regular services, publications, and othermaterials) are reportable as miscellaneous expenses on line 24, not on line 21.]

d. Dues paid to a national headquarters parent. [This answer is correct. Dues paid by a localorganization, chapter, subsidiary, or subordinate to its national headquarters parent are usuallyreported on line 21, along with expenses for providing goods or services to affiliates (that do notmeet certain exclusions) and quota support payments from a federated fundraising agency to itsstate or national organization.]


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Lesson 5: Preparing Form 990-EZIntroduction

Form 990-EZ, which is not as comprehensive as Form 990, can be used by certain tax-exempt organizations toprovide the IRS with required information. This lesson discusses which organizations are eligible to file Form990-EZ instead of Form 990 and the relevant reporting requirements. This lesson also includes a case study toillustrate how Form 990-EZ is completed.

The Form 990-EZ headings of Parts I, II, III, IV, V, and VI each include check boxes that an organization must checkif its Schedule O contains a response to a question in that part.


Completion of this lesson will enable you to:¯ Identify the general information necessary to complete and file Form 990-EZ and how to report revenue,expense, and changes in fundbalance (Part I); balance sheets (Part II), andprogramservice accomplishments(Part III).

¯ Determine the best method for completing Parts IV, V, and VI of Form 990-EZ.

General Information That Can Be Used to Complete and File Form 990-EZ

Most organizations exempt from income tax under Section 501(a) must file an annual information return (Form 990or 990-EZ) or submit an annual electronic notice (Form 990-N), depending on the organization’s gross receipts andtotal assets.

Who May File

Generally, an organization that has gross receipts of less than $200,000 and total assets at the end of the year ofless than $500,000 may choose to file Form 990-EZ instead of Form 990.

If an organization normally has annual gross receipts of $50,000 or less, it must submit Form 990-N if it does not fileForm 990 or Form 990-EZ and is not otherwise exempt from filing. If the organization chooses to file Form 990 or990-EZ, it must file a complete return.

Certain organizations cannot file Form 990-EZ and instead must file Form 990, such as (1) a sponsoring organiza-tion of a donor advised fund [as defined in IRC Sec. 4966(d)(1)], (2) organizations that operate a hospital facility, (3)organizations recognized by the IRS as Section 501(c)(29) nonprofit health insurance issuers, and (4) a controllingorganization described in IRC Sec. 512(b)(13). In addition, use Form 990, rather than Form 990-EZ, when thecentral or parent organization is filing a group return on behalf of subordinates in a group exemption.

Although the IRS has granted relief for smaller organizations, states may require the organization to file Form 990.

Gross Receipts Test. Gross receipts are the total amounts received from all sources during the organization’sannual accounting period, without subtracting any costs or expenses (see “Gross Receipts Test” in Lesson 1 formore information).

Total Assets Test. Total assets is the amount reported by the organization on its balance sheet as of the end of theyear, without reduction for liabilities.

What to File

When completing the return, unless specified otherwise, information should be provided for the organization’s taxyear (e.g., answer “Yes” to a question asking whether a certain type of activity was conducted only if the organiza-tion conducted that activity during the tax year).


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Disregarded Entity. Under the check-the-box entity classification regulations (Regs. 301.7701-1 through301.7701-3), an entity owned by a single owner can be disregarded as an entity separate from the owner (adisregarded entity), and its operations are treated as a branch or division of the owner. An owner that is exemptfrom tax under IRC Sec. 501(a) must include, as its own, information pertaining to the finances and operations of adisregarded entity in its annual information return.

Completing Form 990-EZ. Parts I–V must be completed by all filing organizations [Part VI must be completed bySection 501(c)(3) organizations and Section 4947(a)(1) nonexempt charitable trusts] and require reporting on theorganization’s exempt and other activities, finances, compliance with certain federal tax filings and requirements,and compensation paid to certain persons.

Depending on its activities, the organizationmay need to include some of the Form 990 schedules and attachmentsin its Form 990-EZ, such as the following:

Schedule TitleA Public Charity Status and Public SupportB Schedule of ContributionsC Political Campaign and Lobbying ActivitiesE SchoolsG Supplemental Information Regarding Fundraising or Gaming ActivitiesL Transactions with Interested PersonsN Liquidation, Termination, Dissolution, or Significant Disposition of AssetsO Supplemental Information to Form 990 or 990-EZ

Before filing Form 990-EZ, assemble the forms and attachments in the following order: (1) core form, (2) letteredschedules (as applicable) in alphabetical order, and (3) the attachments (completed as applicable) in the followingorder:

1. Any name change amendment to the organizing document required by item B under heading.

2. A reasonable cause explanation for a delinquent return.

3. Any articles of merger or dissolution, resolutions, and plans of liquidation or merger required for ScheduleN (Liquidation, Termination, Dissolution, or Significant Disposition of Assets).

Do not attach materials not authorized in the instructions or not otherwise authorized by the IRS. Do not passwordprotect or encrypt PDF attachments. If an organization is not required to file Form 990-EZ but chooses to do so, itmust file a complete return and provide all of the information requested, including the required schedules.

Where and When to File

Form 990-EZ has the same requirements as Form 990 for where and when to file. See “Where and When to File” inLesson 1 for a discussion of these requirements.

Electronic Filing

Organizations can file Form 990-EZ electronically. See “Electronic Filing” in Lesson 1.

Extension Requests

Form 990-EZ follows the same guidelines as Form 990 for extending the return. See Lesson 1 for a discussion ofrequesting an extension of time to file Form 990-EZ.

Amended Return

Form 990-EZ has the same requirements as Form 990 for amending a return. See Lesson 1 for a discussion ofthese requirements.


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Public Inspection

In general, all information the organization reports on or with its Form 990-EZ (including schedules and attach-ments) must be made available for public inspection. However, only certain parts of Schedule B (Schedule ofContributors) are required to be disclosed since the contributors’ names and addresses are not open to publicinspection. See Appendix D (Public Inspection of Returns) of the Form 990 or 990-EZ instructions for moreinformation on public inspection.

State Reporting

Most states that accept Form 990-EZ in lieu of the state’s forms require that all amounts be reported based on theaccrual accounting method. If the organization prepares Form 990-EZ for state reporting purposes, it may file anidentical return with the IRS even though the return does not agree with the books of account unless the way oneor more items are reported on the state return conflicts with the IRS instructions for preparing Form 990-EZ.

Heading Completion

Items A through E. See Lesson 2 for a discussion of completing the heading of Form 990 for items A through Ebecause they are identical to those on the Form 990-EZ. (See Lesson 1 for guidance on filing when an applicationis pending or in a final year.)

Item F—Group Exemption Number (GEN). The GEN is a number assigned by the IRS to the central/parentorganization of a group that has a group exemption letter. If the organization is covered by a group exemption letter,enter the four-digit GEN. Contact the central/parent organization if the organization is unsure of the GEN assigned.(See Lesson 1 for more information on group returns.)

The central/parent organization cannot file a Form 990-EZ for the group return. (It must use Form 990.)

Item G—Accounting Method. Indicate the accounting method used in preparing the return.

Item H—Schedule B. Check the box if the organization is not required to attach Schedule B. Form 990-EZ isincomplete if neither the box is checked nor Schedule B attached. (See Lesson 3 for guidance on which organiza-tions must attach Schedule B.)

Item I—Website. Provide the organization’s website address as of the date of filing this return or enter “N/A” if it doesnot have a website.

Item J—Tax-exempt Status. An organization must indicate the IRC section that governs its exempt status, whichnormally can be found in the exemption letter from the IRS (or subsequent modification to such letter). Organiza-tions exempt under IRC Sec. 501(c) [other than under IRC Sec. 501(c)(3), which has its own check box] must fill inthe appropriate subsection.

Item K—Form of Organization. Check the box describing the organization’s legal entity form or status under statelaw in its state of legal domicile. Legal entity forms include corporations, trusts, unincorporated associations, andother types of entities (e.g., partnerships and limited liability companies).

Item L—Gross Receipts. Only those organizations with gross receipts of less than $200,000 and total assets of lessthan $500,000 at the end of the year can file Form 990-EZ. An organization that does not meet these requirementsmust file Form 990. Add lines 5b, 6c, and 7b to line 9 to determine gross receipts. An organization with annual grossreceipts of $50,000 or less, other than a Section 527 political organization, may be required to submit Form 990-Nif it does not file Form 990 or Form 990-EZ.

Signature Block (Page 4)

Signature of Officer. An officer of the organization who is authorized as of the filing date to sign the return must signin the space provided. This can be the president, vice president, treasurer, assistant treasurer, chief accountingofficer, or other corporate (e.g., tax) officer. A receiver, trustee, or assignee must sign for any return he or she filesfor a corporation or association. The authorized trustee(s) must sign for a trust.


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Paid Preparer Signature. Generally, anyone paid to prepare the return must sign the return. A paid preparer mustcomplete the “Paid Preparer’s Use Only” area as follows:


2. Complete the preparer information, including the preparer’s taxpayer identification number (PTIN) and thefirm’s EIN (if applicable).


Check “Yes” on the last line of Part VI if the IRS is authorized to contact the paid preparer to—

1. answer any questions arising while processing the return as well as provide any missing information,

2. contact the IRS about processing the return, or

3. respond to IRS notices about math errors, offsets, and return preparation.

However, checking “Yes” does not authorize the paid preparer to bind the organization to anything or represent theorganization before the IRS. If the organization checks “No,” the IRS will contact the organization at the address ortelephone number listed in the heading instead of the paid preparer.

Part I: Revenue, Expense, and Changes in Fund Balance

Part I must be completed for all organizations filing Form 990-EZ with the IRS or any state. Some states that acceptForm 990-EZ instead of their own formsmay require additional information. Such additional information required bystates need not be included with the Form 990-EZ filed with the IRS.

Check the box in the heading of Part I if Schedule O (Supplemental Information to Form 990 or 990-EZ) containsany information pertaining to this part.

Revenue

Line 1. Report the gross amounts of contributions, gifts, grants, and bequests that the organization received fromindividuals, trusts, corporations, estates, affiliates, foundations, public charities, and other exempt organizations.Also, include similar amounts raised by an outside fundraiser. Include voluntary contributions [payments in excessof fair market value (FMV)] and noncash contributions valued at the date donated. Reporting contributions inaccordance with FASB ASC 958 is allowed but not required by the IRS. Under FASB ASC 958, an organization thatreceives a grant to be paid in future years should report the grant’s present value on line 1.

Do not include the value of donated services (including the value of donated advertising space, broadcast air time,or public service announcements) or the free use of materials, equipment, or facilities. Any unreimbursed expensesof officers, employees, or volunteers are not reported on Form 990-EZ. Do not include a grant that is a payment forservices (i.e., the terms of the grant provide the grantor with a specific service, facility, or product rather thanproviding a benefit to the general public or the public served by the grant recipient). Do not net losses fromuncollectible pledges, refunds of contribution and service revenue, or reversal of grant expenses on line 1. Instead,report these items on Part I, line 20 as “Other changes in net assets or fund balances” and explain in Schedule O.

Example 5B-1 Payment in excess of fair market value.

Good Cause (GC), a Section 501(c)(3) organization, holds a dinner gala (i.e., fundraising event), charging$400 per person to attend. The dinner has a retail value of $160. The purchase of a ticket results in a $240contribution ($400 ticket price minus $160 FMV). The $240 contribution is reported on line 1 and again on line6b (within the parentheses). The revenue received from the fundraising event (i.e., the $160 retail value of thedinner) is reported on line 6b. Expenses directly related to the dinner (e.g., catering, entertainment, ordecorations) are reported on line 6c. Fundraising expenses related to the contribution of $240 are reported onlines 12 through 16.


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Variation: If a contributor pays more than $400 for the gala ticket, he or she is making a larger contribution.For example, if $500 was paid for the ticket, the contribution reported on line 1 would be $340 ($500–$160FMV).

If an organization offers goods or services through a special event or distributes free, unordered items of onlynominal or insubstantial value to patrons, report the entire amount received for such benefits as a contribution online 1. Benefits have a nominal or insubstantial value if the organization informs patrons howmuch of their paymentis a deductible contribution, and either:

1. the FMV of all the benefits received for the payment is 2% or less of the payment or $107 (for 2017, $109for 2018) whichever is less; or

2. the payment is $53.50 (for 2017, $54.50 for 2018) or more and only token benefits are received (e.g.,bookmarks, calendars, key chains, mugs, posters, T-shirts) bearing the organization’s name or logo. Thecost to the organizationof all benefits receivedby thedonormust be nomore than$10.70 (for 2017, $10.90for 2018).

Also include on line 1 the following items:

1. Grants received to further the organization’s exempt programs and purpose.

2. Grants or grant equivalents fromagovernmental unit (whether the payment is labeleda grant or a contract)that enable the recipient organization to provide a service to, or maintain a facility for, the direct publicbenefit.

3. Membership dues and assessments to the extent they are contributions and are not payments for benefitsreceived (see line 3 discussion following).

4. Contributions received indirectly from the public through solicitation campaigns of federated fundraisingagencies (e.g., the United Way).

5. Contributions received from closely associated organizations (i.e., a parent, subordinate, or brother/sisterorganization).

6. Contributions received from a commercial co-venture by the organization for allowing the donor to use therecipient organization’s name in a sales promotion campaign (e.g., 2% of the sales proceeds arecontributed to the organization).

7. Contributions of conservation easements and other qualified conservation contributions consistently withhow they are reported in the books and financial statements.

8. Assets contributed by another entity in the course of the entity’s liquidation, dissolution, or termination.

Schedule B is generally required to be filed by organizations that receive more than $5,000 in money, securities, orother property during the year from a single contributor.

Line 2. Program services are those activities that primarily form the basis of an organization’s exempt status.Program service revenue includes admissions to a concert or other performing arts event, charges by a clinic formedical services, or tuition received by a school. It also includes income earned on program-related investments(i.e., investments made primarily to accomplish an exempt purpose of the investing organization). Examplesinclude scholarship loans and low-interest loans to charitable organizations, indigents, or victims of disaster; andbelow-market rental income received from housing leased to low-income persons. Some unrelated businessactivities that generate fees for services may also be program service activities. For example, a social club shouldreport on this line the fees it charges both members and nonmembers for the use of its tennis courts and golfcourses. Program service revenue can also include income earned by the organization for providing a governmentagency with a service, facility, or product that benefited that agency directly and not the general public.


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Line 3. Enter members’ and affiliates’ dues and assessments that are not contributions. Dues and assessments thatare not contributions are those that compare reasonably with the benefits of membership or that generally matchdues and benefits [i.e., typically Section 501(c)(5), (6), or (7) organizations]. Membership benefits may includesubscriptions to publications, newsletters, free or reduced-rate admission to organization-sponsored events, andother discounts. Dues or assessments received that exceed the FMV of available membership benefits (whether ornot they are used) are a contribution reported on line 1. However, if a college fraternity or sorority chargesmembership initiation fees, but not annual dues, report the amount of the fees on this line. Such fees are includedin gross receipts, even though initiation fees are generally excluded.

Line 4. Report as investment income interest earned on savings and temporary cash investments (i.e., checkingand money market accounts, certificates of deposit, and U.S. Treasury bills). In addition, report dividends andinterest from stocks and bonds, mutual savings banks, and mutual funds as investment income. Also report grossrental income received from investment property and any other real property rented by the organization (other thanprogram-related investments reported on line 2) on this line. Include the organization’s share of investment incomefrom a joint venture, limited liability company, or other entity treated as a partnership for federal tax purposes. Alsoinclude royalties received by the organization from licensing the use of property to others (but not royaltiesgenerated as part of the organization’s exempt function reported on line 2).

Do not report capital gains dividends (reported on line 5) or unrealized gains and losses on investments carried atmarket value as investment income. In addition, exempt function (i.e., program service) rental income is reportedon line 2 rather than on line 4. Examples of exempt function rental income include the rent received by anorganization whose exempt purpose is to provide low-rental housing to qualified individuals and rent charged to atenant organization whose activities are related to the filing organization’s exempt purpose.

Line 5a. Report all sales of securities and other types of investments (i.e., real estate, royalty interests, or partner-ship interests). Also, report the sales of all other noninventory assets (i.e., program-related investments and fixedassets used in related and unrelated activities). In addition, report capital gains dividends, the organization’s shareof capital gains and losses from a joint venture, limited liability company, or other entity treated as a partnership forfederal tax purposes, and capital gain distributions from trusts.

Line 5b. Report the cost basis or other basis (less depreciation) and selling expenses. For reporting sales ofsecurities on Form 990-EZ (but not the Form 990-T), the organization may use the more convenient average-costbasis method for calculating basis of the particular security sold.

Line 5c. Report the net gain (or loss) from the sale of assets other than inventory (line 5a− line 5b). Details of otherassets sold are not required to be attached to Form 990-EZ.

Line 6a. Report the gross income from gaming activities (e.g., raffles, bingo, or other gaming). If the organizationreports income from gaming on line 6a of more than $15,000, Part III of Schedule G (Supplemental InformationRegarding Fundraising or Gaming Activities) must be completed.

Line 6b. Report the gross revenue from all fundraising events in the right-hand column without reduction for cashor noncash prizes, cost of goods sold, compensation, fees, or other expenses. Fundraising events and activitiesare those endeavors with a primary purpose of raising funds for the organization (other than contributions) tofinance the organization’s exempt activities. The fundraiser involves some event or activity, rather than being purelya solicitation of funds (e.g., dinners, dances, carnivals, and door-to-door sales of merchandise). The income fromsuch an event only incidentally accomplishes an exempt purpose by generating operating funds. In addition, theseevents do not include activities regularly carried on.

Income from a fundraising event or activity can generate both revenue reported on line 6b of Form 990-EZ as wellas receipts reported as contributions on line 1. If a buyer pays more than FMV for the goods or services received,report as gross revenue on line 6b (right-hand column) the FMV of the goods or services. In addition, report theexcess as contributions on both line 1 and line 6b (within the parentheses). If the goods or services offered haveonly a nominal value, report the full amount received as a contribution.

If the sum of the organization’s gross income and contributions from fundraising events is more than $15,000 (i.e.,line 6b, including the contribution amount in the parentheses), Part II of Schedule G must be completed.


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Line 6c. Report only the direct expenses attributable to the goods or services the buyer receives from a fundraisingevent. If the organization includes an expense on line 6c, do not report it again on line 7b.

Line 7a. Report the organization’s gross income from sales of inventory items, less returns and allowances. Includesales of those items the organization makes to sell to others or buys for resale. Report the sales revenuesregardless of whether the sales activity is an exempt function of the organization or an unrelated trade or business.However, do not include sales of goods at special fundraising events that are reported on line 6b or sales of assetsheld for investment that are reported on line 5a.

Line 7b. Report the cost of goods sold (COGS) related to the inventory sales. COGS usually includes direct andindirect labor, material and supplies consumed, freight-in, and a portion of overhead expenses. For purposes ofPart I, the organization may include as cost of donated goods their fair market value at the time of acquisition.Marketing and distribution costs are not included in the COGS but are reported in lines 12 through 16.

Line 8. Enter the total revenue from all sources not covered by lines 1 through 7. Examples include interest on notesreceivable not held as investments or as program-related investments; interest on loans to trustees, directors,officers, and key employees (TDOKEs) and other employees; and royalties that are not investment income orprogram service revenue.

Expenses

Line 10. Enter the amount of actual grants and similar amounts paid to individuals and organizations selected bythe filing organization. Include scholarships, fellowships, and research grants to individuals. Report specific assis-tance to individuals, including payments to, or for the benefit of, particular patients or clients. Also report predeter-mined quota support and dues payments to organizations affiliated with the reporting organization. Do not reportthe cost of goods or services purchased from affiliates or administrative expenses incurred in selecting or monitor-ing grant recipients. Report these expenses on lines 12 through 16. In addition, do not include membership duespaid to an unaffiliated organization for general membership benefits, such as regular services, publications, andmaterials, which should be reported on line 16.

In Schedule O, itemize grants (and similar amounts) in excess of $5,000 paid during the organization’s tax year toa grantee organization or individual. Show—

1. each class of activity (i.e., for nursing services; fellowships; and payments for food, shelter, or medicalservices for indigents);

2. the grantee organization’s name and address (do not list individual grantees);

3. the amount given (aggregate amount of grants and payments to or for the benefit of the grantee during theorganization’s tax year); and

4. the relationship of the grantee (for grants to individuals), control, or ownership (if any) to any person orcorporation with an interest in the organization (i.e., creator, donor, TDOKE, or related organization).

Do not provide the name of the grantor or contributor if the individual grantee is related to the grantor or contributorto the organization. Instead, identify persons generically as grantee and as grantor or contributor.

If any related organization received any payment reported on line 10, list it and specify the purpose of the payment.If noncash property is awarded or granted and the gift is measured using FMV, indicate on the attachment the dateof the gift, the description and book value of the property, and how book value and FMV were determined. Anydifference between FMV and book value should be recorded in the organization’s books and on line 20.

Line 11. For organizations that provide benefits to members or dependents [e.g., organizations exempt under IRCSec. 501(c)(8), (9), or (17)], enter the amounts paid for or paid to obtain insurance that provides—

1. death, sickness, hospitalization, or disability benefits;


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2. unemployment compensation benefits; and

3. other benefits [including patronagedividendspaid bySection 501(c)(12) organizations to theirmembers].

Do not include the cost of employment-related benefits the organization gives its officers and employees reportedon line 12.

Line 12. Report salaries and wages paid to employees and officers and the payments made to directors andtrustees, including compensation reported on Forms W-2 and 1099. Include all other forms of income and benefitsreceived from the organization during the year, such as the employer’s share of deferrals (for unfunded plans) andcontributions paid to qualified and nonqualified pension plans and to employee benefit programs (i.e., insurance,health and welfare programs). Include the employer’s share of federal, state, and local payroll taxes for the year.Also report expenses paid or incurred for employee events such as a picnic or holiday party.

Line 13. Enter legal, accounting, auditing, other professional fees (i.e., for fundraising or investment services), andrelated expenses charged by outside firms and individuals who are not employees of the filing organization. Do notinclude broker fees and commissions that should be reported as sales expenses on line 5b. Do not include anypenalties, fines, or judgments imposed against the organization as a result of legal proceedings (as these expensesare reported on line 16).

If the organization is able to distinguish between fees paid for independent contractor services and expensepayments or reimbursements to the contractors, report the fees paid on this line and report the expenses on lines14 through 16 by appropriate category. If unable to distinguish between service fees and expense payments orreimbursements, report the entire amount on this line.

Line 14. Report amounts paid or incurred for office space or other facilities used to conduct the organization’sexempt function. These expensesmay include: heat, light, power, and other utilities; outside janitorial services; rentor mortgage interest; real estate taxes; property insurance; and similar expenses. Report expenses related to realproperty used for investment purposes on line 16. If part of the property is occupied by the organization and partis leased to others, allocate the related expenses between occupancy-related (reported on line 14) and invest-ment-related (reported on line 16). Do not reduce rental expenses by any rental income received from renting orsubletting rented space. If the organization records depreciation on property it occupies, include the total for theyear on this line.

Line 15. Enter the printing and related costs of producing the filing organization’s newsletters, leaflets, films, andother informational materials, including the cost of outside mailing services. Also report the cost of any purchasedpublications and their postage and shipping costs not reported on line 5b, 6c, or 7b. Do not include any expenses,such as salaries, for which a separate line is provided.

Line 16. Report expenses that are not reportable on lines 10 through 15. Examples include penalties, fines, andjudgments; unrelated business income taxes; insurance, interest, depreciation, and real estate taxes not reportedas occupancy expenses; travel and transportation costs; and expenses for conferences, conventions, and meet-ings. Do not report on this line payments made by organizations exempt under Section 501(c)(8), (c)(9), or (c)(17)to obtain insurance benefits for members. These expenses are instead reported on line 11. Expenses should bedetailed in Schedule O.

Changes in Fund Balance

Line 20. Describe in Schedule O any changes in net assets or fund balances between the beginning and end of theyear that are not accounted for by the amount on line 18 (current year excess or deficit). Amounts reported on thisline include adjustment of a prior year’s activity (e.g., losses on uncollectible pledges, refunds of contributions andprogram service revenue, and reversal of grant expenses); unrealized gains and losses on investments booked atmarket value; any difference between the FMV and book value of property given as an award or grant; and anySection 481(a) adjustment that was the result of a change in accounting method.


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Part II: Balance Sheets

A complete and accurate return must include complete Columns (A) and (B) of Part II of the Form 990-EZ. If thereis no amount to report in Column (A), Beginning of year, enter “-0-” in that column. Do not submit a substitutebalance sheet.

Check the box in the heading of Part II if Schedule O (Supplemental Information to Form 990 or 990-EZ) containsany information pertaining to this part.

Line 22. Include all interest and noninterest-bearing accounts (e.g., petty cash; checking, savings, and moneymarket accounts; commercial paper; certificates of deposit; U.S. Treasury bills; and other government obligations).Also include the book value of assets held for investment such as securities, land, and buildings.

Line 23. Enter the book value (cost or other basis less accumulated depreciation) of all land and buildings ownedby the organization and not held for investment.

Line 24. Enter the total of other assets including accounts receivable, inventories, and prepaid expenses on thisline. Also include the organization’s share of assets in any joint ventures, limited liability companies, and otherentities treated as a partnership for federal tax purposes. Describe the other assets on Schedule O.

Line 26. Report liabilities such as accounts payable, grants payable, mortgages or loans payable, and deferredrevenue (revenue received but not yet earned) on this line and describe on Schedule O.

Line 27. Net assets equal total assets (line 25) minus total liabilities (line 26). The net assets entered on this line inColumn B must equal the amount on line 21.

Part III: Program Service Accomplishments

Briefly state the organization’s primary exempt purpose in the blank provided on the top line of Part III. A programservice is a major, typically ongoing, objective of an organization. Some examples of program services areadoptions, recreation for the elderly, and journal or newsletter publication. See Lesson 2 for more information onexplaining program service accomplishments and achievements.

Check the box in the heading of Part III if Schedule O (Supplemental Information to Form 990 or 990-EZ) containsany information pertaining to this part.

Lines 28 through 30. All organizations must describe their program service accomplishments, but only Section501(c)(3) and (4) organizations are required to report grant and expense information in Part III.

Description. All organizations must describe their exempt purpose achievements for each of their three largestprogram services as measured by total expenses incurred. If there were three or fewer program service activities,describe each. Use measurements such as clients served, days of care, therapy sessions, or publications issuedto describe the program services. Describe each program’s objective, including both current and long-term goals.Reasonable estimates for any statistical information may be used when exact statistics are not available; however,indicate that an estimate is being provided. Be clear, concise, and complete in the description.

Expenses. If part of the total expenses (reported on line 17) of any program service consisted of grants (reported online 10), enter the amount of the grants in the parentheses. If the amount of the grants includes foreign grants,check the box to the left of the expense column. Enter the total expenses (including grants reported in theparenthesis) related to the each program service reported on line 28 through 31 in fields 28a through 31a.

Line 31. Include in Schedule O a list of the organization’s other program services. The detailed descriptionsrequired for the three largest services are not required for this schedule. However, organizations required to reportexpenses must show the expenses attributable to each program service.


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SELF-STUDY QUIZ


20. Which of the following comes last when assembling Form 990-EZ for filing?

a. Lettered schedules.

b. The core Form 990-EZ.

c. An article of merger or dissolution.

d. A name change amendment.

21. What is reported on Line 1 of Part I of Form 990-EZ?

a. Admission fees for a concert.

b. Gross amounts of contributions and gifts.

c. Membership dues.

d. Revenue from selling securities.

22. Which of the following statements best describes an aspect of filing Form 990-EZ?

a. Only the largest program service accomplishment is described in Part III.

b. Additional information required by a state for Part I is also included on the form submitted to the IRS.

c. Information contained in Form 990-EZ is kept confidential and not available for public view.

d. Program services not described in Part III are included on Schedule O.


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SELF-STUDY ANSWERS


20. Which of the following comes last when assembling Form 990-EZ for filing? (Page 361)

a. Lettered schedules. [This answer is incorrect. The second thing in the packet would be the letteredschedules (as applicable) in alphabetical order.]

b. The core Form 990-EZ. [This answer is incorrect. The core form should be the first thing in the packet, notthe last.]

c. An article of merger or dissolution. [This answer is correct. The final items in the Form 990-EZ filingpacket areanyapplicableattachments; however, even theattachmentshaveaprescribedorder. Thelast one should be any articles of merger or dissolution, resolutions, and plans of liquidation ormerger required for Schedule N.]

d. A name change amendment. [This answer is incorrect. Any name change amendment to the organizingdocument required by item B in the heading section is grouped with the attachments in the Form 990-EZpacket; however, this would be the first attachment in the prescribed order. Therefore, there could besomething after such an amendment in the packet.]

21. What is reported on Line 1 of Part I of Form 990-EZ? (Page 364)

a. Admission fees for a concert. [This answer is incorrect. Program service revenue includes admissions toa concert or other performing arts event, charges by a clinic for medical services, or tuition received by aschool. It also includes some program-related investments. This revenue is reported on line 2 of Part I.]

b. Gross amounts of contributions and gifts. [This answer is correct. Line 1 is used to report the grossamounts of contributions, gifts, grants, and bequests that the organization received fromindividuals, trusts, corporations, estates, affiliates, foundations, public charities, and other exemptorganizations. Similar amounts raised by an outside fundraiser would also be included, as wouldvoluntary contributions and noncash contributions valued at the date donated.]

c. Membership dues. [This answer is incorrect. Members’ and affiliates’ dues and assessments that are notcontributions are entered on line 3 of Part I.]

d. Revenue from selling securities. [This answer is incorrect. All sales of securities and other types ofinvestments are reported on line 5a of Part I.]

22. Which of the following statements best describes an aspect of filing Form 990-EZ? (Page 369)

a. Only the largest program service accomplishment is described in Part III. [This answer is incorrect. Allorganizations must describe their exempt purpose achievements for each of their three largest programservices as measured by total expenses incurred. If there were three of fewer program service activities,each should be described.]

b. Additional information required by a state for Part I is also included on the form submitted to the IRS. [Thisanswer is incorrect. Part I must be completed for all organizations filing Form 990-EZ with the IRS or anystate. Some states that accept Form990-EZ instead of their own formsmay require additional information.Such additional information required by states need not be included with the Form 990-EZ filed with theIRS.]


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c. Information contained in Form 990-EZ is kept confidential and not available for public view. [This answeris incorrect. In general, all information the organization reports on or with its Form 990EZ must be madeavailable for public inspection.]

d. Program services not described in Part III are included on Schedule O. [This answer is correct. Alist of anorganization’s other programservices are included inScheduleO. Thosedescribed inPartIII arenot required tobe includedonScheduleO, aswell.Organizations required to report expensesmust show the expenses attributable to each program service.]


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Part IV: Officers, Directors, Trustees, and Key Employees

Check the box in the heading of Part IV if Schedule O (Supplemental Information to Form 990 or 990-EZ) containsany information pertaining to this part.

Generally, report all forms of cash and noncash compensation received by each listed trustee, director, officer, orkey employee (TDOKE) of the organization whether paid currently or deferred. Treat amounts paid or accrued by acommon paymaster [as defined in Reg. 31.3121(s)-1(b)(2)] or a payroll or reporting agent for services performedfor the filing organization as paid or accrued directly by the filing organization. Treat amounts paid or accrued to anyother person (i.e., a management services company, an employee leasing company, or a professional employerorganization) for services provided to the filing organization by a TDOKE of the organization as paid or accrueddirectly by the filing organization.

Column (a). For each person required to be listed, enter the name in the top of each row and the person’s title orposition within the organization in the bottom of the row. If the person had more than one title or position during theyear, list all (e.g., President and Director). List persons in the following order: individual trustees or directors,institutional trustees, officers, and key employees, with those who receive no compensation at the end of the list.

Column (b). For each person listed in column (a), report the average hours per week devoted to the organizationduring the year. Although an estimate of the hours is acceptable, listing phrases such as “as needed,” “asrequired,” or “40+” are not. Enter “-0-” if no hours were spent during the year on the nonprofit’s activities. If theaverage is less than one hour per week, the organization can enter a decimal rounded to the nearest tenth (e.g., 0.2hours per week).

Definitions

Director or Trustee. A director or trustee with voting rights is considered a member of the organization’s governingbody at any time during the year and therefore reported in Part IV. The governing body is the group of personsauthorized under state law to make governance decisions on behalf of the organization. If the director or trustee isa member of an advisory board with no voting authority over the organization’s governance, he or she is notconsidered a director or trustee for reporting compensation.

Officer. An officer is an elected or appointed person who manages the organization’s daily operations at any timeduring the year. The officers may be described and determined in the organizing document (e.g., articles ofincorporation), bylaws, or other resolutions of the governing body. State law often requires each corporation/orga-nization to have certain officers (e.g., president, vice president, secretary, or treasurer).

Key Employee. A key employee is someone that has responsibilities or powers similar to those of officers, directors,or trustees. It includes the chief management and administrative officials of the organization (such as an executivedirector or chancellor). A chief financial officer and the officer in charge of the administration or program operationsare both key employees if they have the authority to control the organization’s activities, its finances, or both.

Reporting Compensation

Compensation reporting on Form 990-EZ is similar to the Form 990 method of compensation reporting butsimplified. All compensation reporting is based on the calendar year ending with or within the organization’s taxyear. For example, if a fiscal year organization’s tax year is the 12-month period ending August 31, 2018, theorganization must report compensation for the calendar year ending December 31, 2017.

Column (c). Report the TDOKEs’ reportable compensation. For officers and other key employees, report box 1 or5 wages from FormW-2 (whichever amount is greater). For directors and individual trustees, report box 7 compen-sation from Form 1099-MISC for director services and other independent contractor services to the organization(plus the greater of box 1 or 5 of FormW-2 if also compensated as an officer or employee). For institutional trustees(i.e., banks or trust companies), report fees for services paid pursuant to a contractual agreement or statutoryentitlement. If no compensation was paid, enter “-0-.”


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Column (d). Report the following items of deferred compensation and benefits:

1. Employer tax-deferred contributions to a qualified defined contribution retirement plan.

2. The annual increase or decrease in the value of a qualified defined benefit plan (whether or not funded orvested).

3. The value of health benefits provided by the employer that are not included in reportable compensation(e.g., paymentsof healthplanpremiums,medical reimbursement and flexible spendingprograms, and thevalue of health coverage provided by an employer’s self-insured or self-funded arrangement).

4. Tax-deferred employer and employee contributions to a fundednonqualified defined contributionplananddeferrals under an unfunded nonqualified defined contribution plan, whether or not vested or subject toa substantial risk of forfeiture.

5. The annual increase or decrease in actuarial value of a nonqualified defined benefit plan, whether or notfunded, vested, or subject to a substantial risk of forfeiture.

Enter “-0-” if there were no reportable items of deferred compensation or benefits paid during the year.

Reasonable estimates may be used if precise cost figures are not readily available to determine column (d)amounts.

Column (e). Enter both taxable and nontaxable fringe benefits but do not include compensation reported in column(c) or (d) of the following: (1) working condition fringe benefits described in Section 132(d), (2) expense reimburse-ments and allowances under an accountable plan described in Reg. 1.62-2(c)(2), and (3) deminimis fringe benefitsdescribed in IRC Sec. 132(e). Enter “-0-” if there was no other reportable compensation paid during the year.

Enter expense reimbursements only to the extent they are taxable to the recipient. Examples include—

1. amounts for which the recipient did not account to the organization or allowances that weremore than thepayee spent on serving the organization;

2. payments made under indemnification arrangements (e.g., a reimbursement for legal expenses incurredafter being personally sued because of work-related activities);

3. the value of personal use of an organization’s asset (e.g., an auto or housing), whether the organizationowns it, leases it, or receives the use of it free of charge; and

4. the value of other taxable and nontaxable fringe benefits [to the extent they have not been reported incolumn (c) or (d)].

$10,000-per-item Exception. The organizationmay exclude from reporting in column (e) any item of “other compen-sation” given to a person listed in Part IV if its total value is less than $10,000 for the calendar year ending with orwithin the organization’s tax year.

Short Year and Final Returns

For a short year return in which there is no calendar year that ends with or within the short year, leave columns (c),(d), and (e) blank unless the return is a final return. If the return is a final return, report in column (c) thecompensation that is reportable compensation on FormsW-2 and Forms 1099 for the short year, from both the filingorganization and related organizations, whether or not Forms W-2 or Forms 1099 have been filed to report thiscompensation. Report health benefits, contributions to employee benefit plans, and other deferred compensationfor the year in column (d), and other compensation for the short year in column (e).

Part V: Other InformationCheck the box in the heading of Part V if Schedule O (Supplemental Information to Form 990 or 990-EZ) containsany information pertaining to this part.


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Statement Regarding Personal Benefit Contract

A personal benefit contract is generally any life insurance, annuity, or endowment contract that benefits, directly orindirectly, the transferor (or a family member), or any other person designated by the transferor [other than anorganization described in IRC Sec. 170(c)]. If, in connection with a transfer of funds to the organization, theorganization directly or indirectly pays premiums on any personal benefit contract, or there is an understanding orexpectation that any person will directly or indirectly pay such premium, the organization must attach a statementdescribing its involvement with the personal benefit contract. In addition, the organization must report thesepremiums and any premiums paid by others but treated as paid by the organization on Form 8870 (InformationReturn for Transfers Associated With Certain Personal Benefit Contracts).

Other Required Reporting

Line 33. If the organization engaged in any significant activities prior to the end of the tax year not previouslyreported to the IRS on either Form 990 or Form 990-EZ, indicate “Yes” and include in Schedule O (SupplementalInformation to Form 990 or 990-EZ) a detailed description of each activity. Also describe any significant activitiesthat were discontinued.

Line 34. The organization must report significant changes to its organizing document (i.e., articles of incorporation,association, or organization; trust instrument; constitution; or similar document) and to its rules governing its affairs(i.e., bylaws, regulations, operating agreement, or similar document) in Schedule O. Report changes made thathave not been reported on any previous Form 990 or 990-EZ and that were made prior to the end of the tax year.Attach a conformed copy of the changes if the name of the organization has been changed.

Line 35a. Section 527 political organizations are not required to answer this question. For all others, indicate if theorganization had gross income of $1,000 or more during the year from unrelated business activities, such as thosereported on lines 2, 6, and 7 (among others).

Line 35b. Answer “Yes” if the organization filed the Form 990-T by the time its Form 990-EZ is filed. Answer “No” ifthe organization has income from business activities (e.g., reported on line 2, 6, or 7 of Part I, among others) notreported on Form 990-T or it has filed an extension of time for filing Form 990-T, but has not yet filed Form 990-T.

Additionally, if not reported on Form 990-T, explain in Schedule O the reasons for not reporting the income.

Line 35c. Answer “Yes” if the organization was subject to Section 6033(e) notice, reporting, and proxy tax require-ments. If the organization checks “No” to line 35c, it is certifying that it was not subject to the notice and reportingrequirements of IRC Sec. 6033(e) and had no lobbying and political expenditures potentially subject to the proxytax.

Line 36. All organizations must answer “Yes” if they liquidated, terminated, dissolved, or had a significant disposi-tion of net assets during the year. A significant disposition of net assets is a sale, exchange, disposition, or othertransfer of more than 25% of the FMV of the organization’s net assets during the year (regardless of whether theorganization received full or adequate consideration). A significant disposition of net assets may result from eitheran expansion or contraction of operations. For a complete termination, check the Final return/terminated box in theheading of the return. Organizations that answer “Yes” must complete the applicable parts of Schedule N (Liquida-tion, Termination, Dissolution, or Significant Disposition of Assets).

A significant disposition of net assets involves—

1. oneormoredispositionsduring the tax year totallingmore than25%of theFMVof theorganization’sassetsas of the beginning of its tax year; or

2. one of a series of related dispositions or events commenced in a prior year that, when combined, totalsmore than 25% of the FMV of the organization’s assets as of the beginning of the tax year when the firstdisposition of net assets occurred.

Whether a significant disposition of assets took place through a series of related dispositions depends on the factsand circumstances of each case.


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Line 37. Report the direct or indirect political expenditures paid or incurred during the year. A political expenditureis any expenditure intended to influence the selection, nomination, election, or appointment of anyone to a federal,state, or local public office, or office in a political organization, or the election of presidential or vice-presidentialelectors. It does not matter whether the attempt succeeds.

An expenditure includes a payment, distribution, loan, advance, deposit, or gift (cash or noncash). It also includesa contract, promise, or agreement to make an expenditure, whether or not legally enforceable.

A Section 501(c) organization that is not a political organization must file Form 1120-POL (U.S. Income Tax Returnfor Certain Political Organizations) if it has political organization taxable income under IRC Sec. 527(f)(1). If aSection 501(c) organization establishes andmaintains a Section 527(f)(3) separate segregated fund (SSF), it is thefund’s responsibility to file its own Form 1120-POL (if required). The SSF’s receipts, expenditures, and balancesheet items are not included on the Section 501(c) organization’s Form 990-EZ. In addition, the SSF’s activity isdisregarded when the Section 501(c) organization answers line 37. However, when a Section 501(c) organizationtransfers its own funds to the SSF for use as political expenses, the Section 501(c) organization must report thetransferred funds as its own political expenses.

Line 37b. Answer “Yes” if the organization filed Form 1120-POL for this year.

Line 38a. Check “Yes” if the organization borrowed from or made any loans (secured or unsecured) to any trustee,director, officer, or key employee (TDOKE) for which the balance was unpaid at the end of the tax year. Report anyinterest expense paid to a TDOKE on line 16 of Part I (except for mortgage interest reportable on line 14). Report anyinterest income paid by a TDOKE on line 8.

Line 38b. If the answer to line 38a was “Yes,” complete Schedule L (Transactions With Interested Persons), Part II,and enter the total of year-end unpaid balances. For example, if the organization borrows $1,000 from one officerand loans $500 to a key employee during the year and nothing has been repaid on either loan, $1,500 should bereported on line 38b.

Line 39a. Section 501(c)(7) organizations should enter the initiation fees, capital contributions, and unusualamounts of income included in gross receipts on line 9, Total Revenue. However, if the organization is a collegefraternity or sorority that chargesmembership initiation fees but not annual dues, do not include such initiation fees.

Line 39b. Enter the amount of gross receipts derived from the general public for the use of the organization’sfacilities, that is, from persons other than members, their spouses, dependents, or guests. Also include theappropriate amount of unrelated business income, if any, on Form 990-T (if required).

Nondiscrimination. Section 501(c)(7) organizations must not discriminate on the basis of race, color, or religion tomaintain their tax-exempt status. However, membership may be limited (in writing) to members of a particularreligion if the social club is an auxiliary of a Section 501(c)(8) organization, or the limitation is a good faith attemptto further the teachings or principles of that religion and not intended to exclude individuals of a particular race orcolor.

Line 40a. Section 501(c)(3) organizations must disclose any excise tax imposed during the year under IRC Sec.4911 (excess lobbying expenditures), 4912 (disqualifying lobbying expenditures) or, unless abated, 4955 (politicalexpenditures).

Line 40b. Answer “Yes” if the organization is a Section 501(c)(3), (4), or (29) organization that engaged in anyexcess benefit transactions (EBTs) during the year or became aware prior to filing the return that it engaged in anyEBTs in a prior year that have not been reported on a prior Form 990 or 990-EZ. If “Yes,” complete Schedule L(Transactions with Interested Persons), Part I.

Line 40c. Section 501(c)(3), 501(c)(4), or 501(c)(29) organizations enter the amount of taxes imposed during theyear on an organization manager or disqualified person under IRC Secs. 4912 (disqualifying lobbying expendi-tures), 4955 (political expenditures), and 4958 (excess benefit transactions), unless abated.

Line 40d. Section 501(c)(3), 501(c)(4), or 501(c)(29) organizations enter the amount of tax reported on line 40c thatwas reimbursed by the organization. Any reimbursement of the excise tax liability of an organization manager or


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disqualified person will be an excess benefit unless (1) it is included in the individual’s compensation during theyear the reimbursement is made, and (2) the individual’s compensation (including reimbursement) is reasonable.

Line 40e. This line applies to all organizations. Answer “Yes” if at any time during the tax year, the organization wasa party to a prohibited tax shelter transaction (PTST) as described in IRC Sec. 4965(e).

Line 41. List the states with which a copy of this return is filed in full or partial satisfaction of state filing requirements.

Line 42a. Provide the name of the person who possesses the books and records along with either the businessaddress and telephone number of such person or the organization. The address or telephone number of anindividual’s personal residence is not required to be provided.

Line 42b. Answer “Yes” if either item one or two applies:

1. At any time during the calendar year ending with or within the organization’s tax year, the organization hadan interest in, or signature or other authority over, a financial account in a foreign country (such as a bankaccount, securities account, or other financial account); and

a. the combined value of all such accountswasmore than $10,000 at any time during the calendar year;and

b. the accounts were not with a U.S. military banking facility operated by a U.S. financial institution.

2. The organization owns more than 50% of the stock in any corporation that would answer “Yes” to item 1.

If “Yes,” enter the name of each foreign country in which a foreign account is located. If more space is needed to listthe accounts, use Schedule O (Supplemental Information to Form 990 or 990-EZ). In addition, file FinCEN Form114 electronically with the Department of the Treasury. See www.fincen.gov and search for “Form 114” for moreinformation on this filing requirement.

Line 42c. If the organization maintained an office outside of the U.S. at any time during the calendar year, check“Yes” and enter the name of the foreign country in which the office was located.

Line 43. This line only applies to Section 4947(a)(1) trusts; all others should leave line 43 blank. A Section4947(a)(1) trust is one that devotes all remaining interest in income and principal to qualified charities and for whichthe grantor was allowed a charitable deduction. If a Section 4947(a)(1) nonexempt charitable trust has no taxableincome under Subtitle A, filing Form 990-EZ and checking the box on line 43 will meet the income tax return filingrequirement under IRC Sec. 6012 (that is normally fulfilled by filing Form 1041). Enter on line 43 the tax-exemptinterest or dividends received or accrued (if reporting under the accrual method) during the tax year.

Line 44a. A sponsoring organization of a donor advised fundmust file Form 990 instead of Form 990-EZ, regardlessof the amount of its gross receipts or net assets.

Line 44b. An organization that operated one or more hospital facilities during the year must file Form 990 andSchedule H (Form 990) and not Form 990-EZ.

Line 44c. If the organization provided indoor tanning services for a fee, check “Yes.” Indoor tanning services areservices employing any electronic product designed to incorporate one or more ultraviolet lamps and intended forthe irradiation of an individual by ultraviolet radiation, with wavelengths in air between 200 and 400 nanometers, toinduce skin tanning.

Line 44d. Organizations receiving payment for services for indoor tanning services during the year must collectfrom the recipient of the services a tax equal to 10% of the amount paid for the service. If the organization filed Form720 (Quarterly Federal Excise Tax Return) during the year, it should check “Yes.” If it has not filed the required Form720 to remit the tax to the IRS, check “No” and explain in Schedule O.

Line 45. Controlling organizations of one or more controlled entities, as defined in IRC Sec. 512(b)(13), must fileForm 990 and Schedule R (Form 990) instead of Form 990-EZ if the controlling organization either (1) received or


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accrued from the controlled entity any interest, annuities, royalties, or rent, regardless of amount, during the taxyear; or (2) engaged in other transactions with the controlled entity if the amounts involved during the yearexceeded $50,000. [See “Controlling Organizations Described in IRC Sec. 512(b)(13)” in Lesson 1 for the definitionof control.]

Line 46. If the organization participated or intervened (directly or indirectly) in any political campaign on behalf of (orin opposition to) any candidate for public office, answer “Yes” and complete Part I of Schedule C (PoliticalCampaign and Lobbying Activities). Political campaign activities are all activities that support or oppose candidatesfor elective federal, state, or local public office whether or not the candidate is elected. It does not include anyactivity to encourage participation in the electoral process, such as voter registration or voter education, providedthat the activity does not directly or indirectly support or oppose any candidate.

Part VI: Additional Reporting for Certain Organizations

All Section 501(c)(3) organizations, including, for purposes of Form 990-EZ, Section 4947(a)(1) trusts must com-plete Part VI. A Section 4947(a)(1) trust is one that devotes all remaining interest in income and principal to qualifiedcharities and for which the grantor was allowed a charitable deduction.

Check the box in the heading of Part VI if Schedule O (Supplemental Information to Form 990 or 990-EZ) containsany information pertaining to this part.

Line 47. Answer “Yes” if the organization engaged in lobbying activities or had a Section 501(h) election in effectduring the year. If the answer is “Yes,” complete Schedule C, Part II. Lobbying activities are activities intended toinfluence foreign, national, state or local legislation. Such activities include direct lobbying (attempting to influencethe legislators) and grassroots lobbying (attempting to influence legislation by influencing the general public).

Line 48. Answer “Yes” and complete Schedule E (Schools) if the organization is a school described in IRC Sec.170(b)(1)(A)(ii) and it checked the box on line 2 of Schedule A (Public Charity Status and Public Support), Part I,indicating that it is a school.

Line 49a. Answer “Yes” if the organization transferred something of value (e.g., cash, other assets, services, or useof property) to a related organization that is an exempt organization other than a Section 501(c)(3) organization(e.g., a related Section 501(c)(4) or 527 political organization) whether or not for adequate consideration. Theorganization may (but is not required to) explain the transfer in Schedule O.

Related Organization. For Form 990-EZ reporting, a related organization is an organization (including a nonprofitorganization, a stock corporation, a partnership or limited liability company, a trust, and a governmental unit orother government entity) that is in one or more of the following relationships to the filing organization at any timeduring the tax year.

¯ Parent—an organization that controls the filing organization.

¯ Subsidiary—an organization controlled by the filing organization.

¯ Brother/Sister—an organization controlled by the same person or persons that control the filingorganization. However, if the filing organization is a trust that has a bank or financial institution trustee thatis also the trustee of another trust, the other trust is not a brother/sister related organization of the filingorganization on the ground of common control by the bank or financial institution trustee.

¯ Supporting/Supported—an organization that is (or claims to be) at any time during the organization’s taxyear (1) a supporting organization of the filing organization within the meaning of IRC Sec. 509(a)(3) if thefiling organization is a supported organization within themeaning of IRC Sec. 509(f)(3); or (2) a supportedorganization if the filing organization is a supporting organization.

Control. Control can be indirect. For example, if the filing organization controls Entity A, which controls Entity B, thefiling organization is deemed to control Entity B. Apply the Section 318 rules to determine indirect control of a


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corporation through constructive ownership. Similar rules apply for other entities. For example, if an entity (X)controls an entity treated as a partnership (P) by being one of three or fewer partners or members, then anorganization that controls X also controls P.

Line 49b. Answer “Yes” if the related organization was a Section 527 organization.

Line 50. Complete this table for the five highest compensated employees other than trustees, directors, officers,and key employees (TDOKEs) that receivedmore than $100,000 of compensation from the organization. If there arenone, enter “None.” On line 50f, enter the number of other employees (other than TDOKEs) with annual compensa-tion over $100,000 who are not individually listed.

A fiscal-year organization uses the calendar year ending within its tax year to determine its five highest compen-sated employees over $100,000. Combine the compensation includable in Part VI, columns (c), (d), and (e) todetermine whether compensation exceeds the $100,000 threshold for the calendar year. [Guidance on what toreport in columns (c) and (d) was provided earlier in this lesson.]

See the discussion of Part IV compensation reporting earlier in this lesson for information on completing columns(a) through (e) of line 50, and for information on the $10,000-per-item exception for column (e).

Example 5G-1 Calculating compensation includable in Part VI.

Sally is not a key employee of Good Deeds (GD), a calendar-year organization. Sally is the highest paidnon-key employee and received the following compensation and benefits during the year:

Paid by employerColumnReported

Salary $80,000 (c)Bonus 2,000 (c)Matching defined contribution plan contribution 5,000 (d)Nontaxable employee and family health benefits 10,000 (d)Nontaxable family education benefits 5,000 N/Aa

Paid by employeeQualified defined contribution plan contribution $5,000Qualified health plan contribution 5,000

To determine whether Sally is listed among the five highest compensated employees over $100,000 for line50, Part VI, her total compensation is $97,000 [($80,000+ $2,000+ $5,000+ $10,000)]; therefore, Sally is notlisted.

Note:

a Excluded under the $10,000-per-item exception for column (e).

Line 51. Complete this table for the five highest compensated independent contractors that received more than$100,000 of compensation from the organization for services (professional or otherwise). Independent contractorsinclude organizations and individuals (e.g., professional fundraisers, legal firms, accounting firms, managementcompanies), but not public utilities or insurance providers. If there are none, enter “None.” On line 51d, enter thenumber of other independent contractors with annual compensation over $100,000 who are not listed individually.Organizations must use the calendar year ending with or within its tax year to determine and report the five highestcompensated independent contractors.

Enter the compensation paid (whether reported on Form 1099-MISC, box 7, or paid under the parties’ agreementor applicable state law). Compensation to independent contractors includes fees and similar payments but notreimbursement of expenses. However, for this purpose, the organization must report the gross payment to the


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independent contractor that includes expenses and fees if the expenses are not separately reported to theorganization (for example, itemized separately on the contractor’s invoice).

Line 52. Indicate whether or not the organization has completed Schedule A. All Section 501(c)(3) organizationsand 4947(a)(1) nonexempt charitable trusts must attach a completed Schedule A.

A Case Study about Completing Form 990-EZ

Facts

Community Education Resources (CER) is a calendar-year Section 501(c)(3) organization that qualifies to file Form990-EZ. CER provides resources for teachers/educators and conducts continuing education events and freeworkshops throughout the year.

During the year, CER received $50,000 from registration fees for continuing education events. In addition, CERconducted 12 free workshops. Direct expenses incurred related to conducting the seminars and free workshopsincluded $14,000 rent, $20,000 speaker fees, and $3,500 printing and postage.

CER received $77,875 of membership dues (623 members × $125 dues). In addition, CER held two fundraisingevents—a dinner gala and an auction. Gala tickets sold for $100 each (FMV of each ticket was $75, and 250 ticketswere purchased). The direct expenses of the gala were as follows: $3,000 rent, $8,750 catering, and $2,500entertainment. The auction generated $20,000 of revenue. The FMV of the items donated to CER for the auctionwas $16,000.

The following general expenses were incurred during the year:

¯ Ten scholarships of $2,000 each were granted to college students majoring in education.

¯ Accounting fees of $5,500.

¯ Rent of $12,000.

¯ Depreciation on copier of $500.

¯ Telephone expense of $1,500.

¯ Postage of $1,200.

¯ Office supplies of $2,000; beverage service of $1,200; and miscellaneous of $850.

CER pays its executive director, Alice Smith, a $60,000 annual base salary. On December 30, 2016, CER’s Boardapproved a bonus of $3,000 for Alice. The bonus was paid May 15, 2017. On December 31, 2017, the Boardapproved a $4,000 bonus payable to Alice in May 2018. CER’s 2016 and 2017 returns were filed before May 15 ofthe following year.

In addition, Alice Smith received an expense reimbursement of $1,000 during 2017. This included $370 of travelexpenses (for which she adequately accounted) and $630 ofmileage (1,000miles incurred in January–June at $.63per mile) for using her personal car to carry out CER’s exempt functions.

CER has five uncompensated board members.

Conclusions

The $50,000 of continuing education registration fees are reported as program service revenue on Part I, line 2.

The $77,875 of income from membership dues is reported on Part I, line 3.


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Since payments in excess of FMV are reported as contributions, the fundraising event income must be splitbetween contributions and fundraising event income. The fundraising event income is reported as follows:

Auction Income $16,000 Part I, line 6bFundraising Event Income 18,750 ($75 FMV × 250 tickets) Part I, line 6bContribution Income 6,250 [($100 − $75) × 250 tickets] Part I, line 1Contribution Income 4,000 Part I, line 1

$45,000

The gala direct expenses are reported as follows on Form 990-EZ:

Value of Auction Items $16,000 Part I, line 6cFacility Rental 3,000 Part I, line 6cCatering 8,750 Part I, line 6cEntertainment 2,500 Part I, line 6c

$30,250

For 990-EZ reporting purposes, no distinction is made between cash and noncash contributions received; there-fore, the value of the items donated for the auction is reported as follows:

Noncash Contributions $16,000 Part I, line 1

The $20,000 (10 × $2,000) in scholarships granted is reported on Part I, line 10.

Compensation Reporting. Part IV of CER’s 2016 Form 990-EZ should have reflected the $3,000 payable to Alice incolumn (d) (contributions to employee benefit plans and deferred compensation). On its 2017 Form 990-EZ, thesame $3,000 is included in column (c) (reportable compensation) of Part IV because it was paid during the year.The $4,000 bonus approved in 2017 is reported in column (d) of Part IV on its 2017 return. Assuming it is paid asplanned in 2018, the $4,000 bonus is also included in column (c), Part IV, of the 2018 Form 990-EZ.

The mileage reimbursement in excess of the IRS standard mileage rate ($.535) is taxable to Alice and must beshown on her W-2 as part of her wages. Since the taxable amount [$95 = 1,000 miles× ($.63− $.535)] is reportedin column (c), it is not included in column (e) of Part IV, Form 990-EZ. In addition, the $535 of nontaxable mileagereimbursement is not reported in column (e) because it is excluded under the $10,000-per-item exception dis-cussed previously.

In addition to holding the position of executive director for CER, Alice is also a director of Early Childhood EducationAssociation and an officer of Community Resource Center for Teachers. She receives compensation of $12,000 peryear from each of these entities. Both are related to CER. Even though Alice received compensation from relatedentities, CER is not required to report the compensation from the related entities on its Form 990-EZ.

General expenses and the expenses from conducting the educational seminars and workshopsmust be combinedand reported on lines 13–16, as shown below.

Expense GeneralSeminars andWorkshops Total

Reported onPart 1, line

Professional fees $ 5,500 $ 20,000 $ 25,500 13Occupancy, rent, utilities 13,500 a 14,000 27,500 14Printing, postage 1,200 3,500 4,700 15Other expenses 5,455 b — 5,455 16

Notes:a $12,000 rent + $1,500 telephone expense = $13,500

b $500 depreciation + $2,000 office supplies + $370 travel expenses + $535 mileage reimbursement ($630 −$95 treated as wages) + $1,200 beverage service + $850 misc. expenses = $5,455


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SELF-STUDY QUIZ


23. What is the term for someone elected or appointed to manage an organization’s daily operations during theyear?

a. Director.

b. Trustee.

c. Officer.

d. Key employee.

24. Where on Part V of Form 990-EZ should an organization indicate a significant disposition of assets?

a. Line 35c.

b. Line 36.

c. Line 37.

d. Line 39a.


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SELF-STUDY ANSWERS


23. What is the term for someone elected or appointed to manage an organization’s daily operations during theyear? (Page 374)

a. Director. [This answer is incorrect. If a director has voting rights, he or she will be considered part of theorganization’s governing body. However, members of the governing body are not necessarily taskedwithmanaging daily operations. There is a more specific answer to this question.]

b. Trustee. [This answer is incorrect. A trusteewith voting rights is amember of the organization’s governingbody. Agoverning body is the group of persons authorized under state law tomake governance decisionson behalf of an organization; however, all members of a governing body do not have to be responsible fordaily operations. Another choice better answers this question.]

c. Officer. [This answer is correct. An officer is an elected or appointed person who manages theorganization’s daily operations at any time during the year. The officers may be described anddetermined in the organizing document, bylaws, or other resolutions of the governing body.]

d. Key employee. [This answer is incorrect. A key employee is someone that has responsibilities or powerssimilar to those of officers, directors, or trustees. It includes the chief management and administrativeofficials of the organization.]

24. WhereonPart Vof Form990-EZshouldanorganization indicate a significant dispositionof assets? (Page 375)

a. Line 35c. [This answer is incorrect. If an organization is subject to Section 6033(e) notice, reporting, andproxy tax requirements, it should answer “Yes” on line 35c.]

b. Line 36. [This answer is correct. All organizations must answer “Yes” on line 36 if they liquidated,terminated, dissolved, or had a significant disposition of net assets during the year. A significantdisposition of assets is a sale, exchange, disposition, or other transfer of more than 25% of the FMVof theorganization’s net assets during theyear (regardlessofwhether theorganization received fullor adequate consideration).]

c. Line 37. [This answer is incorrect. On this line, an organization should report the direct or indirect politicalexpenditures paid or incurred during the year.]

d. Line39a. [This answer is incorrect. This line is used to report theamountof gross receipts thatwerederivedfrom the general public for the use of the organization’s facilities.]


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Companion to PPC’s 990 Deskbook—Course 3—Selected Topics Related toForm 990 (990TG183)










3. Each answer sheet sent for print grading must be accompanied by the appropriate payment ($95 for answersheets sent by email or fax; $105 for answer sheets sent by regular mail). Discounts apply for three or morecourses submitted for grading at the same time by a single participant. If you complete three courses, the pricefor grading all three is $271 (a 5% discount on all three courses). If you complete four courses, the price for


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grading all four is $342 (a 10% discount on all four courses). Finally, if you complete five courses, the price forgrading all five is $404 (a 15% discount on all five courses). The 15% discount also applies if more than fivecourses are submitted at the same time by the same participant. The $10 charge for sending answer sheets inthe regular mail is waived when a discount for multiple courses applies.





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Companion to PPC’s 990 Deskbook—Course 3—Selected Topics Related to Form 990 (990TG183)


1. Based on their gross receipts and total assets, which of the following organizations should file Form990,whichshould file Form 990-EZ, and which should file Form 990-N?

Helping Hands has gross receipts of $250,000 and total assets of $400,000.

Wheel Meals has gross receipts of $100,000 and total assets of $200,000.

Local Harvest has gross receipts of $40,000.

Equality Forever has gross receipts of $300,000 and total assets of $500,000.

a. Equality Forever should file Form 990. Helping Hands and Wheel Meals should file Form 990-EZ. LocalHarvest should file Form 990-N.

b. Helping Hands and Wheel Meals should file Form 990. Local Harvest should file Form 990-EZ. EqualityForever should file Form 990-N.

c. Helping Hands and Equality Forever should file Form 990. Wheel Meals should file Form 990-EZ. LocalHarvest should file Form 900-N.

d. Local Harvest and Wheel Meals should file Form 990. Equality Forever should file Form 990-EZ. HelpingHands should file Form 990-N.

2. Assuming all other conditions are met, which of the following must occur for an organization to be subject tomandatory electronic filing requirements for its Form 990?

a. The organization must file a minimum of 100 returns of any type during the tax year.

b. The organization must have total assets of at least $10 million at the end of the tax year.

c. The organization must pass the $5,000 gross receipts tests for the current tax year.

d. The organization must plan to make its Form 990 available for public inspection.

3. The Goodwill Group is a filing organization. The people who control the Goodwill Group also control anothernonprofit organization called Kindness Matters. What relationship do these two organizations have?

a. The Goodwill Group and Kindness Matters are brother/sister organizations.

b. The Goodwill Group is a supporting organization for Kindness Matters.

c. The Goodwill Group is a parent organization, and Kindness Matters is a subsidiary.

d. Kindness Matters is a parent organization, and the Goodwill Group is a subsidiary.


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4. Plentiful Harvest is a nonprofit organization that runs on the calendar year. Barring holidays or weekends,Plentiful Harvest’s Form 990 is due when?

a. January 1.

b. April 15.

c. May 15.

d. June 30.

5. Which of the following special filing considerations applies specifically to a Section 512(b)(13) controllingorganization?

a. It must include combined amounts from both inside and outside the U.S. in U.S. dollars.

b. It is allowed to file Form 990-N, unless it voluntarily decides to file Form 990 or Form 990-EZ.

c. If it has income of more than $100, it is required to file Form 1120-POL as its annual income tax return.

d. If it is required to file an annual information return, it must be a Form 990, not Form 990-EZ.

6. What type of organization is most likely to be statutorily exempt from filing Form 990 or Form 990-EZ?

a. Religious organizations.

b. Governmental organizations.

c. Political organizations.

d. Organizations with high gross receipts.

7. When might a charitable trust be exempt from income taxes?

a. It is operated solely for religious purposes.

b. It provides benefits to private individuals.

c. It devotes ample resources to changing legislation.

d. It performs campaign activities for candidates for public office.

8. The Anti-Hunger Group has been in existence for two years. It filed for tax exemption during its second year,but had not yet received approval by the IRS as of the due date for its Form 990. How should the nonprofitorganization proceed?

a. It should file a Form 1040 for every tax year until its exemption is approved.

b. It should file Form 990 for the first year and the year in which the application is pending.

c. It should file a Form 1040 for the first year and a Form 990 for the second year.

d. It should postpone filing its Form 1040 until its tax-exempt status is approved or denied.


389

9. The IRS can levy a penalty of $20 per day up to $10,000 (adjusted for inflation) or 5%of an organization’s grossreceipts for what reason?

a. Filing an amended return.

b. Requesting an extension of more than six months.

c. Losing tax-exempt status.

d. Filing a return late without reasonable cause.

10. The Anderson Group, a nonprofit organization, files a group return that includes several subsidiaryorganizations. Which of the following should it leave blank in the heading section of Form 990?

a. Information about its accounting period in item A.

b. Its name and address in item C.

c. Its Employer Identification Number (EIN) in item D.

d. Its state of legal domicile in Item M.

11. Which of the following could happen if an organization uses a nonemployee paid preparer to fill out its Form990?

a. The paid preparer will need to find an officer of the organization to sign the return.

b. Thepaidpreparerwill beauthorized to represent theorganization to the IRS for issues related to this return.

c. If the appropriate “yes” box is checked, the IRS will contact the paid preparer about any questions relatedto the return.

d. The paid preparer will need to include his or her social security number on the return.

12. Part III of Form 990 helps the IRS do what?

a. Evaluate whether the organization’s program services support its exempt purpose.

b. Keep the organization’s information private and away from public knowledge.

c. Look over a snapshot of the organization’s mission, governance, and other key information.

d. Determine whether or not the organization’s name has changed in the past year.

13. How many program services should an organization fully describe in Part III of Form 990?

a. All program services provided during the fiscal year.

b. The three largest program services measured by total expenses.

c. The largest program service measured by total expenses.

d. The program services that best reflect the organization’s exempt purpose.


390

14. Legal Access is a public interest law firm that operates as a nonprofit organization. What information must itinclude in its Form 990 that other nonprofit organizations would not need to include?

a. The value of any noncash donations received during the year.

b. The total revenue it earned from any program service activity listed in Part III.

c. A formal mission statement that addresses why the organization exists and who it serves.

d. A list of all the cases currently being litigated or that were litigated over the year.

15. When would an organization fill out Part I of Schedule N?

a. When an organization has ceased its operations and there are no plans to continue.

b. When an organization made a significant disposition of net assets during the year.

c. When an organization has supplemental narrative information to provide.

d. When an organization may be subject to a penalty for failing to provide adequate information.

16. If an organization is unable to meet the 331/3 test, howmuch would it have to receive from a single contributorfor Schedule B to be required?

a. $1,000.

b. $3,000.

c. $5,000.

d. $10,000.

17. Which of the following activities would require an organization to file Schedule D? (List all that apply.)

i. Maintaining works of art. iv. Reporting amounts for buildings, equip-ment, land, or leasehold improvements.

ii. Performing lobbying or politicalactivities.

v. Receiving or holding conservation ease-ments.

iii. Maintaining a donor advised fund. vi. Performing activities outside of the UnitedStates.

a. ii. and v.

b. i., iii., and vi.

c. ii., iv., v., and vi.

d. i., iii., iv., and v.

18. Schedule K is required for which of the following?

a. Tax-exempt bonds.

b. Excess benefit transactions.

c. Grants of $5,000 or more.

d. Noncash contributions.


391

19. Which organization must answer “yes” on line 3a of Part V?

a. The Red Organization has $250 of unrelated business income.

b. The Blue Organization has $500 of unrelated business income.

c. The Yellow Organization has $750 of unrelated business income.

d. The Green Organization has $1,000 of unrelated business income.

20. On June 15, Janice pledges to donate a vehicle worth $5,000 to Neighborhood Rides (NR), a local nonprofitorganization. NR receives the vehicle on July 1 and plans to keep it for use to further its exempt purpose ofproviding free transportation todisabledandelderlymembersof thecommunity.WhenmustNRprovideJanicewith Copy B of Form 1098-C?

a. June 15.

b. July 1.

c. July 30.

d. August 29.

21. Which of the following is most likely to be a Section 501(c)(12) organization?

a. A cooperative telephone company.

b. A for-profit irrigation company.

c. A nonexempt charitable trust.

d. A tanning salon.

22. When stating the number of a governing body’s voting members in line 1a of Part VI, it should be the numberas of what time period?

a. The number at the beginning of the tax year.

b. The number at the end of the tax year.

c. The average number over the course of the tax year.

d. The maximum number at any point during the tax year.

23. If a person in a position of authority at the organization can benefit financially from a decision theymake in thatposition, which of the following exists?

a. Whistleblowing.

b. Division of assets.

c. A significant change.

d. A conflict of interest.


392

24. What might an organization do to safeguard its tax-exempt status from a joint venture?

a. Cede control of the venture to other involved parties.

b. Prioritize the maximization of profits for the other parties.

c. Refrain from activities such as lobbying or political intervention.

d. Enter into contracts that favor either the organization or the other parties.

25. Which of the following would be reported as a fundraising expense in Column (D) of Part IX?

a. Costs associated with securing a grant considered to be program revenue.

b. Unrelated business income (UBI).

c. Expenses for a campaign kick-off event for volunteers.

d. Lobbying expenses when the organization’s exempt purpose is not lobbying.

26. When dealing with grants, domestic refers to which of the following?

a. An individual’s place of birth.

b. An individual’s location when funds are received.

c. An individual’s citizenship status.

d. The location of the entity that provides the funds.

27. What should an organization include in column (d) of Part II of Schedule I of its Form 990?

a. Total cash grants given to each recipient organization during the filer’s tax year.

b. The employer identification number (EIN) of the grant recipient.

c. The legal name and mailing address of each recipient organization.

d. The value of noncash property and the method used to determine that value.

28. Which of the following information is required on Part III of Schedule I?

a. Personal identifying information for grant recipients.

b. Types of assistance provided in broad, general terms.

c. Payments made to a third party that the third party will give to an individual.

d. The aggregate amount of each type of grant (paid by check, wire transfer, etc.).


393

29. What do organizations report on line 10 of Part IX?

a. Federal, state, and local payroll taxes.

b. Health, life, and dental insurance benefits.

c. Qualified pension plan or profit-sharing benefits.

d. Benefits paid to a class of members or their dependents.

30. Which of the following is included in the legal fees reported on line 11b, column (B), of Part IX?

a. Amounts paid to the internal legal department.

b. Penalties or settlements imposed as part of legal proceedings.

c. Legal expenses associated with a program activity.

d. Legal fees charged by outside firms.

31. The occupancy expenses reported on line 16 of Part IX include which of the following?

a. Rental income.

b. Telephone expenses.

c. Utility expenses.

d. Occupancy costs allocated by salary.

32. Insurance expenses (except for those related to property and occupancy, employee benefits, and membersof an organization) are reported where on Part IX?

a. Line 22.

b. Line 23.

c. Line 24.

d. Line 25.

33. Rank Form 990-EZ, Form 990, and Form 990-N in order from the most comprehensive to the least detailed.

a. Form 990; Form 990-EZ; Form 990-N.

b. Form 990; Form 990-N; Form 990-EZ.

c. Form 990-EZ; Form 990; Form 990-N.

d. Form 990-N; Form 990-EZ; Form 990.


394

34. HealingHearts is a Section 501(c)(3) organizationwith gross receipts of $175,000 and total assets of $410,000at the end of the current tax year. What return can this organization file?

a. It is required to file Form 990.

b. It is required to file Form 990-EZ.

c. It can choose to file Form 990-EZ if it does not file Form 990.

d. It can choose to file Form 990-N if it does not file either Form 990 or Form 990-EZ.

35. What information should be included when itemizing grants on Schedule O of Form 990-EZ?

a. Names and addresses of individual grantees.

b. The amount pledged to be given over the next five years.

c. The class of the activity (e.g., fellowships).

d. A statement that there is no relationship between the grantee and the organization.

36. Which of the following must be included with Part II of Form 990-EZ?

a. A substitute balance sheet.

b. Completed Columns (A) and (B).

c. Changes in fund balances.

d. Program service accomplishments.

37. In what order would the following people be listed in column (a) of Part IV of Form 990-EZ?

i. Key employees.

ii. Individual directors or trustees.

iii. Officers.

iv. Institutional trustees.

a. i., iii., iv., and ii.

b. ii., iv., iii., and i.

c. iii., i., ii., and iv.

d. iv., ii., iii., and i.

38. An item of “other compensation” can be excluded from column (e) of Part IV if it is worth less than whatmaximum amount?

a. $1,000.

b. $5,000.

c. $10,000.

d. $15,000.


395

39. Statements about personal benefit contracts are included in what part of Form 990-EZ?

a. Part III.

b. Part IV.

c. Part V.

d. Part VI.

40. If an organization transfers something of value to a related organization, it should answer “Yes” on what lineof Part VI of Form 990-EZ?

a. Line 48.

b. Line 49a.

c. Line 50.

d. Line 51.


396


397

GLOSSARY

Brother/sister organization: An organization controlled by the same person(s) who control the organization thatfiled Form 990.

Call toaction:Related toanorganization’spurpose, thismust satisfy twoconditions: (1) itmust request theaudiencetoact in a specificwayor to influenceothers toact in a specificwayand (2) the requestedactionmusthelp toadvancethe organization’s mission by either benefitting the recipient or benefitting society.

Conflict of interest:Whena person in a position of authority over an organization (e.g., anofficer, director,manager,or key employee) can benefit financially from a decision he or she could make in such capacity, including directbenefits, such as to family members or businesses with which the person is closely associated.

Controllingorganization:Under IRCSec.512(b)(13), this isanexemptorganization that controlsa controlledentity.

Director or trustee: If they have voting rights, they are considered members of an organization’s governing bodyat any time during the year. If they aremembers of an advisory board with no voting authority over an organization’sgovernance, they are not considered directors or trustees for reporting compensation.

Domestic individual: One who lives or resides in the U.S. and is not a foreign individual.

Donor advised fund: A fund or account (1) that is separately identified by reference to contributions of a donor ordonors, (2) that is owned and controlled by a sponsoring organization, and (3) for which the donor or donor advisorhas or reasonably expects to have advisory privileges in the distribution or investment of amounts held in the donoradvised funds or accounts because of the donor’s status as a donor.

Fundraising expenses: Expenditures made by an organization to raise charitable donation revenue.

Governing body: The group of persons authorized under state law to make governance decisions on behalf of anorganization.

Grant: A voluntary payment made without any consideration received in return.

Gross income:With respect toPart V of Form990, thismeansgross receiptswithout reduction for any cost of goodssold.

Gross receipts: The total amounts an organization receives from all sources during its tax year before any costs orexpenses are subtracted.

Indirect expenses: Expenses that cannot be identified specifically with an activity or project (e.g., the salary of anemployee whose work affects several functional categories).

Indoor tanning services: Services that use any electronic product designed to incorporate one or more ultravioletlamps and intended for the irradiation of an individual by ultraviolet radiation, with wavelengths in the air between200 and 400 nanometers, to induce skin tanning.

Joint costs: For Part IX of Form 990, these are costs from a combined educational campaign and fundraisingsolicitation. According toGAAP, these are costs related to joint activities that include fundraising as well as elementsof other program functions.

Key employee:Someonewith responsibilities or powers similar to those of officers, directors, or trustees, includingthe chief management and administrative officials of an organization.

Lobbying activities:Activities intended to influence foreign, national, state, or local legislation, including bothdirectlobbying (attempting to influence legislators) and grassroots lobbying (attempting to influence legislation byinfluencing the general public).


398

Localaffiliateorunit:Anaffiliateorunit that is responsible fora smaller geographical area than the filingorganization(e.g., a regional organization is considered local to a national organization).

Officer:Anelectedor appointedpersonwhomanagesanorganization’sdailyoperationsat any timeduring theyear.

Parent: An organization that controls the organization that filed Form 990.

Personal benefit contract: Generally any life insurance, annuity, or endowment contract that benefits, directly orindirectly, the transferor (or family member), or any other person designated by the transferor [other than anorganization described in IRC Sec. 170(c)].

Political campaign activities: All activities that support or oppose candidates for elective, federal, state, or localpublic office whether or not the candidate is elected.

Political expenditure:Any expenditure intended to influence the selection, nomination, election, or appointment ofanyone to a federal, state, or local public office, or office in a political organization, or the election of presidential orvice-presidential electors.

Political organization: Any party, committee, fund, or similar organization (even a separate bank account) whosepolitical purpose is to accept contributions and/or make expenditures for political campaign activities.

Principal officer: For the purposes of filling out Form 990, this is the person, regardless of title, who has the ultimateresponsibility for implementing the decisions of an organization’s governing body or for overseeing themanagement, administration, and operation of the organization.

Privileged relationshipexception:Abusiness relationshipdoesnot includea relationshipbetween (1)attorneyandclient, (2)medical professional (including psychologist) and patient, or (3) priest/clergy and penitent/communicant.

Prohibited reportable transaction: A confidential transaction within the meaning of Reg. 1.6011-4(b)(3) or atransaction with contractual protection within the meaning of Reg. 1.6011-4(b)(4).

Prohibited taxshelter transaction:Any listed transaction, asdescribed in IRCSec. 6707A(c)(2), andanyprohibitedreportable transaction.

Reasonable effort standard: An organization is not required to exert more than a reasonable effort to obtain thenecessary information to determine the number of independent voting members of its governing body and can relyon information provided by such members.

Related transaction expenses: When filling out Schedule N, these are payments to a professional or other thirdparty for services rendered to assist in the transaction or the winding down of the organization’s activities (e.g.,attorney or accountant).

Section 4947(a)(1) trusts:One that devotes all remaining interest in income and principal to qualified charities andfor which the grantor was allowed a charitable deduction.

Sponsoring organization of a donor advised fund:Any organization that (1) is described in IRCSec. 170(c) [otherthangovernmental units described in IRCSec. 170(c)(1) andwithout regard to IRCSec. 170(c)(2)(A)], is not aprivatefoundation as defined in IRC Sec. 509(a), and (3) maintains one or more donor advised funds.

Subsidiary: An organization that is controlled by the organization that filed Form 990.

Supporting/supported organization: An organization that is, at any time during the tax year, (1) a supportingorganization under IRC Sec. 509(a)(3) or (2) a supported organization, if the organization that filed Form 990 is asupporting organization.

TDOKEs: Trustees, directors, officers, and key employees.

Total assets:Theamount reportedbyanorganizationon its balance sheet asof the tax year endbefore any liabilitiesare subtracted.


399

INDEX

This index is a list of general topics discussed in this course. More specific key word searches can be performedusing the search feature of this PDF.

A

ADMINISTRATIVE EXPENSES¯ Reporting on Form 990, Part IX 339. . . . . . . . . . . . . . . . . . . . . . . . . .

AFFILIATED GROUPS¯ Payments to affiliated organizations 356. . . . . . . . . . . . . . . . . . . . .

ALLOCATIONS¯ Expenses¯¯ Among program activities 295. . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Functional expenses 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ GAAP guidance 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ GAAP guidance, joint costs¯¯ Audience test 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Content test 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Purpose test 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Indirect expenses 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Joint costs 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

AMENDED RETURN¯ Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

AMORTIZATION¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B

BALANCE SHEETS¯ Form 990-EZ 369. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

BUSINESS RELATIONSHIP¯ Definition 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

C

CHARITABLE TRUSTS¯ Federal filing requirements 276. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Filing requirements for Form 990 or 990-EZ 276. . . . . . . . . . . . . . .¯ Supporting organizations 276. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CHARTER SCHOOLS¯ Filing requirements 274. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CHART OF ACCOUNTS¯ Setting up 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COMPENSATION¯ Employees, Form 990-EZ reporting 364, 379. . . . . . . . . . . . . . . . .¯¯ Short year and final returns 374. . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Form 990, Part VI¯¯ Reporting 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Functional expense, reporting 345. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Independent contractors¯¯ Form 990-EZ 364, 379. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Officers, directors, trustees, and key employees¯¯ Form 990-EZ 364, 374, 379. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Rebuttable presumption of reasonableness 320. . . . . . . . . . . . . . .

CONFLICT OF INTEREST¯ Periodic disclosure 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reporting¯¯ Form 990, Part VI 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONTRIBUTIONS RECEIVED¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .¯ Schedule B reporting 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONTROLLED ORGANIZATIONS¯ Control defined 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Relationships 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reporting on¯¯ Form 990-EZ 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

D

DEPLETION¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DEPRECIATION¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DIRECTORS¯ Compensation, reporting¯¯ Form 990-EZ 374, 379. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Governance 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DISCLOSURE RULES¯ Donated facilities, value of 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Public inspection of returns 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DISPOSITION¯ Schedule N reporting 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DISQUALIFIED PERSONS¯ Reporting compensation on Form 990, Part IX 345. . . . . . . . . . . .

DISREGARDED ENTITIES¯ Form 990 or Form 900-EZ 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reporting on¯¯ 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DISSOLUTION¯ Reporting¯¯ Generally 285, 288. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Schedule N 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DOCUMENT RETENTION POLICY¯ Disclosure of, on Form 990, Part VI 320. . . . . . . . . . . . . . . . . . . . . .

DONOR ADVISED FUNDS¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .¯ Maintained by organization, Form 990 filing required 375. . . . . . .¯ Special funding requirements for sponsoringorganizations of 266. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

E

ELECTRONIC FILING¯ Exempted returns 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990-N (e-Postcard) 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990 or Form 900-EZ 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Waiver 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EMPLOYEES¯ Expenses related to 345. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXCESS BENEFIT TRANSACTIONS¯ Form 990-EZ reporting 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXCHANGES¯ Reporting expenses on Form 990, Part IX 339. . . . . . . . . . . . . . . .

EXCISE TAXES¯ Reporting of¯¯ Form 990-EZ 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


400

EXPENSES¯ Program service 295. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Reporting details of¯¯ Form 990-EZ 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

EXTENSION¯ Time to file¯¯ Form 990 279. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

F

FAMILY RELATIONSHIPS¯ Identity of family 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FILING AND REPORTING REQUIREMENTS¯ Final Form 990 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Other federal filing requirements ofexempt organizations 308. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Schedules, various filing requirements 303. . . . . . . . . . . . . . . . . . .

FILING ERRORS¯ Professional fundraising 288. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Year 285. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FIVE HIGHEST PAID¯ Employees, Form 990-EZ 379. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Independent contractors, Form 990-EZ 379. . . . . . . . . . . . . . . . . .

FOREIGN ACTIVITIES¯ Office, reporting on Form 990-EZ 375. . . . . . . . . . . . . . . . . . . . . . . .¯ Reporting on¯¯ Form 990, Part IV, trigger questions 303. . . . . . . . . . . . . . . . . . .

FOREIGN AND U.S. POSSESSION ORGANIZATIONS¯ Special filing requirements 266. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FOREIGN FINANCIAL ACCOUNTS¯ Reporting on¯¯ Form 990-EZ 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . .

FORMS—ATTACHMENTS TO¯ 990 (Return of Organization Exempt from Income Tax)¯¯ Allowed 285. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Article of merger or dissolution 297. . . . . . . . . . . . . . . . . . . . . .

FORMS, COMPLETING¯ 990-EZ (Short Form Return of OrganizationExempt From Income Tax)¯¯ 990-EZ, case study 381. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ 990 (Return of Organization Exempt From Income Tax)¯¯ General information, form heading 285. . . . . . . . . . . . . . . . . . .¯¯ Measuring program service benefits 295. . . . . . . . . . . . . . . . . .¯¯ Part I, Summary Information 288. . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Part II, Signature Block 288. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Part III, Statement of Program ServiceAccomplishments 289. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Part IX, Functional Expenses 333. . . . . . . . . . . . . . . . . . . . . . . .

FORMS, FILING OF¯ FinCEN 114 (formerly Form TD F 90-22.1) 303, 308. . . . . . . . . . .¯ Form 8940 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990¯¯ Group return 277. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Part IV, Checklist of Required Schedules 303. . . . . . . . . . . . . .¯¯ Part V, Statements Regarding Other IRS Filingsand Tax Compliance 308. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯¯ Part VI, Governance, Management, andDisclosure 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990-N (e-Postcard) 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Change in tax year 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Common compliance error 261. . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ EIN used by another organization 261. . . . . . . . . . . . . . . . . . . .

¯¯ Late filing 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Not allowed 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Pending approval of exempt status 261. . . . . . . . . . . . . . . . . . .

¯ Form 990 or 990-EZ¯¯ Amended return 281. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Application exemption is denied 278. . . . . . . . . . . . . . . . . . . . .¯¯ Application exemption is pending 278. . . . . . . . . . . . . . . . . . . .¯¯ Certain trusts 276. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Electronic filing 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Exceptions to the filing requirements 274. . . . . . . . . . . . . . . . .¯¯ Extension of time to file 279. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Failure to file penalty 280. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Final year of existence 278. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Gross receipts exception 261. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Organizations with special filing requirements 266. . . . . . . . .¯¯ Permitted attachments 280. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Public inspections 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Where and when to file 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Who must file 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Who to include in return 261. . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Schedule A (Form 990 or 990-EZ) 303. . . . . . . . . . . . . . . . . . . . . . .¯ Schedule B (Form 990, 990-EZ, or 990-PF) 303. . . . . . . . . . . . . . .¯ Schedule C (Form 990 or 990-EZ) 303. . . . . . . . . . . . . . . . . . . . . . .¯ Schedule D (Form 990) 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule E (Form 990 or 990-EZ) 303. . . . . . . . . . . . . . . . . . . . . . .¯ Schedule F (Form 990) 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule G (Form 990 or 990-EZ) 303. . . . . . . . . . . . . . . . . . . . . . .¯ Schedule H (Form 990) 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule I (Form 990) 303, 341. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule J (Form 990) 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule K (Form 990) 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule L (Form 990 or 990-EZ) 303. . . . . . . . . . . . . . . . . . . . . . .¯ Schedule M (Form 990) 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule N (Form 990 or 990-EZ) 303. . . . . . . . . . . . . . . . . . . . . . .¯ Schedule O (Form 990 or 990-EZ) 303. . . . . . . . . . . . . . . . . . . . . . .¯ Schedule R (Form 990) 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FUNCTIONAL EXPENSES, STATEMENT OF(FORM 990)

¯ Accounting fees 352. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Accounting system and chart of accounts forexpense allocation 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Advertising 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Affiliates, payments to 356. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Allocating indirect expenses 336. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Allocating joint expenses¯¯ GAAP guidance 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Benefits paid to or for members 345. . . . . . . . . . . . . . . . . . . . . . . . .¯ Compensation and benefits reporting on Form 990 345. . . . . . . .¯ Conferences and meetings 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Depreciation 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Employee benefits 345. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Generally 333. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Grants and other assistance 339. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Independent contractors, fees paid to 352. . . . . . . . . . . . . . . . . . . .¯ Information technology 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Interest 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Investment management 352. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Legal fees 352. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Lobbying 352. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Occupancy 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Office expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Other expenses 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Pension plan contributions 345. . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Professional fundraising 352. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Program service expenses, distinguished fromother expenses 333. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Reporting payments to individuals, governments,or other organizations 333. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Travel 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FUND BALANCES, REPORTING OF¯ Form 990-EZ 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


401

FUNDRAISING¯ Allocating expenses of fundraising appeal 336. . . . . . . . . . . . . . . .¯ Expenses of, reporting on Form 990 333. . . . . . . . . . . . . . . . . . . . .¯ Form 990-EZ reporting 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

G

GAMING ACTIVITIES¯ Reporting¯¯ Form 990-EZ 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GOVERNANCE¯ Policies¯¯ Disclosure on Form 990 320. . . . . . . . . . . . . . . . . . . . . . . . . . . .

GOVERNMENT ORGANIZATIONS¯ Exceptions to filing for certain organizations 274. . . . . . . . . . . . . .

GRANTS¯ Reporting 295. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 990-EZ 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GRANTS AND OTHER ASSISTANCE¯ Reporting¯¯ Form 990, Schedule I 341. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Reporting in Part IX, Form 990 339. . . . . . . . . . . . . . . . . . . . . . .

GROSS RECEIPTS TEST¯ $5,000 test 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ $50,000 test 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Exceptions to filing for certain organizationswith limited gross receipts 274. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GROUP RETURN¯ Extension of filing time 279. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990, filing of 279. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Generally 285. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Impact on filing of when parent losestax-exempt status 277. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

H

HEADING¯ Completing on Form 990 285. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

HEALTH INSURANCE INSURERS¯ Disclosure on Form 990 308. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

HOSPITALS¯ Schedule H (Form 990) reporting 303. . . . . . . . . . . . . . . . . . . . . . . .

I

INDEPENDENT CONTRACTORS¯ Form 990-EZ reporting, five highest paid 379. . . . . . . . . . . . . . . . .¯ Functional expense 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Functional expense, reporting on Form 990 352. . . . . . . . . . . . . . .

INDOOR TANNING SERVICES¯ Disclosure on Form 990 308. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INFORMATION TECHNOLOGY¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INSPECTION, PUBLIC¯ Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INSURANCE¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INTEREST¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INTERESTED PERSONS¯ Schedule L (Form 990), reporting transactions with 303. . . . . . . .

INTERNET WEBSITES¯ Used for fundraising 308. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Used for public disclosure 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INVENTORY¯ Sale of, accounting for¯¯ Form 990-EZ 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

J

JOINT COSTS¯ Allocating in Form 990 336. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Allocating on Form 990 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

JOINT VENTURE ARRANGEMENTS¯ Participation in, reporting¯¯ Form 990, Part VI 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

K

KEY EMPLOYEES¯ Form 990-EZ 374. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

L

LAND, BUILDINGS, AND EQUIPMENT¯ Report¯¯ Form 990 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LAW FIRMS, PUBLIC INTEREST¯ Generally 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LIQUIDATION¯ Form 990-EZ reporting 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule N reporting 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Section 501(c)(3) organization 297. . . . . . . . . . . . . . . . . . . . . . . . . .

LOANS¯ To/from officers, directors, trustees, key employees¯¯ Form 990-EZ reporting 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LOBBYING¯ Allocating functional expenses on Form 990 352. . . . . . . . . . . . . .¯ Form 990-EZ disclosure 375, 379. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule C reporting 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

M

MANAGEMENT AND GENERAL EXPENSES¯ Allocating on Form 990 333. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990 reporting 333. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Management fees paid to an independent contractor 352. . . . . .

MARKETING¯ Reporting program services 289. . . . . . . . . . . . . . . . . . . . . . . . . . . .

MEMBER BENEFITS¯ Functional expense, reporting on Form 990 345. . . . . . . . . . . . . . .

MEMBERSHIP DUES¯ Form 990-EZ reporting 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

MERGER¯ Form 990 reporting 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

MISSION¯ Highlighting 288. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

O

OCCUPANCY EXPENSE¯ Form 990-EZ reporting 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

OFFICERS¯ Compensation reporting¯¯ Form 990-EZ 374. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


402

ORGANIZATIONAL DOCUMENTS¯ Changes in, reporting on Form 990 320. . . . . . . . . . . . . . . . . . . . . .

ORGANIZATION CHANGES¯ Form 990-EZ reporting 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990 reporting 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

P

PAID PREPARER¯ Preclusions to signing a return 288. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Treasury Circular 230 288. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PAYROLL INFORMATION¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .

PLEDGES¯ Reporting as expense when made 339. . . . . . . . . . . . . . . . . . . . . . .

POLITICAL ACTIVITIES¯ Schedule C (Form 990 or 990-EZ) reporting 303. . . . . . . . . . . . . .

POLITICAL CAMPAIGNS¯ Form 990-EZ disclosure 379. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

POLITICAL EXPENDITURES¯ Form 990-EZ reporting 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

POLITICAL ORGANIZATIONS¯ Exemption from filing for certain organizations 274. . . . . . . . . . . .¯ Special filing requirements 266. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PRINTING AND PUBLICATIONS¯ Form 990-EZ reporting 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PROFESSIONAL FEES¯ Functional expense allocation 345. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Investment management fees 352. . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Professional fundraising 352. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PROGRAM SERVICES¯ Discontinued program service 289. . . . . . . . . . . . . . . . . . . . . . . . . .¯ Expenses from, distinguishing from other expenses 333. . . . . . .¯ Expenses, reporting 295. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Multiple, reporting 295. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ New significant program service 289. . . . . . . . . . . . . . . . . . . . . . . .¯ Statement of Program Service Accomplishments¯¯ Form 990 289. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Form 990-EZ 369. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Value of donated services and facilities 297. . . . . . . . . . . . . . . . . .

PROHIBITED TAX SHELTER TRANSACTIONS¯ Form 990, trigger questions 308. . . . . . . . . . . . . . . . . . . . . . . . . . . .

PUBLIC CHARITY¯ Qualifying as¯¯ Schedule A 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PUBLIC INSPECTION¯ Form 990, Part VI, Section C 320. . . . . . . . . . . . . . . . . . . . . . . . . . . .

PUBLIC SUPPORT¯ Schedule A 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

R

RELATED ENTITIES¯ Exempt noncharitable organization, transactions to¯¯ Form 990-EZ disclosure 379. . . . . . . . . . . . . . . . . . . . . . . . . . . .

RELIGIOUS ORGANIZATIONS¯ Exception to Form 990 or Form 990-EZ filingrequirement 261. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

REVENUE, REPORTING OF¯ Form 990-EZ 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Program services, reporting 295. . . . . . . . . . . . . . . . . . . . . . . . . . . .

ROYALTIES¯ Functional expense 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

S

SALES¯ Noninventory¯¯ Form 990-EZ reporting 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SCHOOLS¯ Form 990-EZ disclosure 379. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Schedule E reporting 303. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 501(c)(7) ORGANIZATIONS¯ Reporting initiation fees, capital contributions,and unusual amounts of income¯¯ Form 990-EZ reporting 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 501(c)(12) ORGANIZATIONS¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .

SECTION 501(c)(29) ORGANIZATIONS¯ Filing requirements 278. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .¯ Ineligibility to file Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . .

SECTION 4947(a)(1) TRUSTS¯ Defined 276. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Filing requirements if not treated as aprivate foundation 276. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Form 990-EZ reporting 375, 379. . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .

SECURITIES¯ Sales of¯¯ Form 990-EZ reporting 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SERVICES¯ Donated, reporting 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Volunteer hours 288. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SIGNATURE BLOCK¯ Completing on Form 990 288. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Form 990-EZ 361. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SIGNIFICANT DISPOSITION OF ASSETS¯ Form 990 reporting 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SOCIAL AND RECREATION CLUBS¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .¯ Loss of exempt status 308. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Special filing requirements 266. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SPECIAL EVENTS¯ Form 990-EZ reporting 364. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SUBSTANTIAL CONTRACTION¯ Reporting¯¯ Completing Schedule N 297. . . . . . . . . . . . . . . . . . . . . . . . . . . .

SUPPORTING ORGANIZATIONS¯ Special filing requirements 266. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

T

TANNING INCOME¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .¯ Rules governing 308. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

TAX SHELTER¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .


403

TERMINATION¯ Reporting¯¯ Completing Schedule N 297. . . . . . . . . . . . . . . . . . . . . . . . . . . .

TRAVEL¯ Functional expense, reporting 353. . . . . . . . . . . . . . . . . . . . . . . . . .

TRUSTEES¯ Compensation, reporting¯¯ Form 990-EZ 374. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

¯ Governance 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

U

UNRELATED BUSINESS TAXABLE INCOME (UBTI)¯ Form 990, Part V, trigger questions 308. . . . . . . . . . . . . . . . . . . . . .¯ Form 990-EZ reporting 375. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

V

VALUATION¯ Donated¯¯ Facilities 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯¯ Services 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

VOLUNTEERS¯ Reporting services donated by 288, 297. . . . . . . . . . . . . . . . . . . . .

W

WEBSITES¯ Generally 285. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .¯ Used for public disclosure 320. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

WHISTLEBLOWER POLICY¯ Disclosure of on Form 990, Part VI 320. . . . . . . . . . . . . . . . . . . . . . .


404

Companion to PPC’s 990 Deskbook990T18

405

EXAMINATION FOR CPE CREDIT ANSWER SHEET


CTEC Course No. 3039-CE-2163

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ANSWERS:

This answer sheet and the following evaluation can be printed. If filling out a printed version, please indicate your answer for eachquestion by filling in the appropriate circle as shown: Fill in like this not like this .

You must complete the entire course to be eligible for credit.

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You may complete the exam online for $95 by logging onto our Online Grading Center at cl.tr.com/ogs. Alternatively, you may fax thecompleted Examination for CPE Credit Answer Sheet and Self-study Course Evaluation to Thomson Reuters (Tax & Accounting) Inc. at(888) 286-9070 or email it to [email protected]. Mailing instructions are included in the Exam Instructions. Paymentinformation must be included for all print grading. The price for emailed or faxed answer sheets is $95; the price for answer sheets sentby regular mail is $105.

Expiration Date: February 28, 2019

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Companion to PPC’s 990 Deskbook 990T18

406

Self-study Course Evaluation

Course Title: Companion to PPC’s 990 Deskbook—Course 1—Form 990-T Course Acronym: 990TG181

Your Name (optional): Date:

CTEC Number: 3039-CE-2163 Email:

IRS Program Number(s): 0YC0C-T-01126-18-S CE Provider: Checkpoint Learning

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Name:

Firm Name:

Firm Address:

City: State /ZIP:


Firm Email:

CTEC No.: PTIN:

Signature:



ANSWERS:




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Course Title: Companion to PPC’s 990 Deskbook—Course 2—Form 1023 Course Acronym: 990TG182





Satisfaction Level:

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409


Companion to PPC’s 990 Deskbook—Course 3—Selected Topics Related to Form 990 (990TG183)


Name:

Firm Name:

Firm Address:

City: State /ZIP:


Firm Email:

CTEC No.: PTIN:

Signature:



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410


Course Title: Companion to PPC’s 990 Deskbook—Course 3—SelectedTopics Related to Form 990

Course Acronym: 990TG183





Satisfaction Level:

Low (1) . . . to . . . High (10)

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