Tax Exempt Organizations Outline

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                          TAX EXEMPT ORGANIZATIONS

I. Calculating the Charitable Deduction
      a. Tax exempt charity – Possible charitable deduction; Other exempt organization –
          No charitable deduction
      b. 50%/30% Calculation
      c. C corp deduction (not S corp)
      d. Process – 11 steps
                i. Treas. Reg. § 1.170A-1(c)
                       1. Start with the FMV of the property donated.
               ii. § 170(e)(1)(A)
                       1. Subtract any potential non-long-term capital gain
             iii. § 170(e)(1)(B)(i)(I)
                       1. Subtract 100% of any potential long-term capital gain if the
                          transfer is a gift of unrelated tangible personal property given to a
                          public charity or to a § 170(b)(1)(F) private foundation
              iv. § 170(e)(1)(B)(i)(II)
                       1. Subtract 100% of any potential long-term capital gain if the
                          transfer is a gift of tangible personal property but (1) is sold,
                          exchanged, or disposed of by the done before the last day of the
                          taxable year and (2) the done has not made a 170(e)(7)(D)
                          certification with respect to the property.
               v. § 170(e)(1)(B)(ii)
                       1. Subtract 100% of any potential long-term capital gain if the
                          transfer is a gift to a private foundation other than one described in
                          § 170(b)(1)(F)
              vi. § 170(e)(1)(B)(iii)
                       1. Subtract 100% of any potential long-term capital gain if the
                          transfer is a gift of a patent, copyright, trademark, trade name,
                          trade secret, know-how, software, or similar property, or
                          applications or registrations of such property
             vii. § 170(e)(1)(B)(iv)
                       1. Subtract 100% of any potential long-term capital gain if the
                          transfer is a gift off taxidermy property by the person who
                          prepared, stuffed, or mounted the property or by a person who paid
                          for preparation, stuffing, or mounting
            viii. § 170(b)(1)(A)
                       1. Limit the amount of contributions to 50% of the taxpayer’s
                          contribution base if they are either to a public charity or to a §
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                          170(b)(1)(F) private foundation. Carryover the remainder of such
                          contributions for five years per §170(d)
              ix. §170(b)(1)(B)
                      1. Limit any contributions to private foundations other than those
                          described in §170(b)(1)(F) to the lesser of:
                               a. 30% of the contribution base
                               b. 50% of the contribution base minus the amount from step 8
                      2. Carry over remainder for five years
               x. §170(b)(1)(C)
                      1. Limit the contributions from step 8 to 30% of the contribution base
                          if they involve capital gain property and Steps 3 through 7 did not
                          cause a reduction. Carry over the remainder for five years. Do not
                          change Step 9, or
                      2. Elect §170(b)(1)(C)(iii) to apply all capital gain property. If you
                          elect, do not apply the 30% limitation in this Step 10, but go back
                          to steps 4 through 7.
              xi. §170(b)(1)(D)
                      1. Limit the contributions from Step 9 to the lesser of:
                               a. 20% of the contribution base, or
                               b. 30% of the contribution base minus the Step 10 amount (if
                                   no § 170(b)(1)(C)(iii) election was made).
             xii. Carry over the remainder for 5 years
       e. Reduction versus limitation
II. Qualifying as a Public Charity
       a. Four methods
                i. Public safety
               ii. One third public support
                      1. Listed
                      2. One third public support
                      3. Ten percent plus facts and circumstances
                               a. Continuous and bona fide government or public fundraising
                                   program
                               b. How much over ten percent?
                               c. Diverse sources of support
                               d. Representative governing body
                               e. Services continuously available to general public
              iii. Section 509 one third public support
                      1. More than one third may NOT come from:
                               a. Passive investment income
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                      b. After tax unrelated business taxable income
     iv. Supporting organization
              1. Organized and operated exclusively for the benefit of, or to
                  perform the functions, or to carry out the purposes of one or more
                  publicly supported organization, §509(a)(3)(A)
              2. And is either
                      a. Operated, supervised or controlled in connection with one
                          or more publicly supported organizations §509(a)(3)(B)(I),
                          or
                      b. Supervised or controlled in connection with one or more
                          publicly supported organization §509(a)(3)(B)(II), or
                      c. Is controlled in connection with one or more publicly
                          supported organization §509(a)(3)(B)(III),
              3. And not directly or indirectly controlled by a disqualified person,
                  other than a foundation manager or a publically supported
                  organization
              4. The organization documents must state that the entity’s purpose is
                  to support one or more specifically identified publically supported
                  organizations. Treas. Regs. § 1.509(a)-4(h)(1)(i)
b. Test
        i. Public support/All support
      ii. 4-year look-back; status is for current and following years
     iii. Public support
              1. Total support – Gifts, grants, membership fees, net income from
                  unrelated business even if the business is not regularly carried on,
                  Taxes collected for the benefit of the organization, Free
                  government services provided to organization (but not fees for
                  performing exempt purpose)
              2. 2% Rule
              3. Unusual gift rule – Rev. Proc. 81-7
                      a. Not from related person
                      b. Cash, marketable stock, or related to exempt purpose
                      c. Unrestricted
              4. Governmental contract rules
                      a. No more than $5,000/1% (see below)
     iv. Permitted persons
              1. Not disqualified person (§4946)
              2. Government unites described in §170(c)(1)
              3. Listed organizations
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                       4. Donation is not included in public support to the extent that it
                          exceeds 1% of total support
III. Excise Taxes
        a. Private charity – Good public policy/Potential evasion conduit
                i. 2 types of exempt organizations
                       1. Tax-exempt charities – 2 types (difference is oversight)
                               a. Private foundations
                               b. Public charities
                       2. Other exempt organizations
        b. Disqualified persons – Relationships, Draw a chart
        c. Private operating foundation
                i. Status
                       1. Spend directly for its exempt purpose substantially all of the lesser
                           of:
                               a. Its adjusted net income, or
                               b. Its minimum investment return
                       2. And must fit into one of the following categories:
                               a. devote substantially more than half of its assets to its
                                  charitable activities or to a functionally related business; or
                               b. derives substantially all of its support (other than gross
                                  investment income) from at least five independent exempt
                                  organizations or from the general public, with not more
                                  than 25 percent of its support being received from any one
                                  such exempt organization and not more than half of its
                                  support from gross investment income; or
                               c. make qualifying distributions directly, for the active
                                  conduct of its exempt activities, of at least two-thirds of its
                                  minimum investment return (5% of FMV of noncharitable
                                  assets, less acquisition indebtedness)
                       3. Note: Substantially more than half is defined as at least 65
                           percent, under Reg. §53.4942(b)-2(a)
                       4. Note: “Substantially all” is defined as at least 85 percent, Treas.
                           Reg. §53.4942(b)-1
               ii. Exempt operating foundation status
                       1. Operating foundation status
                       2. Ten years of meeting either:
                               a. the §170 public support test (one third)
                               b. the §509 public support test (more than one third, less than
                                  one third)
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              3. A representative governing board
                       a. With no more than 25% disqualified persons (§4940(d)(2))
              4. No disqualified people as officers of the private foundation
d. Excise taxes – If a private foundations runs afoul of the qualifications
       i. Audit fee tax – §4940 (2% of the private foundation’s “net investment
          income”)
              1. Gross investment income, plus
                       a. Interest, dividends, rents, royalties
              2. Capital gain net income,
                       a. Gains from sale of property used for the production of
                           unrelated income and interest, dividends, rents, royalties
                       b. Objective/Subjective standard for determining capital gain
                           (class of property/this specific property)
                                i. Case law
              3. Less ordinary and necessary expenses related to gross investment
                  income and property held for production of income
              4. Increase in net investment income  Increase in audit tax
              5. Net investment income = Gross investment income + Capital gain
                  net income – Related expenses
              6. Unrelated business income is not investment income
              7. Proceeds from the sale of an asset that is utilized exclusively in the
                  furtherance of the purposes of the organization are not included in
                  income
      ii. Self-dealing excise tax – §4941 (sale, exchange, or leasing of property
          between a private foundation and a disqualified person)
              1. Disqualified persons (watch out for attributions)
                       a. Substantial contributor
                       b. Member/Owner of substantial contributor
                       c. Partner of member/owner/substantial contributor
                       d. First degree of consanguinity of member/owner/substantial
                           contributor
                       e. First degree of consanguinity of partner of
                           member/owner/substantial contributor
              2. Indirect disqualification
                       a. A transaction between a disqualified person and an
                           organization “controlled” by a private foundation
                                i. A private foundation controls an organization when
                                   a disqualified person and other individuals who are

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                           also disqualified persons by reason of their
                           relationship to the first disqualified person
                       ii. Can only by joining their voting power with that of
                           the foundation,
                      iii. Cause the organization to engage in a self-dealing
                           transaction with a disqualified person
iii. Mandatory distributions – §4942
       1. Tax is 30% on undistributed income
              a. Undistributed income = Distributable amount – Qualifying
                   distribution
                        i. Distributable amount = Minimum investment return
                           (i.e. 5% of the value of noncharitable assets less
                           acquisition indebtedness) + any repayments of
                           previous qualifying distributions + amounts
                           received from the sale or disposition of charitable
                           assets + set aside any amounts that are no longer
                           necessary to achieve the purpose for which the
                           amount was set aside – any taxes imposed
                       ii. Non-charitable asset = Not directly used or held for
                           the use of the exempt purpose
                                1. Do not include:
                                        a. Investments that help the charity
                                            achieve its exempt purpose
                                            (program-related investments)
                                        b. Investments in functionally-related
                                            businesses
                      iii. Qualifying distribution = Amounts paid for
                           charitable purposes
                      iv. Suitability test (Rev. Rul. 74-450) = Set aside
                           involving relatively long term grants or
                           expenditures that must be make in order to assure
                           the continuity of particular charitable projects (e.g.
                           a plan to erect a building)
                       v. Cash distribution test
                                1. Foundation must have made: Aggregate
                                   cash or “equivalent” distributions in
                                   amounts equal to the sum of 20% of its
                                   distributable amount for the first taxable of
                                   its “start up” period + Successive annual
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                                   distributions increasing by 20% per year
                                   until the fourth year of its start up period of
                                   53.4942(a)-3(b)(3)
                      vi. Foundation would have to establish to the
                           satisfaction of the Commissioner that:
                               1. Its immediate use of the funds for the
                                   exempt purpose of building its new
                                   headquarters is not practical (based on the
                                   facts and circumstances of the particular
                                   case), and
                               2. That definite plans exist to commence such
                                   use within a reasonable time. Treas. Reg.
                                   §53.492(a)-2(c)(3)(i)
                                       a. Property “to be used” for an exempt
                                           purpose will be deemed “used” for
                                           an exempt purpose even though it is
                                           being leased for a reasonable period
                                           of time pending its actual conversion
                                           to exempt uses.
                                       b. 1 year is acceptable; more than that
                                           requires proof
iv. Excess business holdings – §4943
       1. Two-tier tax – Imposed if the foundation does not divest itself of
           the excess business holdings by the end of the taxable period
       2. §4942(c)(1) excess business holdings = Percentage of a “business
           enterprise” owned by a private foundation and its disqualified
           persons
       3. Dependent on type of business enterprise
               a. Corporation = 20% of voting stock (combined ownership)
               b. If the corporation is controlled by a person who is NOT a
                   disqualified person, then the limit for how much
                   disqualified persons plus the foundation can own is raised
                   to 35% of the voting stock
       4. Grace periods
               a. When the private foundation does not know of the conflict
                   before purchasing shares
                        i. Within 90 days of the knowledge
                       ii. One way to obtain knowledge is through an annual
                           survey of the disqualified person’s holdings
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               b. When a foundation receives business holdings other than
                   by purchase by the foundation or its disqualified persons
                        i. 5-year grace period with possible extension
                       ii. Extension is based on constraints of the market
               c. In any case in which all disqualified persons together do
                   not own more than 20 percent of the voting stock of an
                   incorporated business enterprise, nonvoting stock held by
                   the private foundation shall also be treated as permitted
                   holdings. IRC § 4943(c)(2)(A) [flush language]
               d. Had the foundation's holdings exceeded its permitted
                   holdings, it would have to sell the stock to a person who
                   was not a disqualified person. IRC § 4943(c)(1); Treas.
                   Reg. § 53.4943-2(a)(1)(ii).
 v. Jeopardizing investments – §4944
       1. Standard: Foundations and their managers must exercise ordinary
           business prudence under the facts and circumstances prevailing at
           the time of making the investment, in providing for the long and
           short term financial needs of the foundation to carry out its exempt
           purposes
       2. Examples of investments that do not meet this standard of
           ordinary business prudence: Treas. Reg. §53.4944-1(b)(2)(i)
               a. Exception: Program related investments are never
                   jeopardizing investments no matter how risky §4944(c)
       3. Two tier tax
               a. 1st tier on the foundation = 10% of Jeopardizing
                   investment
                        i. Foundation manager is also subject to 10% tax
                               1. With a maximum of $10,000 per investment
                                  §4944(a)(2)
                       ii. But only for knowing and willful actions
                               1. Knowing = actual knowledge of facts that
                                  would make the investment a jeopardizing
                                  investment and is aware that the investment
                                  might violate §4944. Treas. Regs. §
                                  53.4944-1(b)(2)(i)
                               2. Willful = voluntary, conscious, or
                                  intentional
               b. 2nd tier tax = 25% of jeopardizing investment
vi. Taxable expenditures – §4945
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                     1. Harm to be avoided = Political and legislative activities
                     2. 2-tier tax system
                     3. Taxable expenditure =
                             a. Amounts spent for lobbying and political campaign
                                 activities
                             b. Grants to individuals for travel and study (some exceptions)
                             c. Grants to non-public charities
                             d. Grants for non-charitable purposes
             vii. Termination tax – §507
                     1. Private foundations are terminated for:
                             a. A single flagrant violation leading to an excise tax
                             b. Two or more willful violations leading to an excise tax
                     2. Ways to avoid termination tax
                             a. Service may abate the termination tax if, after assessment,
                                 the foundation’s net assets are distributed to one or more
                                 charities, each of which has been in existence for at least 60
                                 months
IV. Unrelated Business Income Tax (UBIT) – UBIT is a tax on a trade or business
       regularly carried on by an exempt organization that is not substantially related
       to the organization’s exempt purpose.
               i. “Substantially”
                     1. Test is whether the business is substantially related to the
                         exempt purpose of the organization, aside from the need for
                         funds.
                             a. The activity which generates income must "contribute
                                 importantly" to the accomplishment of the exempt purposes
                                 for which the organization was formed,
                             b. Sale of products resulting from the performance of exempt
                                 functions is not an unrelated trade or business if:
                                      i. The product is sold in substantially the same state as
                                          on completion of the exempt function.
                             c. Thus, the sale of milk by a scientific organization that
                                 maintains an experimental dairy herd would not constitute
                                 an unrelated trade or business,
                                      i. but the sale of ice cream would constitute an
                                          unrelated trade or business
                     2. “Fragmentation rule” - §513(c)(unrelated income embedded in
                         activity)

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      a. For purposes of this section, the term "trade or business"
         includes any activity which is carried on for the production
         of income from the sale of goods or the performance of
         services. For purposes of the preceding sentence, an
         activity does not lose identity as a trade or business merely
         because it is carried on within a larger aggregate of similar
         activities or within a larger complex of other endeavors
         which may, or may not, be related to the exempt purposes
         of the organization. Where an activity carried on for profit
         constitutes an unrelated trade or business, no part of such
         trade or business shall be excluded from such classification
         merely because it does not result in profit.
      b. Does not includes those sales carried on primarily for the
         convenience of its members
3. Corporate sponsorship exception (“Qualified sponsorship
   payments”)
      a. any payment made by any person engaged in a trade or
         business with respect to which there is no arrangement or
         expectation that such person will receive any substantial
         return benefit other than the use or acknowledgement of the
         name or logo (or product lines) of such person's trade or
         business in connection with the activities of the
         organization that receives such payment.
      b. There is no substantial return benefit (and so no unrelated
         business taxable income from among other things):
               i. Exclusive sponsorship arrangements
              ii. The use of the sponsor's logo or slogans if they do
                  not contain qualitative or comparative descriptions,
             iii. Value neutral descriptions, displays or visual
                  depictions of the sponsor's products or services.
      c. A sponsor does receive substantial return benefits from:
               i. Advertising
              ii. Exclusive provider arrangements
             iii. The use of the exempt organization's goods,
                  facilities, services or other privileges, or
             iv. The exclusive or nonexclusive right to use the
                  exempt organization's trademark, patent, logo or
                  designation.

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               4. Treas. Regs. §1. 513-1(b) any activity that is carried on for the
                  production of income and otherwise possesses the characteristics
                  required to constitute a trade or business under IRC § 162 is a trade
                  or business for purposes of IRC § 511 and so is also potentially an
                  unrelated trade or business.
               5. 3 requirements
                      a. The exempt organization derives income from a trade or
                          business, and
                      b. That trade or business is regularly carried on by the exempt
                          organization, and
                      c. The exempt organization's conduct of its trade or business
                          is not substantially related to the organization's exempt
                          function
b. §501(c)(3)
       i. Tax-exempt charity is organized exclusively for:
               1. religious,
               2. charitable,
               3. scientific,
               4. testing for public safety,
               5. literary, or educational purposes,
               6. foster national or international amateur sports competition (but
                   only if no part of its activities involve the provision of athletic
                   facilities or equipment),
               7. for the prevention of cruelty to children or animals
      ii. no part of the net earnings of which inures to the benefit of any private
           shareholder or individual,
     iii. no substantial part of the activities of which is carrying on propaganda, or
           otherwise attempting, to influence legislation (except as otherwise
           provided in subsection (h)), and
     iv. which does not participate in, or intervene in (including the publishing or
           distributing of statements), any political campaign on behalf of (or in
           opposition to) any candidate for public office.
c. Definition:
       i. the gross income derived from any unrelated trade or business less
           deductions directly connected with the carrying on of such trade or
           business,
      ii. subject to certain modifications the gross receipts from an unrelated trade
           or business less the associated costs
d. UBIT is imposed on:
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               i. the unrelated business taxable income ("UBTI") of otherwise exempt
                   organizations
              ii. Rate is the corporate tax rate (except for trusts)
V. Unrelated Business Income Tax Modifications
      a. All dividends, interest, payments with respect to loans of securities, and annuities
          are excluded.
      b. Royalties (including overriding royalties), whether measured by production or by
          gross or taxable income, are excluded.
               i. Sierra Club standard
                        1. royalties are "payments received for the right to use intangible
                           property rights and that such definition does not include payments
                           for services.".
              ii. Arkansas State Police Ass’n standard
                        1. A royalty exists when A uses B's name to promote A's products.
                        2. The affinity credit card cases involved royalties because the credit
                           card company used the tax-exempt organization's name to promote
                           the credit card company's product.
                        3. But the magazine publisher used the exempt organization's name
                           to promote the exempt organization not the magazine publisher
                        4. The fact that the parties labeled their agreement a "Royalties and
                           Licensing Agreement" is of no consequence because the agreement
                           was really an agency relationship.
      c. Rent from real property, and rents from personal property leased with real
          property if the rents attributable to the personal property are only an incidental
          amount of the total rents received or accrued under the lease,
               i. EXCEPTION If more than 50 percent of the rent under a lease is
                   attributable to personal property, then none of the rent, whether
                   attributable to the real property or the personal property, qualifies for the
                   modification exclusion. . . .
      d. All gains or losses from the sale, exchange or other disposition of property other
          than the sale of property of a kind properly includable in inventory and property
          held primarily for sale to customers in the ordinary course of a trade or business
          are excluded
      e. Also excluded are all gains on the lapse or termination of options to buy or sell
          securities written by the organization in connection with its investments
          activities.
      f. Income from various research activities.
               i. All income from research performed for the United States, a State, or a
                   political subdivision of a State is excluded.
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               ii. In the case of a college, university, or hospital and in the case of an
                   organization operating primarily for the purpose of carrying on
                   fundamental research that makes the results of its research freely available
                   to the public, all income derived from research is excluded, regardless of
                   for whom performed.
       g. Expenses directly connected to the conduct of unrelated business are fungible and
           may be deducted against any other unrelated activity. Treas. Reg. 1.512(a)–
           1(f)(2)(i).
                i. However, if the unrelated activity produces a net gain, and the exploited
                   exempt activity produces a net loss, then the loss is deductible against any
                   net gain from that specific unrelated business
               ii. Any loss in excess of the net gain is not fungible and may not be deducted
                   against any unrelated activity that does not exploit the exempt activity.
                   Treas. Reg. 1.512(a)–1(f)(2)(ii).
VI. Controlled Entities
       a. Potential income paid as tax-free rent results in wiping out all taxable income to
           company and no income for the tax exempt
       b. §512(b)(13)
                i. Include in unrelated trade or business income
                       1. any interest, annuity, royalty, or rent
                       2. that is paid by a controlled organization,
                       3. to the extent that payment of such income to the charitable
                           organization
                       4. Reduces the controlled organization's income otherwise subject to
                           tax.
               ii. A charity controls the subsidiary if:
                       1. It owns more than 50% of the sub's voting stock, or
                       2. If the controlled organization is a corporations
                                a. More than 50% of the total value of the sub's stock.
                       3. If the controlled organization is a partnership, control means:
                                a. Ownership of more than 50% profit or capital interest
              iii. To determine which specified payments reduce the controlled entity’s
                   taxable income:
                       1. The portion of any specified payment that reduces the payor's
                           taxable income (and therefore must be included in the payee's
                           taxable income) is derived by:
                                a. Multiplying the amount of the specified payment by an
                                   inclusion ratio.

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                              i. When the controlled organization is another charity,
                                 the ratio is the controlled organization's unrelated
                                 income divided by the controlled organization's
                                 taxable income or unrelated income (whichever
                                 amount is greater).
                             ii. When the controlled organization is a taxable entity,
                                 the ratio is the amount of the controlled
                                 organization's income that would be unrelated if
                                 earned directly by the charitable parent (what we
                                 refer to as "the deemed unrelated amount") divided
                                 by the controlled entity's taxable income or the
                                 deemed unrelated amount, whichever is greatest.
                     b. The denominators are determined without reduction for
                         amounts paid to the controlling organization.
c. §511(a)(1) – Tax on UBTI (unrelated business taxable income)
       i. IRC § 512(b)(2) and (3)
              1. unrelated business taxable income does not include income from
                 rents and royalties.
      ii. IRC § 512(b)(13)(A)
              1. provides an exception to the rule that rents and royalties are not
                 unrelated business taxable income.
                     a. The exception applies when the exempt organization
                         receives the rents or royalties from a "controlled entity."
              2. Treas. Regs. § 1.512(b)-1(1)(1)(iii) provides that rents and
                 royalties received by an exempt organization from its controlled
                 entity are included in computing the exempt organization's
                 unrelated business taxable income to the extent that the rents or
                 royalties reduce the controlled entity's "net unrelated income."
     iii. IRC § 512(b)(13)(D) defines a controlled entity as:
              1. a corporation, partnership or other organization
                     a. that the exempt organization has an ownership interest in of
                         more than 50%.
              2. Under IRC § 512(b)(13)(D)(ii) the constructive ownership rules of
                 IRC § 318 apply in determining the exempt organization's stock
                 ownership in a corporation by attribution from other owners.
              3. IRC § 318(a)(2)(C) and (a)(3)(c)
                     a. if 50% or more in value of the stock in a corporation is
                         owned, directly or indirectly, by or for any person, then that
                         person is considered as owning the stock owned, directly or
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                  indirectly, by or for the corporation in the proportion that
                  the value of the stock the person owns bears to the value of
                  all the stock in the corporation.
iv. TR §1.512(b)-(1)(3)
       1. When the controlled organization is a taxable entity
              a. Ratio derived from the amount of the controlled
                  organization's income that would be unrelated if earned
                  directly by the charitable parent,
              b. Divided by the controlled entity's:
                        i. Taxable income, or
                       ii. The deemed unrelated amount,
                      iii. Whichever is greatest.
                      iv. The denominators are determined without reduction
                           for amounts paid to the controlling organization.
       2. §512(b)(13)
              a. Includes in the controlling tax exempt organization's
                  unrelated business income:
              b. Interest, rent, annuity, or royalty payments made by a
                  controlled entity to the controlling tax-exempt organization
                  to the extent that:
              c. The payment from the controlled entity to the controlling
                  tax exempt organization reduces the controlled entity's net
                  unrelated income (or increases any net unrelated loss).
 v. IRC §512(b)(13)(E)(i) limits
       1. The amounts included in the controlling tax exempt organization's
          unrelated business income by IRC § 512(b)(13) is limited to the
          portion of payments received or accrued in a taxable year that
          exceeds the amount of the specified payment that would have been
          paid or accrued if such payment had been determined under the
          principles of section 482.
              a. Thus, if a payment of rent by a controlled subsidiary to its
                  tax-exempt parent organization exceeds fair market value,
                  then the excess amount of the rents paid over the fair
                  market value (as determined in accordance with section
                  482) is included in the parent organization's unrelated
                  business income, to the extent that the excess over fair
                  market value reduced by the net unrelated income (or
                  increased any net unrelated loss) of the controlled entity
                  (determined as if the entity were tax exempt).
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               2. In addition, IRC§ 512(b)(13)(E)(ii) provides a 20 percent penalty
                   tax on the amount of the excess over what IRC § 482 would allow.
                        a. IRC § 512(b)(13)(E)(iii) defines "qualified specified
                           payment" as a payment made pursuant to a biding written
                           contract or renewal entered into after adoption of new
                           section 512(b)(13)(E).
d. Non-exempt subsidiary calculation
        i. Subsidiary l's taxable income (disregarding rent and royalties paid to
           National Geographic), less
       ii. Subsidiary l's taxable income from the 5 Discovery Channel episodes
           [because this income is related to National Geographic's exempt purpose]
     iii. $5,000,000 minus $3,500,000 = $1,500,000
      iv. Excess taxable income = (Subsidiary l's taxable income that is not related
           to National Geographic's exempt purpose)
       v. Ratio of Subsidiary l's excess taxable income to all of Subsidiary l's
           income
      vi. 1,500,000/5,000,000 = 30%
     vii. Total rents and royalties paid by Subsidiary 1 to National Geographic –
           $1,000,000
    viii. National Geographic's deductible expenses associated with the rents and
           royalties – None Given
      ix. Portion of $1,000,000 rents and royalties treated as National Geographic's
           gross income from an unrelated trade or business
       x. (30% x 1,000,000) = $300,000
      xi. less directly connected deductions – None Given
     xii. Net rent and royalty income treated as National Geographic's unrelated
           business taxable income $300,000
    xiii. Limitation — Only the amount of the payment in excess of what would be
           allowed under IRC § 482 is subject to tax. Thus, only the amount of the
           rents that exceed fair market value are subject to the 20 percent tax.
    xiv. Subsidiary l's taxable income (disregarding rent and royalties paid to
           National Geographic) $5,000,000
               1. Less Subsidiary l's taxable income from the 5 Discovery Channel
                   episodes [because this income is related to National Geographic's
                   exempt purpose] $3,500,000]
               2. Excess taxable income (Subsidiary l's taxable income that is not
                   related to National Geographic's exempt purpose) =$1,500,000
               3. Ratio of Subsidiary l's excess taxable income to all of Subsidiary
                   l's income 1,500,000/5,000,000        30%
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                       4. Total rents and royalties paid by Subsidiary 1 to National
                           Geographic $1,000,000
                       5. National Geographic's deductible expenses associated with rents
                           and royalties= $50,000
                       6. Portion of National Geographic's $1,000,000 rents and royalties
                           gross income from unrelated trade or business (30% x 1,000,000)
                           = $300,000
                       7. less directly connected deductions (30% x $50,000) = [$15,000]
                       8. Net rent and royalty income treated as National Geographic's
                           unrelated business taxable income = $285,000
       e. Exempt subsidiary calculation
                i. Subsidiary l's unrelated taxable income (disregarding rent and royalties
                   paid to National Geographic) $1,000,000
               ii. Subsidiary l's total taxable income computed as if Subsidiary 1 were not
                   an exempt organization and disregarding any rents or royalties paid to
                   National Geographic $4,000,000
             iii. Ratio of Subsidiary l's unrelated business taxable income to Subsidiary l's
                   total taxable income 1,000,000/4,000,000 = 25%
              iv. Total rents and royalties paid by Subsidiary 1 to National Geographic
                   $1,000,000
               v. National Geographic's total deductions in relation to the rents and royalties
                   National Geographic receives from Subsidiary 1                 [$50,000]
              vi. Total rents and royalties treated as National Geographic's unrelated
                   business taxable income [25% x 1,000,000]               $250,000
             vii. Less directly connected deductions [25% x 50,000] = [12,500]
            viii. Net rent and royalty income included in National Geographic's unrelated
                   business income $237,500
VII.   Debt-Financed Property
       a. Definition
                i. All property held to produce income and with respect to which there is
                   “acquisition indebtedness” at any time during the taxable year (or during
                   the preceding 12 months, if the property is disposed of during the year)
               ii. Exception
                       1. Property whose use is substantially related to the exercise or
                           performance of the organization's exempt function; property where
                           all of its income is already subject to tax as income from the
                           conduct of an unrelated trade or business,
                       2. Property whose income is exclusively derived from research
                           activities excepted from UBIT
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        3. Property used in a trade or business that is exempted from tax
            because:
                a. substantially all the work is performed without
                     compensation,
                b. the business is carried on primarily for the convenience of
                     members, students, patients, etc.,
                c. or the business is the selling of merchandise, substantially
                     all of which was received as gifts (sec. 513(a)(1), (2), (3)).
        4. Income from a debt-financed building that is owned by an exempt
            organization and used by any related exempt organization,
                a. is not classified as debt-financed property to the extent it is
                     used by the related exempt organization in the performance
                     of its exempt functions.
        5. income from real property, located in the neighborhood of the
            exempt organization, which it plans to devote to exempt uses
            within 10 years of the time of acquisition. A more liberal 15–year
            rule is established for churches and it is not required that the
            property be in the neighborhood of the church.
iii. Acquisition indebtedness
        1. IRC § 514(c) defines acquisition indebtedness as indebtedness
                a. Incurred in acquiring or improving debt financed property
                     IRC § 514(c)(1)(A)
                b. Incurred before the acquisition or improvement of debt
                     financed property IRC § 514(c)(1)(B), or
                c. Incurred after the acquisition or improvement of the debt
                     financed property if
                          i. The debt would not have been incurred but for the
                              acquisition or improvement of the debt financed
                              property and the incurrence of the debt was
                              reasonably foreseeable at the time of the acquisition
                              or improvement. IRC § 514(c)(1)(C)
        2. Exists whenever the indebtedness was incurred in acquiring or
            improving the property,
        3. Or the indebtedness would not have been incurred "but for" the
            acquisition or improvement of the property.
        4. If debt is incurred after the property is acquired or improved, it is
            not "acquisition indebtedness" unless its incurrence was reasonably
            foreseeable at the time of the acquisition or improvement.

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                5. If property is acquired subject to a mortgage, the mortgage is
                   acquisition indebtedness incurred when the property is acquired.
                6. Exception
                       a. Property subject to indebtedness which an exempt
                           organization receives by devise, by bequest, or, under
                           certain conditions, by gift.
                       b. Indebtedness which was necessarily incurred in the
                           performance or exercise of the purpose or function
                           constituting the basis of the organization's exemption
                       c. Property acquired under a life income contract is not debt-
                           financed property if none of the payments received by any
                           life beneficiary are treated for tax purposes as the proceeds
                           of a sale or exchange of part or all of the property
                           transferred to the exempt organization.
b. Computation of unrelated debt-financed income
        i. Apply the fraction below to the total gross income and deductions
           attributable to debt-financed property :
       ii. average acquisition indebtedness for the taxable year/ average adjusted
           basis of the property during the taxable year
      iii. When debt-financed property is disposed of during the year, "average
           acquisition indebtedness" is the highest acquisition indebtedness during
           the preceding 12 months.
                1. Without this rule, an exempt organization could avoid tax by using
                   other resources to discharge indebtedness before the end of one
                   taxable year and dispose of property after the beginning of the next
                   taxable year.
c. Planning exercise (pg. 839)
        i. IRC § 511(a) taxes most exempt organizations on their unrelated business
           taxable income.
       ii. IRC § 512(b)(3) excludes rents from the definition of unrelated business
           taxable income.
      iii. IRC § 514(a) will force an exempt organization to include some rents (or
           other items of gross income) into the exempt organization's unrelated
           business taxable income if those rents (or other items of gross income) are
           derived from debt financed property.
      iv. IRC § 514(b) defines debt-financed property as "any property which is
           held to produce income and with respect to which there is an acquisition
           indebtedness."

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               v. IRC § 514(c)(1)(A) defines acquisition indebtedness as "the indebtedness
                   incurred by the organization in acquiring or improving" debt financed
                   property.
        d. Neighborhood land rule (§514(b)(3)(A))
                i. Real property
               ii. acquired for the principal purpose of using the land
              iii. Within 10 years of the date of the exempt organization's acquisition of the
                   land
              iv. Substantially in the exercise of the organization's exempt purpose
               v. So long as, at the time of the acquisition of the property by the exempt
                   organization,
                       1. The acquired property is in the neighborhood of other property
                          already owned by the exempt organization,
                       2. The other property that is already owned by the exempt
                          organization is used to further the exempt organization's exempt
                          purpose, and
                       3. The exempt organization does not abandon its intent to use the
                          acquired property in furthering the exempt organization's exempt
                          purpose within a 10-year period
              vi. Facts needed to make the determination:
                       1. Is the acquired land is contiguous to other land owned by the tax-
                          exempt organization that is used in the exempt organization's
                          exempt function?
                       2. That the acquisition of contiguous land was not reasonable under
                          the circumstances and that the acquired land is within a mile of
                          land that the exempt organization uses to further its exempt
                          purpose, or
                       3. The land is actually used in an exempt purpose within 10 years of
                          the original acquisition.
                       4. Any structures on the land? Treas. Regs. § 1.514(b)-1(d)(3)(i)
VIII.   Lobbying
        a. §501(c)(3): Organized, operated, exclusively, for an exempt purpose, No: Private
           inurement, substantial lobbying, or intervening in a political campaign
        b. Definition
                i. Influence legislation
                       1. An organization will lose its exemption if it engages in substantial
                          attempts to influence legislation. Treas. Reg. §1.501(c)(3)-1(c)(3)
                       2. “influence legislation” means either:

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                a. Direct or indirect contacts with legislative officials in order
                   to support or oppose legislation, OR
                b. Advocating the adoption or rejection of legislation.
 ii. Exceptions
        1. Nonpartisan analysis, study or research;
        2. Technical advice or assistance;
        3. Self-defense communications; and examinations
        4. Discussions of broad social or economic problems do not generally
            constitute attempts to “influence legislation.” See §4945(e) and
            Treas. Reg. 53.4945-2(d).
iii. §501(h) safe harbor
        1. The ultimate consequence of IRC §§ 501(h) and 4911 is that an
            electing organization will not be subject to the prohibition against
            substantial lobbying under IRC § 501(c)(3). IRC § 501(h)((1).
        2. Instead, an electing organization will be subject to a 25% excise on
            its "excess lobbying expenditures." IRC § 4911(a)(1).
        3. More importantly, an organization's tax exemption may be revoked
            if:
                 a. its lobbying expenditures normally exceed its lobbying
                    ceiling amount, or
                 b. if its grass roots expenditures normally exceed its grass
                    roots ceiling amount. IRC § 501(h)(1).
        4. Basics:
                 a. Under IRC § 501(h) an electing organization is not subject
                    to the prohibition against substantial lobbying contained in
                    IRC § 501(c)(3).
                 b. Instead, an electing organization is subject to a 25% excise
                    tax on its "excess lobbying expenditures" and its exemption
                    will only be revoked if
                          i. its "lobbying expenditures" normally exceed its
                             "lobbying ceiling amount", or if
                         ii. its "grass roots expenditures" normally exceed its
                             "grass roots ceiling amount."
                 c. The 25% excise tax on "excess lobbying expenditures" is
                    imposed by IRC § 4911(a)(1).
                          i. If an electing public charity's lobbying expenditures
                             are within the dollar limits determined by IRC §
                             4911(c), then the electing charity will not owe any

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                                 tax under IRC § 4911(a) nor will it lose its tax
                                 exempt status as a charity.
                             ii. The potential loss of the tax exemption for normally
                                 exceeding the "lobbying ceiling amount" or the
                                 "grass roots ceiling amount," is contained in IRC §
                                 501(h).
                      d. The IRC § 501(h) election may only be made by "eligible
                         organizations," which include all public charities except
                         religious organizations and public safety testing
                         organizations, IRC § 501(h)(4).
                              i. Treasury regulation § 1.501(h)-2 lists those public
                                 charities that may elect to have their lobbying
                                 expenses judged under IRC § 501(h).
c. Vocabulary
      i. Lobbying expenditures – 501(h)(2)(A), 4911(d) Treas. Reg. 56.4911–
         2(a)(1)
             1. "lobbying expenditure" means "expenditures for the purpose of
                 influencing legislation (as defined in subsection (d)).“ IRC §
                 4911(c)(1)
             2. Under IRC § 4911(d)(1) the term "influencing legislation" is one
                 of either two activities:
                     a. Under IRC § 4911(d)(1)(A) "any attempt to influence
                         legislation through an attempt to affect the opinions of the
                         general public or any segment thereof' is "influencing
                         legislation."
                              i. These are called "grass roots expenditures" under
                                 Treas. Reg. § 56.4911-2(a).
                     b. OR Under IRC § 4911(d)(1)(B) "any attempt to influence
                         any legislation through communication with any member
                         or employee of a legislative body, or with any government
                         official or employee who may participate in the formulation
                         of the legislation," is also "influencing legislation."
                              i. These are called "direct lobbying expenditures"
                                 under Treas. Reg. § 56.4911-2(a).
             3. Expenditure test
                     a. An organization will violate the expenditure test in any
                         taxable year and thus forfeit its tax exemption, if:
                              i. its lobbying/grass roots expenditures for the taxable
                                 year and the three immediately past years (the four
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                             years are collectively referred to as the "base
                             period")
                         ii. exceed 150% of the total lobbying/grass roots
                             nontaxable amounts for the same time period.
                b. Thus, the organization must:
                          i. sum up its nontaxable amounts for each year in the
                             base period.
                         ii. then sum up its lobbying and grass roots
                             expenditures for each year of the base period.
                        iii. If the sum of the lobbying or grass roots
                             expenditures exceed 1.5 times the sum of the
                             lobbying or grass roots nontaxable amounts,
                             respectively, the organization will be in violation of
                             the expenditure test. IRC § 501(h)(2); Treas. Reg.
                             1.501(h)–3(b).
        4. Excess lobbying expenditures
                a. Excess of lobbying expenditures over lobbying nontaxable
                    amount, or
                b. Excess of grass roots expenditures over grass roots
                    nontaxable amount. IRC § 4911(b);
                c. The 25% tax is imposed on the greater of the two excesses.
                    Treas. Reg. 56.4911–1.
                d. "Excess lobbying expenditures" are either:
                          i. The amount by which the organization's "lobbying
                             expenditures" exceed the organization's "lobbying
                             nontaxable amount," Or
                         ii. The amount by which the organization's "grass
                             roots expenditures" exceed the organization's "grass
                             roots non-taxable amount.“
                e. “Lobbying nontaxable amount" is dependent on the amount
                    that the organization spends on exempt purposes up to a
                    maximum lobbying nontaxable amount of $1,000,000.00.
                    IRC § 4911(c)(2)
 ii. Direct lobbying – Treas. Reg. 56.4911–2(b)(1).
iii. Grass roots lobbying – IRC § 4911(d)(1)(A).
        1. a "grass roots expenditure" is an expenditure for "grass roots
             lobbying communication"
        2. grass roots lobbying communication" is "any attempt to influence
             any legislation through an attempt to affect the opinions of the
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            general public or any segment thereof“ Treas. Reg. § 56.4911-2(a)
            and (b)(2),
        3. There are 3 required elements to the definition of "grass roots
            expenditure“ Treas. Reg. § 56.4911- 2(b)(2)(ii)
               a. The communication:
                         i. Refers to specific legislation as defined in Treas.
                            Reg. § 56.4911-2(d)(1),
                        ii. Reflects a view on such legislation,
                       iii. Encourages the recipient of the communication to
                            take action with respect to the legislation as
                            "encouraging the recipient" is defined in Treas.
                            Reg. § 56.4911-2(b)(2)(iii).
iv. Indirect encouragement – Treas. Reg. 56.4911–2(b)(2)(iii)(D).
        1. Encouraging a recipient to take action with respect to legislation:
               a. Include any one of four statements: Treas. Reg. § 56.4911-
                   2(b)(2)(iii)
                         i. That the recipient should contact a legislator or an
                            employee of a legislative body, or should contact
                            any other government official or employee who
                            may participate in the formulation of legislation;
                        ii. Giving out the address, telephone number, or
                            similar information of a legislator or an employee of
                            a legislative body;
                       iii. Providing a petition, tear-off postcard or similar
                            material for the recipient to communicate with a
                            legislator or an employee of a legislative body, or
                            with any other government official or employee
                            who may participate in the formulation of
                            legislation;
                       iv. Identifying one or more legislators who will vote on
                            the legislation as: opposing the communication's
                            view with respect to the legislation; being
                            undecided with respect to the legislation; being the
                            recipient's representative in the legislature; or being
                            a member of the legislative committee or
                            subcommittee that will consider the legislation.
               b. 6 Exceptions
                         i. Treas. Reg. § 56.4911-2(b)(5) provides a special
                            rule for certain mass media advertisements
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                                       ii. Treas. Reg. § 56.4911-5 provides a special rule for
                                           communications to members
                                      iii. The non-partisan communication exception requires
                                           no direct encouragement to action. See Treas. Reg.
                                           § 56.4911-2(c)(1)(v).
                                      iv. The broad social, economic or "similar" problem
                                           exception requires no discussion of the merits of the
                                           proposal or encouragement to action. See Treas.
                                           Reg. § 56.4911-2(c)(2).
                                       v. The technical advice or assistance to a
                                           governmental body or committee exception. See
                                           Treas. Reg. § 56.4911-2(c)(3).
                                      vi. The self-defense exception IRC §4911(d)(2)(C).
              v.    Lobbying nontaxable amount IRC § 4911(c)(2).
                        1. Example
                                a. This $1,500,000 of annual "exempt purpose expenditures"
                                   gives the exempt organization a "lobbying nontaxable
                                   amount" of $225,000.
                                        i. The organization's annual exempt purposes
                                           expenditures are $1,500,000, computed as follows:
                                       ii. IRC § 4911 (e)(1)(A) "charitable“ expenditure
                                           amount $1,250,000
                                      iii. IRC § 4911 (e)(1)(B)(ii) "influencing legislation"
                                           amount $250,000
                                      iv. Total $1,500,000
                                b. The calculation is: $175,000 plus 10 % of the excess of the
                                   exempt purpose expenditures over $1,000,000 (that is 10%
                                   of $500,000) for a total of $225,000. IRC § 4911 (c)(2)
              vi.   Grass roots nontaxable amount § 4911(c)(4).
             vii.   Exempt purpose expenditures Treas. Reg. 56.4911–4(b)
            viii.   Membership communications
              ix.   Indirect lobbying expenditures, Treas. Reg. 56.4911–3(c)(3)(ii).
               x.   Communications specifically excluded from the definition of lobbying
                        1. Nonpartisan analysis, study, or research 4911 (d)(2)(A); Treas.
                            Reg. 56.4911–2(c)(1)(ii).
                        2. Discussion of broad social problems 56.4911–2(c)(2).
                        3. Technical advice Treas. Reg. 56.4911–2(c)(3).
                        4. Self-defense 4911(d)(2)(C).
IX. Last Things
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a. Organized, operated, exclusively, for an exempt purpose, No: Private inurement,
   substantial lobbying, or intervening in a political campaign
b. NOT: Illegality (drugs, homosexuality)
c. Exempt purposes
         i. religious,
        ii. charitable,
      iii. scientific,
       iv. testing for public safety,
        v. literary,
       vi. educational,
      vii. national or international amateur sports competition (but only if no part of
            its activities involve the provision of athletic facilities or equipment),
     viii. the prevention of cruelty to children or animals,
d. Other exempt organizations
         i. Social welfare 501(c)(4)
        ii. Labor, agricultural, or horticultural organizations 501(c)(5)
      iii. Business leagues 501(c)(6)
       iv. Social clubs 501(c)(7)




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