On the Record: All that Glitters Isn't Tax Exempt
Passive investment income such as interest, dividends and royalties generally is exempt from UBIT(1). However, special rules apply when an exempt organization owns an interest in a pass-through entity, such as stock in an S company or an interest in a partnership. If an exempt organization is given stock in an S corporation, all of the income attributable to the donated stock will be subject to UBIT. In addition, all of the income recognized by an exempt organization upon the sale of its stock in an S corporation is subject to UBIT, whereas the gain on the sale by an exempt organization of stock in a C corporation is not(2).
In some circumstances, exempt organizations will have UBIT by owning stock in an S corporation but would not have UBIT if it directly owned the asset owned by the S corporation. For example, if an exempt organization owns a bond, all of the interest income and capital gains on its sale are exempt from any tax. However, if the exempt organization owns shares in an S corporation that owns the bond, the exempt organization’s share of the S income attributable to the interest and capital gain on the bond is subject to UBIT.
Despite the passive investment exception, the income attributable to an exempt organization’s investment in a limited liability company or partnership could be subject to UBIT. In the case of an investment in a partnership, either as a general partner or as a limited partner, or in an LLC, an exempt organization must treat its share of the partnership or LLC income or loss as if it had conducted the business in which the partnership or LLC engages. Therefore, if the partnership or LLC actively conducts a business, the exempt organization’s income attributable to its ownership interest will be treated as UBIT, even if the income is not distributed to the exempt organization, and even if the exempt organization is merely a limited partner or a passive member of an LLC.