On the Record: All that Glitters Isn't Tax Exempt
An exempt organization should be aware that if it is the remainder beneficiary of a CRUT and the CRUT receives unrelated business income, the CRUT will be subject to UBIT and, as a consequence, the potential remainder interest might be diminished.
Danger to exempt status
Finally, too much UBIT could cost an organization its exempt status. The permitted purposes of an exempt organization are spelled out within the Internal Revenue code and regulations, and those purposes do not include maintaining a business. The regulations stipulate that an organization will be exempt only if it is “both organized and operated exclusively” for exempt purposes and that only an “insubstantial part of its activities” can be unrelated to its exempt purposes. If not, the IRS could treat the organization as a business rather than an exempt entity.
In seeking or accepting a gift of a business interest, an exempt organization should consider whether the business is related to its purpose. (A donation of a working farm to an agricultural college might be sufficiently related.) If it is unrelated, organizations should gauge whether the income received from the business will be exempt under the many exceptions to the UBIT rules. The decision to accept an offered donation should be an informed one.
That way, if an otherwise generous donor wants to give the local orchestra a race horse, the orchestra can determine whether it wishes to accept the gift and its potential UBIT consequences, or whether it should look the gift horse in the mouth and respectfully decline.
1. An exception to this rule arises if the payment is made by an entity controlled by the exempt organization. That question and the operation of this rule are complex matters that are beyond the scope of this column.
2. Unlike a C corporation where the corporation pays taxes on its income and shareholders pay taxes on dividends received from the C corporation, an S corporation does not pay income taxes on its income but instead the income is passed to and taxed in the hands of the shareholder.