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  Tax Exemption Home: Non Profit / Exemption Information: Exemption Workshop - Chapter 4 - UBI - Part 2
 

Exemption Workshop - Chapter 4 - Unrelated Business Income - Part 3

Bingo: No Business Income Tax?

Income generated from conducting bingo games is not considered income from unrelated trade or business. So in extension, these incomes are not subjects to unrelated business income tax as long as the bingo games fall under these three exemptions; the game is considered a traditional type of bingo, is legal under state and local law, and is not normally done on a for profit basis.

A traditional bingo game is played with cards that have five rows and columns. A total of 24 randomly selected numbers from 1 to 75 are placed in each square. To play, players and participant mark the randomly selected numbers on their cards as they are called. To win, a player must be able to form a pre-selected pattern like a vertical or horizontal line and even be able to form a triangle or a box. Wagers in a game of bingo must be determined to be able to establish a specific price amount. When you win, your number will be verified and prizes will be given all in the presence of everyone who placed bets or has wagered in the game.
Although there are different kinds of bingo out there, there are some exemptions. Satellite and Internet bingo does not qualify because games are carried out in several places, sometimes even simultaneously. Also because other players may not be present when wagers are placed, when winners are determined, and the reward distributed. Pull tab games such as instant and mini bingos, and similar scratch off cards are not considered traditional bingo.

Bingo income is not subject to business income tax if the bingo game conducted does not breach any local or state law even if the game is explicitly said to be prohibited. It also does not make a difference whether the state or local officials impose the law or not.

The exception also does not apply to bingo games carried out in a controlled environment in which the games are carried out on a profit-making manner. Hence, if a profited company frequently conducts games in any part of the protected field, the exclusion is not relevant.

Exemptions in Business Income Tax

In successfully managing a business, you need to report for an income tax on your earnings and the expenses you had in a year, and you may claim that against your income. The remaining is your taxable income which is paid in installment throughout the year. But this profitable income to be taxed also has deductions in terms expenses. These operating costs are allocated to certain activities that meet the exemptions.

The most common expenses are for interest and dividends. Dividends are monetary divisions given to the stockholders of the company. They are not considered as expenses for the company and hence, it does not lower the company’s net income. And in extension, it is not included in the net income of the company where business income tax is derived. Interest on the other hand, is a sum paid for by someone who borrowed assets from the company. It is a form of payment for the use of the assets. An example of this is the interest given to a depositor in a bank. Other expenses that are exempted from Business income tax are the royalties, rents and gains and losses from the sale of property. Royalties, or more commonly called as private sector taxes, these are payments made by one party to the owner of the assets for its continuing use.

There are also deductions that are done to the net income for these are not taxable income, meaning they are not part of the expenses that are deducted to the total earning to the company. Trade or business expenses deduction, interest expense deduction which is the payment given by the individual who borrowed an amount or the cost of borrowing, deduction for losses, net operating loss deduction, and charitable contribution deduction. These are payments given to charitable institutions in behalf of the company.

Passive Incomes Exemptions

Unrelated Business income taxes exclude what is called passive income. Passive income is a steady income expected on a regular basis. Passive incomes are usually taxable but they can be excluded. Some examples of passive incomes that can be excluded are incomes from a business that is mediated for the owner of the business or does not have direct access by the owner; rent from owned and personal properties by an organization or an individual; royalties from intellectual properties and goods, and dividends and interests from owning resources, stocks, services and assets.

As an explanation as to why there is exclusion from unrelated business taxable income to the income from royalties and all other deductions directly related with royalty income, is to understand what royalties are. Royalties are payments from the use of a copyright, trademark, trade name and other intellectual property one has. An excellent example would be a payment from a brand of shoes to an organization for the use of their trademark and logo for the advertisement of their products and vice versa.

Payments considered as rent from real property are also excluded from the company’s unrelated business taxable income. In a situation where a wedding hall is to be rented from an organization where no other services are available like catering and bartending, and the mortgage of the building is paid full, is a very good example of an excluded rental income.

Gains and losses from sales of a property are also excluded in the calculation of a company’s business income tax. If a business sells a private property like an asset or investment, in an effort to profit, sells the house for more than its value. The taxable income would be the exact amount for the value of the sold property and the gained amount would be part of the exemption.

The Rules for Deductions

When it comes to organizations under section 501(c) (3), they are allowed to submit deductibles for their unrelated business taxable income only if the said amount of deduction is substantially related to the conduct of the organization’s specific activities.

However, there are some things to be considered before an amount can be subtracted. For one, it must be allowed by the first chapter of the code. This first chapter has the rules and guidelines which are for income tax provisions of the general situations. Another situation in which this is permitted is that the amount to be deducted must be directly related to the organization’s activities.

By getting the total everything from the total profit of the organizations and the amount to be deducted of the substantially related activities of the company, from this we can say that a deficit from a business of no substantial value can be used to balance out the income from some other unrelated activity or trade.

Personnel or Assets—Dual Use

In cases where in an employee from a corporation is both employed in a business that is not directly related to the corporation and in activities that are of exemption, then the amount to be deducted that are assigned to such employees or personnel are distributed among the two purposes on acceptable condition. When it is time to calculate the unrelated business taxable income, the amount of the deduction that is of assigned to the unrelated trade is then subtracted.

To help make things clearer, let me give you an example. A non-profit corporation has a parking lot that is for their members, employees, and guests during office hours. However, at night, when the office of the corporation closes, a theatre nearby uses it instead as a rented parking lot for their customers. The income from the morning is not included in the unrelated business income tax. But, the income from the customers of the theatre are included for the reason that providing parking spaces to the public is not the main purpose of the organization and is not directly related to its purpose.

Examples for Process of Expense Allocation

Allow me to give you several examples for expense allocation method. Let us take a school for example. The school is under 501 (c) (3) and it decides to run a camp for tennis in the summer which is not directly related to the purpose of tax exempt of the school. The school supplies all the things needed such as the area, the housing, and the cafeteria. The contractor then supplies the personnel such as the teachers, campers and students and is the one who supervises the camp. The profit that the school makes from this business is from two purposes—both from the supplies and the staff. When it is time to calculate the taxable income from the unrelated business, the deductible amount is the one assigned to the personnel. Afterwards, the school knew that the income from the camp was made up of forty percent students and sixty percent from the campers who do not belong to the school. They also found out that the expenses for everything amounted up to twenty thousand dollars.

In this situation, only one half of the items were employed for the unrelated business and so a half percentage can be attributed to the activity. This means that twenty thousand dollars multiplied by point five is equal to ten thousand dollars. But, the student use of the facilities is not taxable so the amount from this cannot be deducted. Through this computation we can arrive at the conclusion that ten thousand dollars is the only amount that can be deducted using Form 990-T. The computation is ten thousand dollars multiplied by point sixty, equals six thousand dollars.

Let us take another example for the situation. There is a charity called charity X. They have an employee that only spends thirty percent of his or her time working for charitable purposes. The remaining percentage of his time which is seventy percent is only spent in games. Therefore, in the computation of taxes, charity X can distribute seventy percent of the salary of the said employee to taxable income of unrelated business found in Form 990-T.

However, there should be enough documentation to supply on how that certain employee spends his or her time every month.

Other Subtractions

There are some deductions when it comes to unrelated business taxable income or UBTI. One is called the net operating loss. This is only permitted in a single year depending on the loss of the company in the past year.

Let us take an example. A company opened and during its first year of business, this company had a net operating loss worth ten thousand dollars gained from an activity that is not related to the purpose of the organization. On the second year of the business, the income totalled to twelve thousand dollars. On this second year, the company may say that their net operating loss that can be deducted is ten thousand dollars due to the amount of loss on the previous year. The UBI for this year then can be calculated at twelve thousand dollars to two thousand dollars.

There is also a guideline for contributions of charitable value. Any organization under 501 (c) (3) may be permitted a deduction for this. However, it is only up to ten percent of the UBTI not concerning the subtraction for contributions. In order to deduct it, the charitable contributions should be paid to any other organization that qualifies.

Here is an example. A school that is of tax-exempt status manages an activity that is not related to the business. It produces an income of one hundred thousand dollars which is taxable. An amount of ten thousand dollars of a charitable contribution may be subtracted to some other school for education purposes.
There is also a guideline for deduction that is specific. In the rules, only one thousand dollars is permitted when it comes to specific deduction in computing UBTI. And for every tax year, only one specific deduction is allowed, not concerning how many activities of unrelated nature are being conducted.
For instance, a company has a total income from an activity that is not related to their business amounting to fifteen thousand dollars. The tax is computed at fourteen thousand dollars.

There are also those with substantial unrelated business income that may jeopardize exemption. If a company is under 501c3 then the said company can have UBTI without any negative effect on its tax-exempt status. But the tax-exempt status they have may be jeopardized if the unrelated activity they have is already considered unimportant.

Organizations who have income from an activity of unrelated nature of one thousand dollars or more are required to file the Exempt Organization Business Income Tax Return or Form 990-T. This is one of the requirements also of those who are required to file Form 990, 990-PF, 990-N, and 990-EZ.

When you are required to file a Form 990-T, this is due on the fifteenth day five months after the end of your company’s period or accounting or what is known as a tax year. If you end on December 31st, then your due date is on May fifteenth.
If you cannot file on the deadline, then you may apply for an extension of up to six months. You can simply submit the Form 8868 or the Application for Extension of Time to File Exempt Organization Return.

If there are late files, the company may be charged with penalties. The Internet Revenue Service will be the one to calculate the penalty so it is not needed that the company will compute the penalties on the Form 990-T.

If your corporation has an estimated tax of five hundred dollars or more for this year, then you have to make payments in instalments. Use the Form 990-W or the Estimated Tax on Unrelated Business Taxable Income for Tax-Exempt Organizations.

Other forms that you might want to know about are the Tax on Unrelated Business Income of Exempt Organizations or Publication 598, the Exempt Organization business Income Tax Return also known as Form 990-T, the Application for Extension of Time to File Exempt Organization Return or Form 8868, The Estimated Tax On Unrelated Business Taxable Income for Tax-Exempt Organizations or what is called as Form 990-W, and also the US Corporation Income Tax Return on Form 1120.


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