Section 512. See Rev. Rul. 75-201, 1975-1 C.B. 164. See also Treas.

Reg. 1.513-1(c)(2)(ii) and (iii).

c. A two-week horse racing meet featuring pari-mutuel betting conducted by

a Section 501(c)(3) county fair association is a regularly carried on trade or business, because it is usual to carry on such trade or business only during a particular season. See Rev. Rul. 68-505, 1968-2 C.B. 248.

(1) In determining whether or not intermittently conducted activities are regularly

carried on, the manner of conduct of the activities must be compared with the manner in which commercial activities are normally pursued by nonexempt organizations. In general, exempt organization business activities, which are engaged in only discontinuously or periodically, won’t be considered regularly carried on if they are conducted without the competitive and promotional efforts typical of commercial endeavors. See Treas. Reg.1.513-1(c)(2)(ii). Below are a couple of examples.

a. The publication of advertising in programs for sports events, music or

drama performances won’t ordinarily be deemed to be the regular carrying on of business. See Treas. Reg. 1.513-1(c)(2)(ii).

b. However, income an exempt organization derives from the sale of

advertising in its annual yearbook is unrelated business taxable income where an independent commercial firm under a contract covering a full calendar year conducts an intensive advertising solicitation campaign in the organization’s name and is paid a percentage of the gross advertising receipts for selling the advertising, collecting from advertisers, and printing the yearbook. Although the publication is distributed only annually, the advertising solicitation requires that a significant span of time be devoted to these activities. By engaging in an extensive campaign of advertising solicitation, the organization is conducting competitive and promotional efforts typical of commercial endeavors. So, the activities manifest a frequency and continuity and are pursued in a manner not materially different from similar commercial activities. See Rev. Rul. 73-424, 1973–2 C.B. 190.

c. Similarly, National Collegiate Athletic Association v. Commissioner, 92

T.C. 456 (1989), held that income from advertising during the NCAA March basketball tournament was UBTI because the taxpayer failed to show that sales of the ads (part of the business of advertising) weren’t regularly carried on. The Court of Appeals reversed, holding that the display of the advertising during the tournament was the only relevant time period (914 F.2d 1417 (10th Cir. 1990).) The IRS didn’t acquiesce in the decision (IRS AOD-1991-015 (September 20, 1990)). State Police Association of Massachusetts v. Commissioner, T.C. Memo. 1996-407, aff’d, 125 F.3d 1 (1st Cir. 1997), reasoned that the holding in NCAA for advertising in an event program didn’t apply to advertising in an annual

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yearbook. An issue in some cases is whether a contractor is acting as the exempt organization’s agent in conducting publishing and advertising activities, if not, the contractor’s activity might not be taken into account in determining whether EO “regularly carries on” the activity, as well as whether payments to the exempt organization from the contractor are properly characterized as royalties or the proceeds of unrelated business activities conducted on the exempt organization’s behalf. See the discussion in Part VI.A.2(9) of this document.

(2) In Suffolk County Patrolmen’s Benevolent Association, Inc. v. Commissioner,

77 T.C. 1314 (1981), acquiesced by the IRS in 1984-2 C.B. 1 (see IRS AOD1984-20 (March 22, 1984)), an organization entered into contracts with a professional promoter for the production of annual fundraising events, which consisted of the presentation and sponsoring of professional vaudeville entertainment shows and the sale of advertising in a program guide. These shows were held during one weekend per year over the course of a few years. The court examined the relevant legislative history, regulations, and revenue rulings and found that the annual vaudeville show, and sale of advertising was merely an intermittent activity to which Congress didn’t intend the tax on unrelated business income to apply. The court noted that the organization’s advertising activities were “almost identical” to the example in Treas. Reg. 1.513-1(c)(2)(ii), which states that the publication of advertising in programs for sports events or music or drama performances ordinarily isn’t “regularly carried on.” Therefore, the court held that the organization’s activities weren’t conducted with sufficient frequency and continuity, or in such manner, to be regarded as having been “regularly carried on.”

(3) Treas. Reg. 1.513-1(c)(2)(ii) also states that where an organization sells certain

types of goods or services to a particular class of persons in pursuance of its exempt functions or "primarily for the convenience" of those persons per Section 513(a)(2) (as, for example, the sale of books by a college bookstore to students or the sale of pharmaceutical supplies by a hospital pharmacy to patients of the hospital), casual sales in the course of such activity which don’t qualify as related to the exempt function involved or as described in Section 513(a)(2) aren’t treated as regularly carried on. However, where the nonqualifying sales aren’t merely casual, but are systematically and consistently promoted and carried on by the organization, they meet the requirement of regularity under Section 512.

(4) Rev. Rul. 68-374, 1968–2 C.B. 242, presents two contrasting situations to

illustrate the meaning of casual sales:

a. An exempt hospital maintains a pharmacy on its main floor primarily for

the use of its patients. The pharmacy is also open to the general public, and frequent and continuous sales are made to nonpatients. Sales to the public aren’t primarily for the convenience of the patients of the hospital within the meaning of Section 513(a)(2). There is no substantial causal relationship between the achievement of the hospital’s exempt purpose

23

and the general public’s purchases. Therefore, this activity constitutes unrelated trade or business within the meaning of Section 513.

b. The hospital pharmacy is closed to the general public but may

occasionally fill prescriptions for private patients (who aren’t hospital patients) of its staff doctors. The Rev. Rul. states that under these circumstances such sales would constitute unrelated trade or business. However, these nonqualifying sales are considered casual sales (see Treas. Reg. 1.513-1(c)(2)(ii)) because of the manner in which they are conducted. Therefore, the sales activity isn’t considered regularly carried on and income derived from these sales doesn’t constitute UBT.

(1) The regulations provide a special rule for certain intermittent income producing

activities that occur so infrequently that neither their recurrence nor the manner of their conduct will cause them to be regarded as trade or business regularly carried on. See Treas. Reg. 1.513-1(c)(2)(iii). The regulations say that income producing or fundraising activities lasting only a short period of time aren’t ordinarily treated as regularly carried on if they recur only occasionally or sporadically. Furthermore, these activities aren’t regarded as regularly carried on merely because they’re conducted every year.

a. For example, an annual dance or similar fundraising event for charity

wouldn’t be regularly carried on merely because it is conducted every year on a recurrent basis.

b. Rev. Rul. 75-201, 1975-1 C.B. 164, presents another example of this type

of infrequent activity. See Part II.B.2.(4) of this document.

(1) A trade or business is considered unrelated if its conduct isn’t substantially

related (other than through the production of funds) to the exercise or performance of an organization’s exempt purpose. See Section 513(a).

(2) To determine whether a business activity is or isn’t substantially related requires

an examination of the relationship between the business activities which generate the particular income in question—that is, the activities of producing or distributing the goods or performing the services involved—and the accomplishment of the organization’s exempt purpose. To be related, the relationship must be causal. In addition, the causal relationship must be a substantial one. So, the activities which generate the income must contribute importantly to the accomplishment of the organization’s exempt purposes to be substantially related. See Treas. Reg. 1.513-1(d)(1) & (2).

(3) A particular business activity may be substantially related for one Section

501(c)(3) organization and unrelated for another, depending on the purposes of the particular organization. See, for example, Rev. Rul. 73-105, discussed in Part II.C.4.(2) below. But in the case of a state university or other organization

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described in Section 511(a)(2)(B), a business activity isn’t unrelated business if it is substantially related to any purpose or function described in Section 501(c)(3). See Section 513(a).

(4) Where income is realized from activities that are conducted on a larger scale

than is reasonably necessary for the performance of an exempt function, the income attributable to the excess constitutes gross income from the conduct of unrelated trade or business. See Treas. Reg. 1.513-1(d)(3).

(5) Whether activities that produce gross income contribute importantly to the

accomplishment of any purpose for which an organization is recognized as exempt, depends in each case upon the facts and circumstances involved. Following are illustrations of this principle.

(1) Treas. Reg. 1.513-1(d)(4)(i) gives several examples that illustrate the

application of the "contribute importantly" principle. The following revenue rulings offer additional examples of how this rule is applied in educational contexts:

a. The regular sales of membership mailing lists by an exempt educational

organization to universities and business firms is an activity that doesn’t contribute importantly to the accomplishment of the organization’s exempt purposes. See Rev. Rul. 72-431, 1972-2 C.B. 281. But see Section 513(h) and the discussion of member list exchanges and rentals in Part VII.I of this document.

b. A travel tour program operated by a university alumni association for

members and their families, under which the association, working with various travel agencies, schedules several tours annually to destinations around the world, mails out promotional material, accepts reservations, and is paid a fee by the travel agencies on a per person basis, is an unrelated trade or business within the meaning of Section 513. See Rev. Rul. 78-43, 1978-1 C.B. 164. Also, Treas. Reg. 1.513-7 discusses the travel and tour activities of tax-exempt organizations.

c. An exempt school operates a ski facility for use in its physical education

program and also for use, to a substantial degree, for recreational purposes by students attending the school and members of the public who are required to pay slope and ski lift fees comparable to nearby commercial facilities. The recreational use of the facility by students is substantially related and contributes importantly to the school’s exempt purposes and the income derived from the students’ use of the facility isn’t from unrelated trade or business. However, income from use by the public is from unrelated trade or business. See Rev. Rul. 78-98, 1978-1 C.B. 167. See also Rev. Rul. 80-297, 1980-2 C.B. 196 which is discussed in Part VI.B.4(3) of this document.

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d. An organization’s operation of vending machines and laundromat facilities

on a university’s campus is substantially related to the organization’s exempt purposes where the organization operates as an integral part of the university, assisting the university and carrying out its activities. See Rev. Rul. 81-19, 1981-1 C.B. 353.

e. A university enters into a joint venture with a for-profit company (LLC) to

produce interactive video teacher training seminars. Although each partner holds a 50% interest, the university alone approves the curriculum, training materials and instructors, and determines the standards for successfully completing the seminars. All contracts and transactions entered into by the LLC are at arm's length and for fair market value. The LLC members’ ownership interests and all returns of capital, allocations and distributions by the LLC are proportional to the members’ respective capital contributions. A Section 501(c)(3) organization may form and participate in a partnership and meet the Section 501(c)(3) operational test if (1) participation in the partnership furthers an exempt purpose, and (2) the partnership arrangement permits the exempt organization to act exclusively in furtherance of its exempt purpose and only incidentally for the benefit of the for-profit partners. The revenue ruling holds that the activities conducted through the joint venture are substantially related to the university’s educational purposes. See Rev. Rul. 2004-51, 2004-1 C.B. 974.

(1) The leasing of its adjacent office building and the furnishing of certain office

services by an exempt hospital to a hospital-based medical group isn’t unrelated trade or business. See Rev. Rul. 69-463, 1969–2 C.B. 131. See also Treas. Reg. 1.514(b)-1(c)(1) (treating as substantially related an exempt hospital’s lease of clinic space to an association of physicians who provide outpatient medical and surgical services and train the hospital's residents and interns).

(2) The operation by a Section 501(c)(3) hospital of a gift shop patronized by

patients, visitors making purchases for patients, and employees doesn’t constitute unrelated trade or business. See Rev. Rul. 69-267, 1969-1 C.B. 160.

(3) Similarly, the operation by a Section 501(c)(3) hospital of a cafeteria and coffee

shop primarily for its employees and medical staff doesn’t constitute unrelated trade or business. See Rev. Rul. 69-268, 1969-1 C.B. 160.

(4) Also, the operation by a Section 501(c)(3) hospital of a parking lot for patients

and visitors only doesn’t constitute unrelated trade or business. See Rev. Rul. 69-269, 1969-1 C.B. 160.

(5) See Rev. Rul. 68-376, 1968-2 C.B. 246, for a discussion of situations in which

persons who purchase pharmaceutical supplies from an exempt hospital are considered “patients” of the hospital for purposes of determining whether the

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hospital is engaged in unrelated business under the Section 513(a)(2) exception for convenience of patients or otherwise.

(6) The sale of hearing aids to its patients by an exempt hospital whose primary

activity is rehabilitating the handicapped, including those with hearing deficiencies, doesn’t constitute unrelated trade or business. See Rev. Rul. 78435, 1978-2 C.B. 181.

(7) Rev. Rul. 68-375, 1968-2 C.B. 245, holds that the sale of pharmaceutical

supplies by an exempt hospital to private patients of physicians with offices in a hospital-owned medical building constitutes unrelated trade or business. The revenue ruling states that because these customers aren’t patients of the hospital, such sales aren’t primarily for the convenience of the hospital’s patients and there is otherwise no substantial causal relationship between the pharmacy sales and the furthering of the hospital’s exempt purpose.

(8) In Carle Foundation v. United States, 611 F. 2d 1192 (7th Cir. 1979), cert.

denied, 449 U.S. 824 (1980), a hospital pharmacy sold drugs to both hospital patients and the private patients of doctors who operated an independent clinic on a for-profit basis in offices located in the hospital complex. The appellate court reversed the lower court and found no evidence that pharmacy sales to the clinic and the clinic’s private patients furthered the hospital’s exempt purpose. Therefore, the court held that these sales gave rise to unrelated business taxable income.

a. Compare Hi-Plains Hospital v. United States, 670 F. 2d 528 (5th Cir.

1982), where the appellate court reversed the lower court and held that pharmacy sales to private patients of staff physicians were substantially related to a hospital’s exempt purpose where such sales were used as an inducement to recruit doctors to work in a rural community.

(9) In St. Luke’s Hospital of Kansas City v. United States, 494 F. Supp. 85 (W.D.

Mo. 1980), the court held that an exempt hospital’s performance of diagnostic laboratory testing upon specimens of patients of the hospital’s staff physicians wasn’t unrelated trade or business under Section 513. The court found that the hospital needed the specimens to carry on its educational activities. As an independent basis for its holding, the court also stated that the hospital’s staff physicians were "members" of the hospital within the meaning of Section 513(a)(2), and that testing was performed by the hospital primarily for the convenience of the hospital’s members.

a. Rev. Rul. 85–109, 1985–2 C.B. 165, states that the IRS won’t follow that

portion of the St. Luke’s Hospital of Kansas City holding that private patient specimen testing is for the convenience of the hospital’s members and therefore not an unrelated trade or business. The IRS position is that hospital staff physicians are neither "members" nor "employees" of the hospital in their capacities as private practitioners of medicine. Therefore, by providing laboratory testing services on tissue specimens referred by its staff physicians in their private capacities, the hospital isn’t carrying on

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an activity primarily for the convenience of its members, officers, or employees per Section 513(a)(2).

b. On the other hand, the revenue ruling also states that because the

laboratory testing services provide a supply of specimens needed in the hospital’s teaching program, they’re substantially related to the hospital’s exempt purpose.

c. Rev. Rul. 85–110, 1985–2 C.B. 166, holds that the performance of

diagnostic laboratory testing by an exempt non-teaching hospital upon specimens from private office patients of the hospital’s staff physicians constitutes unrelated trade or business if such services are otherwise available in the community. The revenue ruling notes that unique circumstances may exist whereby such services may further the hospital’s exempt purpose. Unique circumstances might include emergency laboratory diagnosis of blood samples from nonpatient drug overdose or poisoning victims, or laboratory testing where other laboratories aren’t available within a reasonable distance from the area served by the hospital or are unable or inadequate to conduct tests needed by hospital nonpatients. The IRS will decide whether these unique circumstances exist on a case- by-case basis.

(1) A state university operated two noncommercial radio stations and a

commercially sponsored television station. The commercially operated television station was held not to be substantially related to the university’s exempt educational purpose. It was also held that the university couldn’t offset net losses derived from the noncommercial radio stations (which weren’t unrelated business activities) against income derived from the commercial television station. See Iowa State University of Science and Technology v. United States, 500 F. 2d 508 (Ct. Cl. 1974).

(2) An organization was formed for the purpose of advancing education and

religion. In furtherance of this purpose, it broadcasts religious and educational programs for all but an insubstantial amount of its broadcast time from a television station it owns and operates under a commercial broadcasting license. The organization may qualify under Section 501(c)(3) even though its remaining broadcast time is devoted to other types of programs that are commercially sponsored; however, these programs constitute unrelated trade or business under Section 513. See Rev. Rul. 68-563, 1968-2 C.B. 212 and Rev. Rul. 78-385, 1978-2 C.B. 174.

(3) The sale of broadcasting rights to sporting events sponsored by a Section

501(c)(6) organization whose purpose is to promote interest in a particular sport, to elevate the standards of the sport as a profession, and to sponsor and conduct tournaments for the encouragement of its members, is directly related to the purposes for which the organization was recognized exempt,

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notwithstanding the amount of income received from the sale of broadcasting rights. See Rev. Rul. 80-294, 1980-2 C.B. 187.

(4) The sale of radio and television broadcasting rights to an independent producer

by a Section 501(c)(3) organization created as a national governing body for amateur athletics, whose purpose is to promote amateur athletics, is substantially related to the purpose constituting the basis for this organization’s exemption, and is therefore, not unrelated trade or business within Section 513. See Rev. Rul. 80-295, 1980-2 C.B. 194.

(5) Similarly, the sale of broadcast rights to an annual intercollegiate athletic event

by a Section 501(c)(3) organization created by a regional collegiate athletic conference contributes importantly to the accomplishment of that organization’s exempt purposes and is substantially related to the purpose constituting the basis for the organization's exemption and therefore not unrelated trade or business within the meaning of Section 513. The Service has traditionally taken the position that income from admissions to college and university athletic events isn’t income from unrelated business because the events themselves are related to the educational purposes of the colleges and universities. See Rev. Rul. 80-296, 1980-2 C.B. 195.

(1) The sale of greeting card reproductions of art works by an art museum

described in Section 501(c)(3) doesn’t constitute unrelated trade or business because the sale contributes importantly to the achievement of the museum's exempt educational purposes by stimulating and enhancing public awareness, interest, and appreciation of art. See Rev. Rul. 73-104, 1973-1 C.B. 263.

(2) The sale of scientific books and city souvenirs by a museum of folk art

described in Section 501(c)(3) constitutes trade or business unrelated to the museum’s exempt function but the sale of reproductions of art from the museum's own collection and reproductions of other art not owned by the museum are related because they contribute importantly to the achievement of the museum's exempt educational purpose by making works of art familiar to a broader segment of the public, thereby enhancing the public's understanding and appreciation of art. See Rev. Rul. 73-105, 1973-1 C.B. 264.

(3) The operation of a dining room, cafeteria, and snack bar by an exempt art

museum for use by the museum staff, employees, and members of the public visiting the museum doesn’t constitute an unrelated trade or business activity because they contribute importantly to the museum’s exempt purposes by helping visitors devote a greater portion of their time to the museum's collection than would be the case if they had to seek outside eating facilities. See Rev. Rul. 74-399, 1974-2 C.B. 172.

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(1) The operation of a coupon redemption service for the members of an

association of retail food merchants, exempt under Section 501(c)(6), doesn’t contribute importantly to the exempt purposes of the association, the promotion of a common business interest, and instead constitutes the performance of services for individual members for a fee; it therefore constitutes the conduct of unrelated trade or business within the meaning of Section 513. See Rev. Rul. 68-267, 1968–1 C.B. 284.

(2) An exempt organization’s operation of a retail grocery store as part of its

therapeutic program for emotionally disturbed adolescents, almost fully staffed by the adolescents, and on a scale that is no larger than is reasonably necessary for the performance of the organization’s exempt functions, isn’t unrelated trade or business. See Rev. Rul. 76-94, 1976-1 C.B. 171.

(3) The operation of a fringe parking lot and a shuttle bus service that favors no

individual merchant or group of merchants, by a Section 501(c)(6) organization whose primary purpose is to retain and stimulate trade in a city’s downtown area, isn’t an unrelated trade or business. However, the organization’s operation of a park and shop plan in which patrons of particular members receive stamps entitling them to free parking isn’t substantially related because it constitutes the provision of a particular service to individual members rather than being directed to the improvement of business conditions of one or more lines of business; it is therefore unrelated trade or business per Section 513. See Rev. Rul. 79-31, 1979-1 C.B. 206.

(1) While federal credit unions described in Section 501(c)(1) aren’t subject to the

UBIT (see Section 511(a)(2)(A)), state-chartered credit unions described in Section 501(c)(14)(A) are subject to the tax.

(2) Bellco Credit Union v. United States, 735 F.Supp. 2d 1286 (D. Colo. 2010) held

that the sale of credit life and credit disability insurance to members wasn’t subject to UBIT because it was substantially related to the organization’s exempt purposes of promoting member thrift and that income from the sale of accidental death and dismemberment insurance (AD&D) wasn’t unrelated business income because it was royalty income. In determining that the income was royalties, the court considered whether the income related to payments for services or payments for intangibles and concluded that the minimal work the credit union did for the AD&D program related to protecting its goodwill and not to promoting the AD&D program.

(3) Community First Credit Union v. United States, 2009 WL 2058476 (E.D. Wis.

2009. denied the government’s challenge to a jury verdict that the sale of credit life and disability insurance to members wasn’t subject to UBIT and that the sale of Guaranteed Asset Protection (GAP) insurance wasn’t subject to UBIT.

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(4) After these cases, the IRS will treat income from credit life and credit disability

insurance and GAP auto insurance as not subject to UBIT, and income from all other insurance products (including AD&D) as subject to UBIT unless there is a royalty arrangement. See TEGE-04-0314-0005.

(1) A Section 501(c)(5) agricultural organization, whose primary purpose is to

promote the betterment of conditions of breeders of Angus cattle and to improve the breed generally engages in unrelated trade or business when it regularly sells cattle for its members on a commission basis because the sale itself neither promotes the betterment of conditions of the cattle breeders nor improves the breed generally but is carried on for the convenience of members and the production of income. See Rev. Rul. 69-51, 1969-1 C.B. 159.

(2) A Section 501(c)(6) exempt association of credit unions that, as part of its

activities, publishes and sells to its members a consumer-oriented magazine designed as a promotional device for distribution to their depositors is engaged in an unrelated trade or business. See Rev. Rul. 78-52, 1978-1 C.B. 166.

(3) The rental of studio apartments to artist-tenants and the operation of a dining

hall primarily to serve these tenants have no substantial causal relationship to the achievement of the exempt purposes of a Section 501(c)(3) fine arts organization created to stimulate and foster public interest in the fine arts by promoting of art exhibits, sponsoring of cultural events, conducting educational programs, and disseminating of information relative to fine arts. Although the studio apartments are leased only to artists, they aren’t leased on the basis of any criteria that further the exempt purposes of the organization, and occupancy in the apartments isn’t primarily for the convenience of the members within the meaning of Section 513(a)(2). The dining hall is operated primarily to serve the tenants of the studio apartments in their capacity as tenants and only incidentally to serve the organization’s employees. Therefore, these activities are unrelated trades or businesses. See Rev. Rul. 69-69, 1969-1 C.B. 159.

(4) An exempt Section 501(c)(6) business league that provides job injury histories

on prospective employees from public state workman’s compensation records to prospective employers on an expedited basis for a specified fee is engaged in an unrelated trade or business. See Rev. Rul. 73-386, 1973-2 C.B. 191.

(5) The provision of pet boarding and grooming services for the general public is

unrelated to the exempt purposes of a Section 501(c)(3) organization operated for the prevention of cruelty to animals. See Rev. Rul. 73-587, 1973-2 C.B. 192.

(6) In Rev. Rul. 78-51, 1978-1 C.B. 165, the IRS concluded that the sale, at a profit,

of standard legal forms by a local bar association described in Section 501(c)(6) may be an unrelated trade or business within the meaning of Section 513.

a. However, a court found that a local bar association’s sale and distribution

of a state bar’s “standard” real estate forms and the forms manual was activity substantially related to the local bar association’s exempt purpose

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and wasn’t an unrelated trade or business. See San Antonio Bar Association v. United States, 1980 WL 1624 (W.D. Tex. 1980).

b. See also Texas Apt. Ass'n v. U.S., 869 F.2d 884 (5th Cir. 1989) (finding

that selling preprinted lease forms and a landlord’s manual was activity substantially related to a Section 501(c)(6) trade association’s exempt purpose and wasn’t an unrelated trade or business).

(7) The operation of a beauty shop and a barber shop for senior citizens is

substantially related to the exempt purpose of a Section 501(c)(3) senior citizens center because it helps meet the psychological and health needs of the elderly in the area of personal grooming, an activity substantially related to the exempt purpose of the center. See Rev. Rul. 81-61, 1981-1 C.B. 355.

(8) A language translation service provided by a Section 501(c)(6) organization that

promotes and develops trade relations between business entities located in the U.S. and the government of a foreign country is unrelated trade or business within the meaning of Section 513. See Rev. Rul. 81-75, 1981-1 C.B. 356.

(9) Assisting member cities in collecting unpaid taxes is substantially related to the

exempt purpose of a Section 501(c)(4) civic league organization that was organized and operated to assist these cities. See Kentucky Municipal League v. Commissioner, 81 T.C. 156 (1983).

(10) Administering vacation pay and guaranteed annual income accounts isn’t

substantially related to a Section 501(c)(6) organization’s exempt purpose, which is to negotiate collective bargaining agreements and resolve disputes arising under such agreements. See Steamship Trade Association of Baltimore, Inc. v. Commissioner, 757 F. 2d. 1494 (4th Cir. 1985).

(11) Section 501(c)(4) homeowner’s association generated unrelated business

taxable income from fees from operating parking lots and a beach club accessible only by members during summer days. The parking lots and club were located eight miles from the subdivision. Because they weren’t open to the public (unlike most of the association’s other facilities and services), the operation of the parking lots and club didn’t contribute to the social welfare of the general public and therefore weren’t substantially related to the organization’s exempt purpose. See Ocean Pines Association, Inc. v. Commissioner, 672 F.3d 284 (4th Cir. 2012) affirming 135 T.C. 276 (2010).

(1) Ordinarily, gross income from the sale of a product that results from the

performance of exempt functions doesn’t constitute gross income from the conduct of unrelated trade or business if the product is sold in substantially the same state it is in upon completion of the exempt functions. See Treas. Reg. 1.513-1(d)(4)(ii). However, if a product resulting from an exempt function is used or exploited in further business endeavors beyond what is reasonably appropriate or necessary for disposition in the state it is in upon completion of

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the exempt function, the gross income derived therefrom would be from conduct of unrelated trade of business. See Treas. Reg. 1.513-1(d)(4)(ii).

(2) This rule is shown in the following examples from Treas. Reg. 1.513-1(d)(4)(ii)

and revenue rulings.

a. In the case of an organization described in Section 501(c)(3) and engaged

in a program of rehabilitation of handicapped persons, income from sale of articles made by such persons as a part of their rehabilitation training wouldn’t be gross income from conduct of unrelated trade or business. The income in this case would be from sale of products, the production of which contributed importantly to the accomplishment of purposes for which exemption is recognized with respect to the organization, namely, rehabilitation of the handicapped. See also Rev. Rul. 68-581, 1968-2 C.B. 250 (income from sale by Section 501(c)(3) vocational school of woven products made by its students isn’t UBTI); Rev. Rul. 73-128, 1973-1 C.B. 222 (income from sale by Section 501(c)(3) organization of toys manufactured in its vocational training program for unskilled persons isn’t UBTI); Rev. Rul. 75-472, 1975-2 C.B. 208 (income from sale by Section 501(c)(3) halfway house of furniture manufactured primarily by persons discharged from alcoholic treatment centers isn’t UBTI); and Rev. Rul. 7637, 1976-1 C.B. 148 (income from sale by Section 501(c)(3) organization of houses built primarily by students in its on-the-job training program isn’t UBTI).

b. In the case of an experimental dairy herd maintained for scientific

purposes by a research organization described in Section 501(c)(3), income from the sale of milk and cream produced in the ordinary course of project operation wouldn’t be gross income from the conduct of unrelated trade or business.

c. If the above research organization were to use the milk and cream in the

further manufacture of food items such as ice cream, pastries, etc., the gross income from the sale of such products would be from the conduct of unrelated trade or business unless the manufacturing activities themselves contribute importantly to the accomplishment of an exempt purpose of the organization.

d. Rev. Rul. 66-323, 1966-2 C.B. 216, held that the practice of a tax-exempt

blood bank of selling blood and blood components to commercial laboratories was a business unrelated to the purpose of the blood bank’s exemption, the collection and distribution of blood for the benefit of the public and related research.

e. Rev. Rul. 78-145, 1978-1 C.B. 169 modified Rev. Rul. 66-323 and held

that the sale of plasma to commercial laboratories by an exempt blood bank, engaged in collecting and maintaining blood products for use by hospitals, wasn’t an unrelated trade or business where the blood bank sells either by-product plasma from which red blood cells have been

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removed for use by hospitals or plasma salvaged from whole blood nearing the end of its shelf life. However, sale of plasma derived from donors through plasmapheresis or purchased from other blood banks is an unrelated trade or business.

(1) If an asset or facility necessary to the conduct of exempt functions is also used

in a commercial endeavor, the fact that the asset or facility is used for exempt functions doesn’t, by itself, make the income from the commercial endeavor gross income from related trade or business. The test, instead, is whether the activities productive of the income in question contribute importantly to the accomplishment of exempt purposes. See Treas. Reg. 1.513-1(d)(4)(iii). See the example below.

a. A museum exempt under Section 501(c)(3) has a theater auditorium

which is specially designed and equipped for showing educational films in connection with its program of public education in the arts and sciences. The theater is a principal feature of the museum and is in continuous operation during the hours the museum is open to the public. If the organization were to operate the theater as an ordinary motion picture theater for public entertainment during the evening hours when the museum was closed, gross income from this operation would be gross income from conduct of unrelated trade or business. See Treas. Reg. 1.513-1(d)(4)(iii)

(2) Operation of a mailing service for other organizations is unrelated trade or

business even though the mailing equipment is also used for exempt activities. The mere fact of the use of the equipment in exempt functions doesn’t make the income from the commercial endeavor gross income from related trade or business. See Rev. Rul. 68-550, 1968-2 C.B. 249.

(3) An exempt school annually contracts with an individual who conducts a 10 week summer tennis camp, with the school furnishing the tennis courts, housing, dining facility and the individual hiring the instructors, recruiting campers, and providing supervision. The amounts received by the school are from unrelated trade or business and are generated through the dual use of facilities and personnel. Therefore, an allocable portion of expenses attributable to such facilities and personnel may be deducted in computing unrelated business taxable income under Section 512. See Rev. Rul.76-402, 1976-2 C.B. 177. Amplified by Rev. Rul. 80-297, 1980-2 C.B. 196.

(4) An exempt school operates a ski facility for use in its physical education

program and also for use, to a substantial degree, for recreational purposes by students attending the school and members of the public who are required to pay slope and ski lift fees comparable to those of nearby commercial facilities. The recreational use of the facility by students is substantially related to the school’s exempt purposes and the income derived from the students’ use of the facility isn’t from unrelated trade or business under Section 513. However,

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income from use of the facility by the public is from unrelated trade or business. See Rev. Rul. 78-98, 1978-1 C.B. 167.

(5) An organization formed for the purpose of advancing education and religion

through operation of a television station on which it broadcasts educational and religious programs qualifies for exemption under Section 501(c)(3). However, the insubstantial amount of commercial programming which it broadcasts constitutes unrelated trade or business under Section 513 because the presentation of commercial programs and the sale of advertising for airtime in connection therewith aren’t substantially related to the purposes forming the basis for exemption of the organization. See Rev. Rul. 78-385, 1978-2 C.B. 174.

(1) In some cases, exempt activities will create goodwill or other intangibles which

are capable of being exploited in commercial endeavors. Unless these commercial endeavors themselves contribute importantly to the accomplishment of an exempt purpose, the income which they produce is from the conduct of unrelated trade or business. Treas. Reg. 1.513-1(d)(4)(iv) contains examples that illustrate this principle.

(1) In United States v. American College of Physicians, 475 U.S. 834 (1986), a

Section 501(c)(3) organization published a journal called Annals of Internal Medicine. The journal contained scholarly articles relevant to the practice of internal medicine, advertisements of pharmaceuticals, medical supplies, products, equipment useful in the practice of internal medicine, and notices of positions desired or available in connection with the practice of internal medicine. Advertisements in the journal were "stacked" in two sections, at the front of and behind the editorial content of each issue. Advertisements were prepared by the advertisers and not by the organization. Advertising space was made available in the journal at rates competitive with those charged by commercial organizations for advertising space in their medical journals. The Supreme Court held that advertising contained in the organization’s journal wasn’t substantially related to its exempt educational purpose. Although the Court rejected the Government’s "per se" argument that advertising published in a tax-exempt professional journal can never be substantially related, it did conclude that, in this case, such advertising didn’t contribute importantly to the organization’s exempt purpose. See the Advertising Lead Sheet (Exhibit X.F of this document).

(2) In Fraternal Order of Police Illinois State Troopers Lodge No. 41 v.

Commissioner, 87 T.C. 747 (1986), the court held that income from advertising appearing in the Section 501(c)(8) organization’s magazine, The Trooper, was subject to tax on unrelated business income. The court rejected the organization’s arguments, stating that "paid business listings" appearing in The

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Trooper constituted advertising and therefore were a trade or business, and that the royalty exclusion modification under Section 512(b)(2) wasn’t applicable.

(3) In Arkansas State Police Association, Inc. v. Commissioner, 282 F. 3d 556 (8th

Cir. 2002), aff’g T.C. Memo. 2001-38, the court held that money received by the Section 501(c)(5) state police association from the publisher, for publishing the association’s magazine three times a year, was unrelated business taxable income and not royalty income.

(4) In Florida Trucking Association, Inc. v. Commissioner, 87 T.C. 1039 (1986), a

Section 501(c)(6) organization published a newsletter or magazine called Florida Truck News, that contained advertisements pertaining to the trucking industry. The publication contained advertisements for truck-related products, including tires, engines, and trailers. Advertisements were often repeated. No formal screening process was used, and the content of the advertisements in each issue wasn’t coordinated with the editorial content of the publication. The Tax Court held that the advertisements weren’t substantially related to the organization’s exempt purpose and, therefore, income from such advertisements was subject to tax on unrelated business income. The court viewed the advertisements as representing straightforward marketing techniques with no systematic effort to relate the products to the publication’s editorial content, and with no screening process.

(5) The exploitation of exempt functions in the context of advertising is illustrated by

some of the examples in Treas. Reg. 1.513-1(d)(4)(iv).

a. W is an exempt business league with a large membership. Under an

arrangement with an advertising agency, W regularly mails brochures, pamphlets, and other commercial advertising materials to its members, for which service W charges the agency an agreed amount per enclosure. The distribution of the advertising materials doesn’t contribute importantly to the accomplishment of any purpose for which W is granted exemption. Accordingly, the payments made to W by the advertising agency constitute gross income from unrelated trade or business.

b. X, an exempt organization for the advancement of public interest in

classical music, owns a radio station and operates it in a manner which contributes importantly to the accomplishment of the purposes for which the organization is granted exemption. However, in the course of the operation of the station the organization derives gross income from the regular sale of advertising time and services to commercial advertisers in the manner of an ordinary commercial station. Neither the sale of such time nor the performance of such services contributes importantly to the accomplishment of any purpose for which the organization is granted exemption. Notwithstanding the fact that the production of the advertising income depends upon the existence of the listening audience resulting from performance of exempt functions, such income is gross income from unrelated trade or business.

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c. Y, an exempt university, provides facilities, instruction and faculty

supervision for a campus newspaper operated by its students. In addition to news items and editorial commentary, the newspaper publishes paid advertising. The solicitation, sale, and publication of the advertising are conducted by students, under the supervision and instruction of the university. Although the services rendered to advertisers are of a commercial character, the advertising business contributes importantly to the university's educational program through the training of the students involved. Hence, none of the income derived from publication of the newspaper constitutes gross income from unrelated trade or business. The same result would follow even though the newspaper is published by a separately incorporated Section 501(c)(3) organization, qualified under the university rules for recognition of student activities, and even though such organization utilizes its own facilities and is independent of faculty supervision, but carries out its educational purposes by means of student instruction of other students in the editorial and advertising activities and student participation in those activities.

d. Z is an association exempt under Section 501(c)(6), formed to advance

the interests of a particular profession and drawing its membership from the members of that profession. Z publishes a monthly journal containing articles and other editorial material which contribute importantly to the accomplishment of purposes for which exemption was granted to the organization. Income from the sale of subscriptions to members and others in accordance with the organization's exempt purposes, therefore, doesn’t constitute gross income from unrelated trade or business. In connection with the publication of the journal, Z also derives income from the regular sale of space and services for general consumer advertising, including advertising of such products as soft drinks, automobiles, articles of apparel, and home appliances. Neither the publication of such advertisements nor the performance of services for such commercial advertisers contributes importantly to the accomplishment of any purpose for which exemption is granted. Therefore, notwithstanding the fact that the production of income from advertising utilizes the circulation developed and maintained in performance of exempt functions, such income is gross income from unrelated trade or business.

e. The facts are as described in the preceding example, except that the

advertising in Z's journal promotes only products which are within the general area of professional interest of its members. Following a practice common among taxable magazines which publish advertising, Z requires its advertising to comply with certain general standards of taste, fairness, and accuracy; but within those limits the form, content, and manner of presentation of the advertising messages are governed by the basic objective of the advertisers to promote the sale of the advertised products. While the advertisements contain certain information, the informational function of the advertising is incidental to the controlling aim of stimulating

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demand for the advertised products and differs in no essential respect from the informational function of any commercial advertising. Like taxable publishers of advertising, Z accepts advertising only from those who are willing to pay its prescribed rates. Although continuing education of its members in matters pertaining to their profession is one of the purposes for which Z is granted exemption, the publication of advertising designed and selected in the manner of ordinary commercial advertising isn’t an educational activity of the kind contemplated by the exemption statute; it differs fundamentally from such an activity both in its governing objective and in its method. Accordingly, Z's publication of advertising doesn’t contribute importantly to the accomplishment of its exempt purposes, and the income which it derives from advertising constitutes gross income from unrelated trade or business.

(6) Several revenue rulings also provide examples of advertising activities

exploiting exempt functions.

a. Income derived by a Section 501(c)(5) exempt organization from the sale

of advertising in its annual yearbook is unrelated business taxable income where an independent commercial firm under a contract covering a full calendar year conducts an intensive advertising campaign in the organization’s name and is paid a percentage of the gross advertising receipts for selling the advertising, collecting from advertisers, and printing the yearbook. See Rev. Rul. 73-424, 1973-2 C.B. 190.

b. Income derived by an association of law enforcement officials described in

Section 501(c)(6), from the sale of space in its journal either for conventional advertising or merely to identify the purchasing organization without a further message constitutes unrelated business income. However, income derived from the listing of 60 names to a page that merely identifies the purchaser without a further advertising message wouldn’t constitute unrelated trade or business because the purchaser of a listing neither expects nor receives more than an inconsequential benefit. See Rev. Rul. 74-38, 1974-1 C.B. 144, as clarified by Rev. Rul. 76-93, 1976-1 C.B. 170.

c. In Rev. Rul. 79-370, 1979-2 C.B. 238, the IRS distinguished Rev. Rul. 74 38 and held that the sale by an organization exempt under Section 501(c)(6) of a membership directory that contributes importantly to the achievement of the organization's purpose and confers no private commercial benefit on any of the members, who are the directory's sole purchasers, doesn’t constitute unrelated trade or business within the meaning of Section 513. The listings in the directory don’t emphasize the relative importance or reputation of certain members over others, and members aren’t permitted to purchase over-size or specially designed listings.

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d. The sale of advertising during a four-month period by the paid employees

of a Section 501(c)(3) exempt organization, which raised funds for an exempt symphony orchestra and published a weekly concert program distributed free at the symphony performances over an eight-month period, is a business subject to the unrelated business income tax because such activities don’t substantially differ from the comparable commercial activities of non-exempt organizations. See Rev. Rul. 75-200, 1975-1 C.B. 163.

e. The publishing of ordinary commercial advertisements for products and

services used by the legal profession in the journal of a Section 501(c)(6) bar association constitutes unrelated trade or business under Section 513 because it doesn’t advance the exempt purposes of the association, even when published in a periodical which contains editorial material related to exempt purposes. However, the publishing of legal notices doesn’t constitute unrelated trade or business because this practice promotes the common interests of the legal profession and, therefore, contributes importantly to the accomplishment of the association's exempt purposes. See Rev. Rul. 82-139, 1982-2 C.B. 108.

(1) Other examples regarding exploitation of exempt functions set forth below are

from Treas. Reg. 1.513-1(d)(4)(iv) except where noted.

a. U, an exempt scientific organization, enjoys an excellent reputation in the

field of biological research. It exploits this reputation regularly by selling endorsements of various items of laboratory equipment to manufacturers. The endorsing of laboratory equipment doesn’t contribute importantly to the accomplishment of any purpose for which U’s exemption is recognized. Accordingly, the income derived from the sale of endorsements is gross income from unrelated trade or business.

b. V, an exempt university, has a regular faculty and a regularly enrolled

student body. During the school year, V sponsors the appearance of professional theater companies and symphony orchestras that present drama and musical performances for the students and faculty members. Members of the general public are also admitted. V advertises these performances and supervises advance ticket sales at various places, including such university facilities as the cafeteria and the university bookstore. V derives gross income from the conduct of the performances. However, while the presentation of the performances makes use of an intangible generated by V’s exempt educational functions—the presence of the student body and faculty—the presentation of such drama and music events contributes importantly to the overall educational and cultural function of the university. Therefore, the income that V receives doesn’t constitute gross income from the conduct of unrelated trade or business.

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c. An exempt school annually contracts with an individual who conducts a

10-week summer tennis camp with the school furnishing the tennis courts, housing, dining facility and the individual hiring the instructors, recruiting campers, and providing supervision. The tennis camp’s patrons are attracted to the school primarily for its capacity to provide suitable tennis facilities and personnel. Its reputation as an educational institution is of secondary importance, if a factor at all, in attracting the patrons. So, the school isn’t exploiting goodwill or other intangibles generated from the performance of its exempt function. The school is, however, using its educational facilities and personnel both for the accomplishment of its exempt purposes and for income-producing purposes that are unrelated to its exempt purposes. See Rev. Rul. 76-402, 1976-2 C.B. 177.

(1) This section provides information on the computation of unrelated business

taxable income under Section 512.

(1) As discussed previously in this guide, Section 511 imposes a tax on the UBTI of

an exempt organization.

(2) Once it is determined that an exempt organization is conducting a “trade or

business” it is necessary to determine to what extent the income from such trade or business is subject to tax under Section 511. In general, the computation of UBTI is affected by a series of modifications found in Section 512(b) and certain items that are excluded per Section 513. These modifications and exclusions are discussed in Parts III-VII of this document.

(1) Per Section 512(a) and Treas. Reg. 1.512(a)-1, when computing its unrelated

business taxable income, the organization may deduct expenses, depreciation and similar items as allowed by Chapter 1 of the Code if such items are directly connected with the carrying on of an unrelated trade or business.

(2) Except as discussed below, to be "directly connected with" the conduct of

unrelated trade or business for purposes of Section 512, an item of deduction must have a proximate and primary relationship to the carrying on of unrelated trade or business. See Treas. Reg. 1.512(a)-1(a).

(3) In the case of an organization with more than one unrelated trade or business,

unrelated business taxable income is calculated separately with respect to each such trade or business, as discussed in Part III.G of this document. See Treas. Reg. 1.512(a)-6.

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(1) Expenses, depreciation, and similar items attributable solely to the conduct of

unrelated trade or business are proximately and primarily related to that business activity. Therefore, such expenses are deductible to the extent that they meet the requirements of Section 162, Section 167, or other relevant provisions of the Code in computing the unrelated business taxable income of the organization. See Treas. Reg. 1.512(a)-1(b).

(1) Expenses attributable solely to accomplishing an organization’s exempt

purpose may not be deducted from the organization’s unrelated business income because such expenses don’t possess the necessary proximate and primary relationship to the unrelated trade or business activity and are therefore not directly connected with that business activity. See, for example, Iowa State University of Science & Technology v. United States, 500 F.2d 508 (1974), where the court held that the expenses of an exempt radio station couldn’t be deducted against the income from a nonexempt television station even though the stations shared facilities and staff.

(1) Where facilities or personnel are used both for exempt functions and the

conduct of unrelated trade or business, the expenses, depreciation, and similar items attributable to such facilities or personnel must be allocated between the two uses on a reasonable basis.

(2) However, allocation of expenses, depreciation, and similar items isn’t

reasonable if the cost of providing a good or service in a related and an unrelated activity is substantially the same, but the price charged for that good or service in the unrelated activity is greater than the price charged in the related activity and no adjustment is made to equalize the price difference for purposes of allocating expenses, depreciation, and similar items based on revenue between related and unrelated activities. For example, if a social club described in Section 501(c)(7) charges nonmembers a higher price than it charges members for the same good or service but doesn’t adjust the price of the good or service provided to members for purposes of allocating expenses, depreciation, and similar items attributable to the provision of that good or service, the allocation method isn’t reasonable. See Treas. Reg. 1.512(a)–1(c).

(3) The portion of such items allocated to the unrelated business activity is

considered proximately and primarily related to that business activity and is allowable as a deduction in computing the unrelated business taxable income to the extent permitted by Section 162, Section 167, or other relevant provisions of the Code. The following examples discuss this principle.

a. X, an exempt organization subject to the provisions of Section 511, pays

its president a salary of $20,000 a year. X derives gross income from the

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conduct of unrelated trade or business activities. The president devotes approximately 10 percent of his/her time during the year to the unrelated business activity. For purposes of computing X’s unrelated business taxable income, a deduction of $2,000 (10 percent of $20,000) is allowed for the salary paid to its president. See Treas. Reg. 1.512(a)-1(c).

b. Amounts received by an exempt school that annually contracts with an

individual who conducts a summer tennis camp with the school furnishing the tennis courts, housing and dining facilities are from dual use of facilities and personnel. An allocable portion of expenses attributable to the facilities and personnel may be deducted in computing unrelated business taxable income. Rev. Rul. 76-402, 1976-2 C.B. 177, amplified by Rev. Rul. 80-297, 1980-2 C.B. 196.

(4) In Rensselaer Polytechnic Institute v. Commissioner, 732 F.2d 1058 (2d Cir.

1984), a Section 501(c)(3) educational organization operated a field house, which it devoted to two uses: student use, including physical education, college ice hockey and student ice skating, and commercial use, including commercial ice shows and public ice skating. Amounts derived from commercial use constitute unrelated business taxable income, and at issue was the correct allocation of indirect expenses. The organization contended that it was entitled to allocate fixed expenses on the basis of actual use, while the IRS argued that such allocation should be based on the total time available for use. The court agreed with the organization and held that apportioning indirect expenses such as depreciation on the basis of actual hours used is a reasonable method of allocation under Treas. Reg. 1.512(a)-1(c). In light of the amendments to Treas. Reg. 1.512(a)-1(c) effective for tax years beginning on or after December 2, 2020, accordingly, the IRS rescinds the AOD to the limited extent of any allocation method that fails to equalize price differences between related activities and unrelated trade or business activities for such taxable years. See TD 9933, 85 FR 77952-01, 77957. See Income and Expense Allocation/Tax Computation Lead Sheet (Exhibit X.E of this document) for additional information.

(5) In CORE Special Purpose Fund v. Commissioner, T.C. Memo. 1985–48, the

court denied an exempt organization business expense deduction in computing unrelated business taxable income attributable to the sale of advertising in an organization’s magazines. Although the organization received income from advertising, the advertising regulations under Treas. Reg. 1.512(a)-1(f) couldn’t be applied because the issue of whether the fund’s publication of the readership content of the magazines is an exempt activity hasn’t been decided, stipulated to, or presented for decision and because the Commissioner couldn’t apply them, due to the fund’s failure to produce credible evidence of its advertising and publishing expenses. The general allocation requirements under Treas. Reg. 1.512(a)-1(c) were deemed applicable. The court held that deductions weren’t allowed because the organization didn’t adequately substantiate a claim that such expenses were incurred or were directly connected with the unrelated

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advertising activity. The court allowed the organization to deduct a portion of its claimed legal and accounting fees and telephone expenses.

(6) The Treasury Department and the IRS currently have an item on the Priority

Guidance Plan under Treas. Reg. 1.512(a)-1(c) regarding methods of allocating expenses relating to dual use facilities. The allocation issues under Section 512(a)(1) remain relevant under Section 512(a)(6) because an exempt organization with more than one unrelated trade or business must not only allocate indirect expenses among exempt and taxable activities as described in Treas. Reg. 1.512(a)-1(c) and (d) but also among separate unrelated trades or businesses. The Treasury Department and the IRS therefore modified the underlying reasonable allocation method in Treas. Reg. 1.512(a)-1(c) and provided specific standards for allocating expenses relating to dual use facilities and the rules under Section 512(a)(6). The amendments to Treas. Reg. 1.512(a)-1(c) effective for tax years beginning on or after December 2, 2020, provid es that “unadjusted gross to gross” isn’t a reasonable allocation method. Therefore, if the cost of providing a good or service in a related and an unrelated activity is substantially the same, but the price charged for that good or service in the unrelated activity is greater than the price charged in the related activity and no adjustment is made to equalize the price difference for purposes of allocating expenses, depreciation, and similar items based on revenue between related and unrelated activities, then the allocation of expenses isn’t reasonable. The AOD relating to Rensselaer Polytechnic Institute v. Commissioner stated that the IRS wouldn’t litigate the reasonableness of an allocation method “until the allocation rules of [Section 1.512(a)-1(c)] are amended.” See 732 F.2d 1058 (2d Cir. 1984), aff’g 79 T.C. 967 (1982); IRS AOD-1987-014 (June 18, 1987). The final regulations issued with TD 9333 amend the rules of Treas. Reg. 1.512(a)-1(c), and TD 9333 states: “the IRS rescinds the AOD to the limited extent of any allocation method that fails to equalize price differences between related activities and unrelated trade or business activities for such taxable years. The IRS will continue to refrain from litigating the reasonableness of other allocation methods pending the publication of further guidance, which the Treasury Department and the IRS continue to consider and expect to publish in a separate notice of proposed rulemaking.”

(1) In certain cases, gross income is derived from an unrelated trade or business

activity which exploits an exempt activity. See Part II.F of this document. One example of such exploitation is the sale of advertising in a periodical of an exempt organization which contains editorial material related to the accomplishment of the organization’s exempt purpose. See Treas. Reg. 1.512(a)-1(f), which provides rules for determining the amount of unrelated business taxable income attributable to the sale of such advertising.

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(2) Generally, expenses, depreciation, and similar items attributable to the conduct

of the exempt activities aren’t deductible in computing unrelated business taxable income from exploitation of exempt functions. Such items are incident to an activity which is carried on in furtherance of the exempt purpose of the organization. They don’t possess the necessary proximate and primary relationship to the unrelated trade or business activity and are, therefore, not directly connected with that business activity. See Treas. Reg. 1.512(a)-1(d).

(3) In certain circumstances, however, expenses that are attributable to the exempt

activity are also directly connected with carrying on the unrelated trade or business activity. See Treas. Reg. 1.512(a)-1(d)(2). For such expenses to be deductible, the unrelated business must be of a kind carried on for profit by taxable organizations and the exploited activity must be of a type normally conducted by taxable organizations in pursuance of such business. Even then, these expenses are allocated first to the exempt function to the extent of income derived from or attributable to it and only the balance, if any, is deductible against unrelated income. Furthermore, allocation of these expenses, that are ordinarily attributable to the exempt function, can be made to the unrelated business activity only to the extent that it doesn’t result in a loss. See Treas. Reg. 1.512(a)-1(e) for more specific examples illustrating this section.

(1) The regulations set forth detailed rules for the determination of UBTI from the

sale of advertising in exempt organization periodicals. See Treas. Reg. 1.512(a)-1(f). For such purpose, it is necessary to determine the gross advertising income, direct advertising costs, circulation income and readership costs. If membership fees are to be allocated to the periodical, it may also be necessary to determine the total periodical costs. See the Advertising Lead Sheet (Exhibit X.F of this document).

(2) Gross advertising income is defined in Treas. Reg. 1.512(a)-1(f)(3)(ii) as all

amounts derived from the unrelated advertising activities of an exempt organization periodical.

(3) Circulation income is defined as the income attributable to the production,

distribution, or circulation of a periodical (other than the gross advertising income), including all amounts realized from or attributable to the sale or distribution of the readership content of the periodical. This includes amounts realized from charges made for reprinting or republishing articles and special items in the periodical, and amounts realized from the sale of back issues. See Treas. Reg. 1.512(a)-1(f)(3)(iii).

(4) Total periodical costs (the total deductions attributable to the periodical) are

equal to the sum of the direct advertising costs of the periodical and the readership costs of the periodical. See Treas. Reg. 1.512(a)-1(f)(6)(i).

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(5) Direct advertising costs include all expenses, depreciation and similar items of

deduction which are directly connected with the sale, publication, and distribution of advertising. See Treas. Reg. 1.512(a)-1(f)(6)(ii)(a). See paragraph (7) below regarding allocation of mechanical and distribution costs.

(6) Readership costs are expenses, depreciation, or similar items which are directly

connected with the production and distribution of the readership content of the periodical. Thus, all deductions that are attributable to an exempt organization’s periodical that aren’t allocated to direct advertising costs are included under readership costs. See Treas. Reg. 1.512(a)-1(f)(6)(iii). National Association of Life Underwriters v. Commissioner, 30 F.3d 1526 (D.C. Cir. 1994) held that using the ratio of journal to non-journal direct costs to allocate indirect costs was a reasonable method of allocation, but the prior year’s numerical ratio wasn’t a method of accounting that had to be used consistently year to year.

(7) The mechanical and distribution costs (for example, costs of composition,

presswork, binding, and mailing for hard-copy periodicals) must be allocated between the direct advertising costs and the readership costs. Unless a more accurate method is available, these costs should be allocated on the basis of lineage. Thus, mechanical and distribution costs are allocated to advertising costs on the basis that the ratio of advertising lineage bears to total lineage. See Treas. Reg. 1.512(a)-1(f)(6)(ii)(c).

(8) In American Medical Association v. United States, 887 F.2d 760 (7th Cir. 1989)

the Seventh Circuit Court of Appeals followed a "dominant motivation" test in determining whether a cost was "directly connected with" an unrelated business. The American Medical Association (AMA) distributed a substantial number of copies of its periodicals free of charge. This "controlled circulation" was specifically directed at physicians who constitute an especially attractive audience for persons likely to advertise in the journals. The parties stipulated that the sole purpose behind the AMA’s controlled circulation was to appeal to advertisers. The IRS argued that the regulations adopt a purely objective standard for determining the nature of an expense, if the expense is related to the production or distribution of the journal’s articles, it is a "readership cost" deductible from advertising income only if circulation income is negative; if the expense is proximately related to production or distribution of advertising, it is a "direct advertising cost" and fully deductible from advertising revenue. The appeals court found this reading to be an overly restrictive construction of the regulations. In finding that the costs of producing articles in copies of the AMA’s journals distributed free of charge as part of the AMA’s controlled circulation were fully deductible "direct advertising costs," the court concluded that where the clearly dominant motivation of a given expenditure is to contribute to the taxable, unrelated enterprise, that cost is "directly connected with" the taxable enterprise and, therefore, deductible in its entirety from the income of the unrelated trade or business.

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(1) If the direct advertising costs exceed the gross advertising income (and

assuming the advertising activity qualifies as an unrelated trade or business), the excess is allowable as a deduction in determining UBTI. Under the Section 512(a)(6) silo rules, however, the deduction may be applied to offset UBI from the trade or business containing advertising only.

(2) If the gross advertising income of the periodical exceeds the direct advertising

costs, then items of deduction attributable to the production and distribution of the readership content of the periodical (its exempt function) may be deducted from the "excess advertising income" in computing unrelated business taxable income, to the extent such deductions exceed "circulation income" (income from the exempt function) but may not result in a loss from the advertising activity. See Treas. Reg.1.512(a)-1(d)(2) and 1.512(a)-1(f)(2)(ii).

(3) Thus, if the circulation income of the periodical equals or exceeds the

readership costs of such periodical, the unrelated business taxable income attributable to the periodical is the excess of the gross advertising income of the periodical over direct advertising costs; but if the readership costs of an exempt organization periodical exceed the circulation income of the periodical, the unrelated business taxable income is the excess, if any, of the total income attributable to the periodical over the total periodical costs. This results in advertising income of an exempt organization periodical being taxed only if the periodical produces an overall profit for the year. See Treas. Reg. 1.512(a)1(d)(2) and 1.512(a)–1(f)(2)(ii).

(1) Where the right to receive an exempt organization periodical is associated with

membership for which fees are received, subscription income includes the portion of membership fees allocable to the periodical. Treas. Reg. 1.512(a)1(f)(4) sets out three methods for allocating membership receipts to a periodical:

a. If 20 percent or more of the total circulation of a periodical consists of

sales to nonmembers, the price of the periodical for purposes of allocating membership receipts is the subscription price charged to nonmembers.

b. If paragraph (a) doesn’t apply and 20 percent or more of the organization’s

members pay lower dues than other members because the former doesn’t receive the periodical, allocation is based on the difference in membership fees paid. The price of the periodical is the amount of the reduction in membership dues for a member not receiving the periodical.

c. Where neither paragraph (a) nor (b) applies, Treas. Reg. 1.512(a) 1(f)(4)(iii) provides a formula for the pro rata allocation of membership

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receipts based on the assumption that membership receipts and gross advertising income are equally available for all of an organization’s exempt activities including the periodical. The share of membership receipts allocated to the periodical under this method is an amount equal to the organization’s membership receipts multiplied by a fraction the numerator of which is the total periodical costs and the denominator of which is such costs plus the cost of other exempt activities of the organization.

(2) The regulations were challenged in American Medical Association v. United

States, cited above in D.(8), on procedural and substantive grounds. On appeal, the regulations were upheld by the Seventh Circuit. In the various opinions on American Medical Association, the courts set forth the following regarding membership dues allocations:

a. Dues placed in an association equity fund must be included in

membership receipts for purposes of the pro rata allocation formula under Treas. Reg. 1.512(a)-1(f)(4)(iii),

b. Dues collected from members who would have received periodicals free of

charge even if they hadn’t been dues-paying members should be included in calculating membership receipts allocable to circulation income under Treas. Reg. 1.512(a)-1(f)(4)(iii),

c. The cost of other exempt activities under Treas. Reg. 1.512(a)-1(f)(4)(iii)

includes all costs of other periodicals, not just readership costs,

d. The one-year subscription rate (rather than one-half the two-year

subscription rate) should be used in calculating membership receipts allocable to circulation income under Treas. Reg. 1.512(a)-1(f)(4)(iii), and

e. A portion of reduced dues paid by medical students, interns and residents

may be used in calculating membership receipts under Treas. Reg. 1.512(a)-1(f)(4)(i).

(3) In American Hospital Association v. United States, 654 F. Supp. 1152 (N.D. Ill.

1987. the court held that free distribution of a Section 501(c)(6) organization’s periodicals to nonmembers shouldn’t be included in determining whether 20 percent or more of total circulation consisted of sales to nonmembers under Treas. Reg. 1.512(a)-1(f)(4)(i).

(4) North Carolina Citizens for Business and Industry v. United States, 18 Cl. Ct.

106 (1989), held that total circulation included distribution to persons designated by members where members received a subscription for every $50 paid in dues and could designate recipients, and the organization treated such distribution as paid circulation for postal purposes.

(5) In American Bar Association v. United States, 53 AFTR 2d 84-851 (N.D. Ill.

1984), the court permitted a Section 501(c)(6) organization to take into account the costs of a separate fund described in Section 501(c)(3) for purposes of calculating the pro rata allocation of membership receipts formula under Treas. Reg. 1.512(a)-1(f)(4)(iii). Although the fund was a separate fund like that

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described in Rev. Rul. 54-243, 1954-1 C.B. 92, which maintained separate financial records and had a separate tax exemption, the fund had no separate legal existence.

(6) A detailed example of the allocation of membership receipts to advertising

income under the formula given in Treas. Reg. 1.512(a)-1(f)(4)(iii) is contained in Rev. Rul. 81-101, 1981-1 C.B. 352. This ruling illustrates that, in applying such formula, the phrase "cost of other activities" means the total costs or expenses incurred by an organization in connection with its other exempt activities, and such costs aren’t offset by any income earned by the organization from such activities. See examples in Treas. Reg. 1.512(a)1(f)(2)(iii).

(1) Where an exempt organization publishes two or more periodicals for the

production of income, it may consolidate the gross income for all periodicals and the items of deduction directly connected with the periodicals (including the readership costs) for purposes of computing the unrelated business taxable income derived from the sale of advertising in the periodicals. Consolidation may not be applied to less than all periodicals of the organization and, once adopted, this treatment is binding unless consent is obtained as provided in Section 446(e) and Treas. Reg. 1.446-1(e). See Treas. Reg. 1.512(a)-1(f)(7). See the Advertising Lead Sheet (Exhibit X.F of this document).

(2) Under Treas. Reg. 1.512(a)-1(f)(7)(ii), a periodical is considered "published for

the production of income" if:

a. The gross advertising income received from the periodical generally is

equal to at least 25 percent of the readership costs, and

b. The publication of the periodical is an activity engaged in for profit.

(3) Treas. Reg. 1.512(a)-1(f)(7) provides, in pertinent part, that the determination of

whether the publication of a periodical is an activity engaged in for profit is to be made by reference to objective standards taking into account all the facts and circumstances involved in each case. The facts and circumstances must indicate that the organization carries on the activity with the objective that the publication of the periodical will result in economic profit (without regard to tax consequences), although not necessarily in a particular year. Thus, an exempt organization periodical may be treated as having been published with such an objective even though in a particular year its total periodical costs exceed its total income. Similarly, if an exempt organization begins publishing a new periodical, the fact that the total periodical costs exceed the total income for the start-up years because of a lack of advertising sales doesn’t mean that the periodical was published without an objective of economic profit. The organization may establish that the activity was carried on with such an objective. This might be established by showing, for example, that there is a reasonable expectation that the total income, by reason of an increase in

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advertising sales, will exceed costs within a reasonable time. See Treas. Reg. 1.183-2 for additional factors bearing on this determination.

(4) Thus, readership losses from one periodical can be used to offset advertising

income from another periodical only if both are published for the production of income, as defined above. If publication of a periodical isn’t an activity engaged in for profit, then it isn’t a trade or business and the income and expenses relating to such publication aren’t taken into account in determining the organization’s UBTI. See, for example, West Virginia State Medical Association v. Commissioner, 91 T.C. 651 (1988), aff’d, 882 F.2d 123 (4 ^th Cir. 1989).

(1) Per Section 512(a)(2) and Treas. Reg. 1.512(a)-1(g), a foreign organization

which is described in Section 511 will be taxed on:

a. Unrelated business taxable income, which is derived from sources within

the United States, but which isn’t effectively connected with the conduct of a trade or business within the United States, plus,

b. Unrelated business taxable income effectively connected with the conduct

of a trade or business within the United States whether or not such income is derived from sources within the United States.

(2) For guidance on how to determine whether income realized by a foreign

organization is derived from sources within the United States or is effectively connected with the conduct of a trade or business within the United States, see part I, subchapter N, chapter 1 of the Code (Section 861 and following) and the regulations thereunder. See Treas. Reg. 1.512(a)-1(g). See also Part II.A.2 of TG 64 (Foreign Organizations) for a discussion of whether certain investment income is derived from sources within the United States.

(1) Section 512(a)(4) and Treas. Reg. 1.512(a)-4(b) exclud es from unrelated

business taxable income amounts attributable to payments for life, sick, accident or health insurance with respect to the members of Section 501(c)(19) veterans’ organizations or their dependents, provided such amounts are set aside for the payments of insurance benefits, the administrative costs of administering the insurance program or for purposes described in Section 170(c)(4) (religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals).

(2) If the income from such an insurance set-aside is used for any other purpose,

such amount is included in unrelated business taxable income without regard to any modifications provided in Section 512(b), in the taxable year in which it is withdrawn from the set-aside. See Treas. Reg. 1.512(a)-4(a).

(3) To properly set aside the income from the insurance fund, an organization must

keep adequate records describing the amount set aside and indicating the

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purpose for which it is to be used. The funds may not be commingled with other funds not to be set aside. Treas. Reg. 1.512(a)-4(b)(5). Income which has been set aside may be invested, pending the action contemplated by the set-aside, without being regarded as having been used for other purposes. Treas. Reg. 1.512(a)-4(b)(5).

(1) The Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97 (TCJA) amended

Section 512(a) by adding Section 512(a)(6) which requires an exempt organization with more than one unrelated trade or business to compute its unrelated business taxable income separately after December 31, 2017, with respect to each unrelated trade or business. It must also determine any net operating losses (NOL) separately with respect to each unrelated trade or business. NOL carryforwards must also be maintained separately. This is sometimes referred to as “siloing,” because each trade or business is separated into its own silo before the total amount of unrelated business taxable income is determined.

(2) Treas. Reg. 1.512(a)-6 provides guidance on how an exempt organization

subject to the unrelated business income tax determines if it has more than one unrelated trade or business, and, if so, how the exempt organization calculates unrelated business taxable income. The final regulations, whose effective date is for tax years beginning on or after December 2,2020, also added a new paragraph to Treas. Reg. 1.513-1 to clarify that the definition of “unrelated trade or business” in Section 513(b) applies to individual retirement accounts and revised Treas. Reg. 1.512(b)-1(a) to clarify that inclusions of subpart F income and global intangible low-taxed income (or “GILTI”) are treated in the same manner as dividends for purposes of Section 512.

(3) Under Section 512(a)(6), the unrelated business taxable income of each

separate trade or business is calculated without regard to the $1,000 specific deduction provided by Section 512(b)(12). The $1,000 specific deduction is only applied after the UBTI of each separate trade or business is added to produce an exempt organization’s total UBTI. The $1,000 specific deduction is then taken against this total UBTI value. Each exempt organization is allowed only one specific deduction of $1,000 regardless of how many separate unrelated trades or businesses it operates. And for purposes of calculating total unrelated business taxable income, the unrelated business taxable income with respect to any trade or business can’t be less than zero.

(1) Generally, Treas. Reg. 1.512(a)-6 provides that a separate unrelated trade or

business is identified by the first two digits of the North American Industry Classification System code (NAICS 2-digit code) that most accurately describes the exempt organization's trade or business activity. In addition, the final regulations add that this determination is based on the more specific NAICS

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code, such as at the 6-digit level, that describes the activity that it conducts. The final regulations also state that the descriptions in the current NAICS manual of trades or businesses (available at www.census.gov) using more than two digits of the NAICS codes are relevant in this determination. Essentially, if two or more unrelated activities have the same first two digits under the NAICS codes, then those activities will be placed in the same “silo” and thus reported on the same Form 990-T, Schedule A. Note: The NAICS updates its business activity codes every 5 years. See www.census.gov.

(1) Generally, investment activities aren’t identified using NAICS 2-digit codes. The

NAICS codes are used to identify separate unrelated trades or businesses except to the extent provided in other paragraphs of the regulations. These codes are identified in the instructions to the Form 990-T.

(2) Treas. Reg. 1.512(a)-6(c)(1) allows an exempt organization to treat its

investment activities collectively as a single separate unrelated trade or business for purposes of Section 512(a)(6). This treatment recognizes the availability of different types of investments, and that exempt organizations often intend to limit their interest in an investment rather than investing with the intent to actively participate in a business generating UBI. Qualifying investment activities can be treated as a single unrelated trade or business.

(3) Treas. Reg. 1.512(a)-6(c)(1) provides an exclusive list of investment activities

that can be treated collectively as one separate unrelated trade or business for purposes of Section 512(a)(6). Generally, such investment activities are limited to:

a. Qualifying partnership interests (discussed in Part III.J.1 of this document),

b. Qualifying S corporation interests, and

c. Debt-financed properties.

(4) The qualifying partnership interest rules don’t apply to social clubs described in

Section 501(c)(7) according to Treas. Reg. 1.512(a)-6(c)(8). However, for organizations subject to Section 512(a)(3), which includes social clubs, (as well as Section 501(c)(9) VEBAs and Section 501(c)(17) SUB trusts), Treas. Reg. 1.512(a)-6(c)(7) clarifies that unrelated business income from the investment activities of organizations includes certain additional amounts. Generally, UBTI from investment activities of an organization subject to Section 512(a)(3) includes amounts that would be excluded under Sections 512(b)(1), 512(b)(2), 512(b)(3) or 512(b)(5) if the organization were subject to Section 512(a)(1). See Treas. Reg. 1.512(a)-6(c)(7). See Part IV of this document for a discussion of UBTI under Section 512(a)(3).

(5) A general partnership interest isn’t a qualifying partnership interest and thus

can’t be aggregated with qualifying partnership interests or other investments as a single trade or business. See Treas. Reg. 1.512(a)-(6)(c)(8)(ii).

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(6) Generally, each of the following are treated as a separately reported unrelated

trade or business:

a. Directly held non-qualifying partnership interests acquired prior to August

21, 2018 (Treas. Reg.1.512(a)-6(c)(9)),

b. Certain income from a Section 512(b)(13) controlled entity (Treas. Reg.

1.512(a)-6(d)(1)),

c. Certain amounts from a Section 512(b)(17) controlled foreign corporation

(Treas. Reg. 1.512(a)-6(d)(2)), and

d. Certain amounts non-qualifying interests in an S corporation (Treas. Reg.

1.512(a)-6(e)(1)).

(1) Per Section 512(b)(6), organizations subject to UBIT are permitted a net

operating loss deduction provided under Section 172. Prior to December 31, 2017, NOLs generally could be carried back two years and carried forward twenty years. Beginning on January 1, 2018, NOLs are carried forward indefinitely and carrybacks were eliminated. Furthermore, the NOL was capped at 80% of UBTI. Notwithstanding, the 2020 Coronavirus Aid, Relief, and Economic Security Act (CARES Act) temporarily provided special NOL rules for taxable years beginning after December 31, 2017, and before January 1, 2021. During the CARES Act period, the 80% limitation was suspended, and a 5-year carryback was available. See Rev. Proc. 2020-24, 2020-18 I.R.B. 750.

(2) For tax years beginning after December 31, 2017, Section 512(a)(6) changes

how an exempt organization with more than one unrelated trade or business calculates and takes NOLs into account with respect to a particular trade or business, as discussed in Treas. Reg. 1.512(a)-6. In particular, Section 512(a)(6)(A) requires such an organization to calculate UBTI, including for purposes of determining any NOL deduction, separately with respect to each trade or business (siloing) for taxable years beginning after December 31, 2017 (post-2017 NOLs).

(3) In general, Section 512(a)(6) permits the carryover of any NOL arising in a

taxable year beginning before January 1, 2018 (pre-2018 NOLs). In particular, section 13702(b)(2) of the TCJA provides that Section 512(a)(6)(A) doesn’t apply to pre-2018 NOLs; rather, pre-2018 NOLs are taken against total UBTI calculated under Section 512(a)(6)(B). Accordingly, even though an exempt organization with more than one unrelated trade or business won’t have any NOL deductions when calculating UBTI with respect to a separate trade or business under Section 512(a)(6)(A) for the first taxable year beginning after December 31, 2017, such an organization may be able to take an NOL deduction against total UBTI calculated for such year under Section 512(a)(6)(B) if the organization has pre-2018 NOLs.

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(4) Section 13702(b)(2) of the TCJA provides that Section 512(a)(6)(A) siloing

doesn’t apply to NOLs attributable to tax years ending on or before December 31, 2017. This differs from the treatment of post-2017 NOLs discussed earlier. In sum, post-2017 NOLs are subject to the siloing rules. Pre-2018 NOLs aren’t subject to the siloing rules. Generally, an exempt organization that has both pre-2018 and post-2017 NOLs will first deduct its remaining pre-2018 NOLs from its total UBTI. It will then deduct any post-2017 NOLs for a given separate unrelated trade or business from the “siloed” UBTI for that same unrelated trade or business.

(5) Under Treas. Reg. Section 1.512(a)-6(h)(2), pre-2018 NOLs continue being

taken against total UBTI because siloing rules don’t apply to these NOLs. However, the final regulations provide that organizations allocate their pre-2018 NOLs in a manner that allows maximum utilization of their post-2017 NOLs in that same tax year. For example, an organization may allocate all its pre-2018 NOLs to one of its separate unrelated trades or businesses, or it may allocate its pre-2018 NOLs ratably among its separate unrelated trades or businesses depending on which approach results in the greatest utilization of the post-2017 NOLs in that taxable year.

(1) The TCJA enacted general changes to the NOL deduction under Section 172

for tax years beginning after December 31, 2017. In particular:

a. The post-2017 NOL deduction in any year is capped at 80% of UBTI.

b. The post-2017 NOL carryback (which previously applied to two taxable

years) is eliminated.

c. The post-2017 NOL carryforward (which previously applied to 20 taxable

years) is now indefinite.

d. Section 512(a)(6)(A) requires an exempt organization to calculate UBTI,

including for purposes of determining any NOL deduction, separately with respect to each trade or business (siloing) for taxable years beginning after December 31, 2017 (post-2017 NOLs).

(2) The CARES Act temporarily modified or suspended certain amendments to