For many, the idea of being a not-for-profit organization means no taxes, right? Not precisely. There are instances when a not-for-profit organization does need to file taxes and understanding the rules around Unrelated Business Income Tax (UBIT) is essential.
A key tool used by not-for-profits when ensuring compliance with UBIT regulations is the Statement of Functional Expense (SFE) which also assists organizations in monitoring the ratio of program expense in order to maintain tax-exempt status with the IRS. How do these tax tools work together?
On this episode of Weaver: Beyond the Numbers, Weaver Tax Partner, Kirby Ross, and Assurance Partner, Jackie Gonzalez, are focused on top issues impacting not-for-profit organizations. They specifically break down UBIT rules and discuss how a SFE can help improve reporting.
Ross and Gonzalez discuss the following in their conversation:
- Examples of unrelated business income scenario
- Questions not-for-profits should consider when reporting unrelated business income
- Keys to setting up a statement of functional expense to accurately report resource allocation and support tax compliance
Under UBIT rules, not-for-profit organizations are generally exempt from paying federal income tax on income generated from activities that are related to their exempt purpose. However, if the organization generates income from activities that are not substantially related to their exempt purpose, that income may be subject to UBIT. For example, sponsorships don’t fall under UBIT, but advertising does. “So, if someone sponsors your program, you can put the name of the company on your promotional material, and that’s considered great,” Ross said. “However, if you start promoting how great that product is, or how great that company is, then you can get into trouble, and you’ve entered into the land of UBIT.”
Statement of functional expenses was also discussed by Gonzalez and Ross who conveyed the importance of accurately allocating expenses between program and supporting services. Consistency in allocations and having clear policies are crucial for both auditing and tax purposes. Rating agencies like Charity Navigator assess not-for-profits based on their expense allocation, with higher ratings going to organizations that allocate a larger percentage of their expenses to program services.
A good target for a highly functioning not-for-profit is to allocate less than 15% of its expenses to supporting services, with the rest going to program services. A lower percentage allocated to program services could have negatively impacted the organization's reputation and deterred potential donors.
The conversation concluded with both speakers acknowledging the importance of auditors in helping not-for-profits to accurately report their expenses and assess their UBIT exposure.
Kirby Ross is a Tax Partner at Weaver and has been with the company since 2020. Previously he was a Shareholder at HSPG & Associates. He’s also a graduate of the University of Central Oklahoma.
Jackie Gonzalez is an Assurance Partner at Weaver and manages the company’s Assurance Services. She’s been with the company for 18 years and is an alum of Texas Wesleyan University.