– Nonprofit organizations have turned to alternative investments to diversify their portfolios in response to the volatility of the stock market.
– Alternative investments can create multiple federal, state, and foreign filing obligations, leading to increased compliance costs.
– Tax-exempt organizations may be subject to unrelated business income (UBI) tax on income generated from activities unrelated to their exempt purpose.
– Interest, dividends, capital gains, and certain types of rental income are statutorily excluded from UBI.
– Alternative investments often operate within a partnership structure, with income passed through to the partner on a Schedule K-1, which shows the amount and character of income or loss that each partner should report on their tax return. 1. If an organization’s investment income is unrelated to its exempt purpose, it is considered unrelated business income (UBI).
2. Income from partnerships in which the organization is invested may be UBI if it is unrelated to the organization’s mission.
3. Investments that are debt-financed can also generate UBI, such as rental property that is financed by a loan and used for activities unrelated to the organization’s exempt purpose. 1. Investing in a blocker corporation can help a tax-exempt organization avoid unrelated business income (UBI) tax, but the blocker corporation will pay tax on all income from the partnership.
2. Foreign investments and partnerships may trigger additional reporting requirements and potential penalties for noncompliance.
3. Owning a partnership investment in a state may create tax filing requirements, even if the organization has no activities in that state. – Some states are more aggressive than others about going after organizations.
– If real estate is generating UBI losses, there may still be a taxable sale in the future, so organizations may want to file to secure the loss carryforward.
– It’s important to consider if the state has a minimum tax liability and the reputational risk to the organization if all filing requirements are not met.
– Under ASC740, uncertain tax positions need to be evaluated and recorded in the financial statements if material. If no return is filed, the statute of limitations would not close for that return. – The prospectus should be checked for information about the amount and types of UBI the investment will generate.
– The prospectus should be checked for information about the states in which the investment will operate.
– Consider whether the organization already files a Form 990-T federally and in one or more states.
– When investing in a foreign organization, consider the type of organization being invested in.
– Consider whether it is better to invest in the blocker or partnership.
Tax Implications of Alternative Investments for Nonprofit Organizations
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