How come National Public Radio, a tax-exempt organization, gets to sell “public service” announcements to Archer Daniels Midland (supermarket to the world) and to GE (we bring good things to life (light? lithe?)) and not pay any taxes on the income? Here’s a hint: it has nothing to do with former Louisiana Senator Russell Long.
It does, however, have something to do with “UBTI,” an acronym for the rules governing how far an exempt entity can go in competing with private, for-profit ventures.
Income earned by a tax-exempt organization in an activity not substantially related to its exempt purpose is subject to income tax. Income which is subject to this tax is referred to in the Internal Revenue Code as unrelated business taxable income, or — not because it sounds pretty — UBTI.
UBTI consists of, not surprisingly, income derived from an unrelated trade or business. Here’s the definition of an unrelated trade or business:
(i) a trade or business which is
(ii) regularly conducted, but which is
(iii) not substantially related to the exempt organization’s exempt purpose.
Organizations which are entitled to an exemption from federal income tax must be both organized and operated exclusively for one or more charitable purposes. Our interest lies with the latter requirement, the operational aspects of exempt organizations.
The operational inquiry looks at how faithfully — how consistently — the organization actually pursues the charitable or other exempt purpose that it promised the IRS it would pursue. The statute requires that a charitable organization be operated “exclusively” for exempt purposes. This is not applied literally. Instead, a charitable organization must operate “primarily” to accomplish its exempt purpose. As the regulations phrase it, not more than “an insubstantial part” of an organization’s activities can consist of non-exempt functions.
Somewhat confusingly, “substantiality” is also the benchmark for determining whether a trade or business is sufficiently related to an organization’s exempt purpose to escape the UBTI tax. In other words, an exempt organization can carry on a substantial trade or business, provided the trade or business is also substantially related to the organization’s exempt mission. Education is big business at Hopkins, but its exempt purpose is to educate. Even an insubstantial trade or business, however, if it is not substantially related to the organizations exempt function — beer at the Legion Hall — will trigger the UBTI rules (but not jeopardize the organization’s exempt status). Rephrased, the trade or business can be substantial, it just can’t be unrelated; and if it is unrelated, it can’t be substantial.
Let’s boil it down:
An exempt organization can earn unrelated business taxable income, it just has to pay a tax on the income that is characterized as such. The organization also must “primarily” engage in activities which further its exempt purpose. Some UBTI means taxation of the UBTI, but no tax on income from exempt activities. Too much UBTI means loss of exempt status.
Now let’s return to those ads on NPR. Is selling air time to GE “substantially related” to NPR’s exempt function? (answer: no) Is the revenue from those ad sales substantial? (answer: yes)
So does NPR have a UBTI problem? Is it in jeopardy of losing its exempt status? No and no, because of a distinction drawn in the Internal Revenue Code between an “advertisement,” with which we are all familiar, and an “acknowledgement,” which is, well, which is what Congress says it is. An acknowledgement is, for UBTI purposes, a message consisting of a sponsor’s name and logo, a value neutral description of the sponsor’s product line and “slogans that do not contain comparative or qualitative descriptions” of the sponsor’s product line. (Hence, ADM’s “supermarket to the world” is an “acknowledgement” and not an “advertisement.”)
Humpty Dumpty declared combatively in Through the Looking Glass that a word “means just what I choose it to mean,” and so too does Congress when the prosperity of the nation — or, at a minimum, the prosperity of one or more of its constituents — hangs in the balance. And therein lies the relevance (or irrelevance) of Senator Long. Senator Long was, in his time, among the more skillful practitioners of the art of “rifle shot” legislation. Rifle shot legislation consists of the half dozen words, or the oddball transition rule, which bestows a special advantage on a single or small group of constituents. For example, an estate probated in Louisiana was the only taxpayer in the country to qualify for favorable oil depletion allowance treatment under a transition rule which applied only to trusts whose “settlor died within the last six days of the fifth month in 1970,”
In the late eighties, the IRS began to take an interest in all the money that the National Collegiate Athletic Association, a nonprofit, was making on broadcasts of college football games and Division I basketball finals. Through a series of rulings and proposed regulations, the IRS was inching toward a not terribly restrictive interpretation of whether those sponsorship payments were taxable to the NCAA. The NCAA got nervous all the same, and figured it had more of a sporting chance with Congress than with the Treasury Department. Congress responded by amending the UBTI statute so that “acknowledgements,” unlike “advertisements,” could never be taxed.
In truth, the tax aspects of the NCAA’s sponsorship and broadcasting income is more complicated than I am letting on. In contrast, however, those nervously succinct GE and ADM promos on NPR are born of the advertisement versus acknowledgement rules. Senator Long had left the Senate by the time Congress spoke in this issue, but the K Street sharpshooters (or did they come from NPR’s neighborhood on Massachusetts Avenue?) who persuaded the IRS and Congress to include “slogans” in the definition of “acknowledgement” appear to have acted in Long’s rifle shot tradition.
Senator Long was (as NPR might have described him) the “powerful chairman” of the Senate Finance Committee, the Senate committee with jurisdiction over tax matters. He once dismissed a tax reform effort bubbling up to his committee as “Don’t tax you, don’t tax me, tax that fellow behind the tree.” Whether or not this qualifies as a UBTI-safe slogan, it surely captures the shell-game quality of tax policy in both the for-profit and not-for-profit sector. We therefore — together with the NCAA, NPR and that grateful tax-reformed widow in Plaquemines Parrish — “acknowledge” our debt to him.
© Maryland Gazette. Reprinted with permission.