Unrelated Business Income Tax Return

Even though an organization is recognized as tax exempt, it still may be liable for tax on its unrelated business income. Unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis for the organization's exemption. An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T.

The obligation to file Form 990-T is in addition to the obligation to file the annual information return, Form 990, 990-EZ, or 990-PF.

Estimated tax.    Exempt organizations must make quarterly payments of estimated tax on unrelated business income. An organization must make estimated tax payments if it expects its tax for the year to be $500 or more.

Travel tour programs.   Travel tour activities that are a trade or business are an unrelated trade or business if the activities are not substantially related to the purpose to which tax exemption was granted to the organization.

Whether travel tour activities conducted by an organization are substantially related to the organization's tax exempt purpose is determined by looking at all the relevant facts and circumstances, including, but not limited to, how a travel tour is developed, promoted, and operated.

Example.   ABC, a university alumni association, is tax exempt as an educational organization under section 501(c)(3) of the Code. As part of its activities, ABC operates a travel tour program. The program is open to all current members of ABC and their guests. ABC works with travel agents to schedule approximately ten tours annually to various destinations around the world. Members of ABC pay $1,000 to XYZ Travel Agency to participate in a tour. XYZ pays ABC a per person fee for each participant. Although the literature advertising the tours encourages ABC members to continue their lifelong learning by joining the tours, and a faculty member of ABC's related university frequently joins the tour as a guest of the alumni association, none of the tours include any scheduled instruction or curriculum related to the destinations being visited. The travel tours made available to ABC's members do not contribute importantly to the accomplishment of ABC's educational purpose. Rather, ABC's program is designed to generate revenues for ABC by regularly offering its members travel services. Therefore, ABC's tour program is an unrelated trade or business.

For additional information on unrelated business income, see Publication 598.

Employment Tax Returns

Every employer, including an organization exempt from federal income tax, who pays wages to employees is responsible for withholding, depositing, paying, and reporting federal income tax, social security and Medicare (FICA) taxes, and federal unemployment tax (FUTA), unless that employer is specifically excepted by law from those requirements or if the taxes clearly do not apply.

For more information, get a copy of Publication 15, Circular E, Employer's Tax Guide, which summarizes the responsibilities of an employer, Publication 15-A, Employer's Supplemental Tax Guide, and Form 941, Employer's Quarterly Federal Tax Return.

Penalty.   If any person required to collect, truthfully account for, and pay over any of these taxes willfully fails to satisfy any of these requirements or willfully tries in any way to evade or defeat any of them, that person will be subject to a penalty. The penalty, often called the trust fund recovery penalty is equal to the tax evaded, not collected, or not accounted for and paid over. The term person includes:

• An officer or employee of a corporation, or
• A member or employee of a partnership.

Exception.   The penalty is not imposed on any unpaid volunteer director or member of a board of trustees of an exempt organization if the unpaid volunteer serves solely in an honorary capacity, does not participate in the day-to-day or financial operations of the organization, and does not have actual knowledge of the failure on which the penalty is imposed.

This exception does not apply if it results in no one being liable for the penalty.

FICA and FUTA tax exceptions.   Payments for services performed by a minister of a church in the exercise of the ministry, or a member of a religious order performing duties required by the order, are generally not subject to FICA or FUTA taxes.

FUTA tax exception.   Payments for services performed by an employee of a religious, charitable, educational, or other organization described in section 501(c)(3) that are generally subject to FICA taxes if the payments are $100 or more for the year, are not subject to FUTA taxes.

FICA tax exemption election.    Churches and qualified church-controlled organizations can elect exemption from employer FICA taxes by filing Form 8274, Certification by Churches and Qualified Church-Controlled Organizations Electing Exemption from Employer Social Security and Medicare Taxes.

To elect exemption, Form 8274 must be filed before the first date on which a quarterly employment tax return would otherwise be due from the electing organization. The organization may make the election only if it is opposed for religious reasons to the payment of FICA taxes.

The election applies to payments for services of current and future employees other than services performed in an unrelated trade or business.

Revoking the election.    The election can be revoked by the IRS if the organization fails to file Form W-2, Wage and Tax Statement, for 2 years and fails to furnish certain information upon request by the IRS. Such revocation will apply retroactively to the beginning of the 2-year period.

Definitions.   For purposes of this election, the term church means a church, a convention or association of churches, or an elementary or secondary school that is controlled, operated, or principally supported by a church or by a convention or association of churches.

The term qualified church-controlled organization means any church-controlled section 501(c)(3) tax-exempt organization, other than an organization that both:

1. Offers goods, services, or facilities for sale, other than on an incidental basis, to the general public at other than a nominal charge that is substantially less than the cost of providing such goods, services, or facilities, and
2. Normally receives more than 25% of its support from the sum of governmental sources and receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities, in activities that are not unrelated trades or businesses.

Effect on employees.    If a church or qualified church-controlled organization has made an election, payment for services performed for that church or organization, other than in an unrelated trade or business, will not be subject to FICA taxes. However, the employee, unless otherwise exempt, will be subject to self-employment tax on the income. The tax applies to income of $108.28 or more for the tax year from that church or organization, and no deductions for trade or business expenses are allowed against this self-employment income.

Schedule SE (Form 1040), Self-Employment Tax, should be attached to the employee's income tax return.

Political Organization Income Tax Return

Generally, a political organization is treated as an organization exempt from tax. Certain political organizations, however, must file an annual income tax return, Form 1120-POL, for any year it has any political organization taxable income in excess of the $100 specific deduction allowed under section 527 of the Code. In addition, for tax years beginning after June 30, 2000, a political organization that has $25,000 or more in gross receipts for the tax year is also required to file Form 1120-POL, even if it has no taxable income.

For tax years beginning after June 30, 2000, a political organization that has $25,000 or more in gross receipts for the tax year must file Form 990 or 990-EZ (and Schedule B of the form). See Forms 990 and 990-EZ, earlier.

Political organization.   A political organization is a party, committee, association, fund, or other organization (whether or not incorporated) organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures, or both, for an exempt function.

Exempt function.   An exempt function means influencing or attempting to influence the selection, nomination, election, or appointment of any individual to any federal, state, local public office or office in a political organization, or the election of the Presidential or Vice Presidential electors, whether or not such individual or electors are selected, nominated, elected, or appointed. It also includes certain office expenses of a holder of public office or an office in a political organization.

Beginning July 1, 2000, certain political organizations are required to notify the IRS that they are section 527 organizations. These organizations must use Form 8871. Certain of the notifying section 527 organizations must use Form 8872 to file periodic reports with the IRS dealing with their contributions and expenditures. For a discussion on these forms, see Reporting Requirements for a Political Organization, later.

Political organization taxable income.   Political organization taxable income is the excess of:

1. Gross income for the tax year (excluding exempt function income) over
2. Deductions directly connected with the earning of gross income.

To figure taxable income, allow for a $100 specific deduction, but do not allow for the net operating loss deduction, the dividends-received deduction, and other special deductions for corporations. Newsletter funds cannot claim the specific deduction of $100.

Exempt organization not a political organization.   An organization exempt under section 501(c) of the Code must file Form 1120-POL, for any year in which it:

1. Spends any amount for an exempt function, or
2. Has net investment income,

whichever is less.

Separate fund.   A section 501(c) organization can set up a separate segregated fund that will be treated as an independent political organization. The earnings and expenditures made by the separate fund will not be attributed to the section 501(c) organization.

Section 501(c)(3) organizations are precluded from, and suffer loss of exemption for, engaging in any political campaign on behalf of, or in opposition to, any candidate for public office.

Due date.   Form 1120-POL is due by the 15th day of the 3rd month after the end of the tax year. Thus, for a calendar year taxpayer, Form 1120-POL is due on March 15 of the following year. If any due date falls on a Saturday, Sunday, or legal holiday, the organization may file the return on the next business day.

Form 1120-POL is not required of an exempt organization that makes expenditures for political purposes if its gross income does not exceed its directly connected deductions by more than $100 for the tax year.

Failure to file.   A political organization that fails to file Form 1120-POL, or fails to include the required information on the form, is subject to a penalty of $20 per day for each day such failure continues. The maximum penalty imposed on failures regarding any one return is the lesser of $10,000 or 5% of the gross receipts of the organization for the year. In the case of an organization having gross receipts exceeding $1,000,000 for any year, the penalty is increased to $100 per day with a maximum penalty of $50,000.

For more information about filing Form 1120-POL, refer to the instructions accompanying the form.

Failure to pay on time.   An organization that does not pay the tax when due generally may have to pay a penalty of 1/2 of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. The penalty will not be imposed if the organization can show that the failure to pay on time was due to reasonable cause.

Reporting Requirements for a Political Organization

Certain political organizations are required to notify the IRS that the organization is to be treated as a section 527 political organization. The organization is also required to periodically report certain contributions accepted and expenditures made by the organization. To notify the IRS of section 527 treatment, an organization must file Form 8871. To report contributions and expenditures, certain notifying organizations must file Form 8872.

Form 8871.   A political organization must file Form 8871 to notify the IRS both electronically and in writing that it is to be treated as a section 527 organization. However, an organization is not required to file Form 8871 if:

• It reasonably expects its gross receipts to always be less than $25,000,
• It is a political committee required to report under the Federal Election Campaign Act of 1971 (FECA)(2 U.S.C. 431(4), or
• It is a section 501(c) organization that is treated as having political organization taxable income under section 527(f)(1) of the Code.

All other political organizations, including state and local candidate committees, are required to file Form 8871.

An organization must provide on Form 8871:

1. Its name and address (including any business address, if different) and its electronic mailing address,
2. Its purpose,
3. The names and addresses of its officers, highly compensated employees, contact person, custodian of records, and members of its Board of Directors, and
4. The name and address of, and relationship to, any related entities (within the meaning of section 168(h)(4) of the Code).