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Tax Update For Educational & Non-Profit Institutions

On October 15, 2018, the U.S. Court of Appeals for the 6th Circuit affirmed a very important tax case for exempt organizations with UBI loss activities and net operating losses.

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On October 15, 2018, the U.S. Court of Appeals for the 6th Circuit affirmed a very important tax case for exempt organizations with UBI loss activities and net operating losses.

Losantiville Country Club v. Commissioner

On October 15, 2018, the U.S. Court of Appeals for the 6th Circuit affirmed the Tax Court’s decision in Losantiville Country Club v. Commissioner, a very important tax case for exempt organizations with UBI loss activities and net operating losses. Although it’s a country club in this particular case, any educational or non-profit institution that can’t demonstrate a profit motive for an activity reporting UBI losses should take heed.

  • The tax-exempt’s streak of losing money for 13 years drew scrutiny.
  • The Court of Appeals did not agree with the Tax Court on two important items. The Appeals court said,
    • the requirement is not necessarily to show profitability, but to show “intent to profit” and
    • the principles in the 9-factor hobby loss rules, although not directly applicable, have been used by courts “to guide their profit motive analyses” and “could illuminate that intent.”
  • Nevertheless, based on the uncontested facts of the case, Appeals affirmed the Tax Court’s decision to disallow the losses and impose accuracy-related penalties.
  • The taxpayer had a long history of unexplained losses and did not show realistic expectation of recovering the losses. And the tax-exempt organization did not have evidence it
    • kept books and records for the purpose of cutting costs, increasing profits and evaluating performance of the activity; or
    • adopted any “new techniques” or abandoned “unprofitable methods …”
  • Tax-exempts also may need to consider if this is a FIN 48 matter (ASC 740), when losses are used in the current year—or were used to offset any taxable activities in prior years for which the statute of limitations is open.
    • FIN 48 is the accounting standard that requires management to evaluate tax positions taken by the organization. If a tax benefit (such as use of a net operating loss) is not more than 50% likely to be sustained upon challenge by a tax jurisdiction, then the organization must recognize a tax liability.
    • For example, assume an organization offsets net income from a profitable unrelated business activity by another activity that continually produces losses. If those losses would not be deemed to be carried on with the intent to make a profit, there is tax exposure that, since the losses would be disallowed upon challenge by the IRS, the remaining profitable activity would result in a tax liability. This tax liability may be reportable for financial statement purposes—even if the risk of actually being audited by the IRS is low!
    • Statutes of limitations are generally open for the current tax year and three prior tax years. So management needs to evaluate the tax positions and potential tax liability for all years open under the statute of limitations.
  • The taxpayer in the tax case was also not able to use the reasonable cause exception for the mandatory 20% accuracy-related penalty. The organization did not have any evidence it had an objectively reasonable or good faith reliance on a qualified advisor’s tax advice.
  • The Appeals court cited another case that said, “The mere fact that a certified public accountant has prepared a tax return does not mean that he or she has opined on any or all of the items reported therein.”

Here are ways we’ve helped clients:

  • Analyze your existing unrelated business activities
  • Calculate tax risk exposure
  • Consult with you regarding potential action steps
  • Provide written tax analysis of your unrelated business activity positions

Let us help you! If your educational or non-profit institution has been reporting recurring net operating losses from an unrelated business activity, please contact us if you’d like to discuss the best way to handle your institution’s tax position in light of tax reform and this recently decided Appeals court tax case.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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