You need a plan for your UBTI

Getting creative in fundraising can mean getting into trouble with the Internal Revenue Service (IRS) and state regulators.

Many organizations seek to fundraise by means other than the traditional ones, and such alternative sources can be quite helpful. They can also be quite effective in raising red flags with the Internal Revenue Service (IRS) and state regulators, resulting in close scrutiny of an organization’s finances and severe penalties when lines have been crossed.

Speaking during an AICPA Non-for-Profit Industry Conference, Ed Jennings, tax director at the University of Michigan in Ann Arbor, discussed some of the pitfalls associated with Unrelated Business Taxable Income (UBTI) and ways to avoid getting into trouble. Jennings suggested conducting due diligence reviews, with a partnership agreement including “protective” language. That includes:

* A “best efforts” clause to minimize UBTI;

* A “best efforts” clause to limit borrowings for ordinary and routine investments;

* A notification clause to inform the investor of any transactions likely to generate significant tax liabilities on a quarterly basis;

* A tax liquidity clause that requires mandatory distributions to pay any anticipated taxes on the investments; and,

* An indemnification clause in which the manager indemnifies the investor for penalties and interest, if any, that result from the manager improperly computing or failing to disclose tax liabilities.