Applicability of UNICAP rules to exempt organizations.

• Author: Tapajna, Joseph J.
• Position: Uniform capitalization

The uniform capitalization (UNICAP) rules of Sec. 263A apply to inventory purchased for resale, subject to an exception for taxpayers with gross receipts of $10 million or less. The UNICAP regulations make clear that gross receipts for this purpose include gross receipts from any business. As a consequence, tax-exempt organizations are clearly subject to the UNICAP rules for inventory used in an unrelated business unless they qualify for the $10 million exception. Gross receipts from exempt activities are not aggregated in applying the $10 million exception because they are not considered related to a business. Nevertheless, several issues concerning the aggregation rules for determining whether an exempt organization qualifies for the $10 million exception may arise.

Consider, for example, a tax-exempt hospital with a pharmacy that sells both to patients and nonpatients. The sales to nonpatients are an unrelated business activity. Assume further that the hospital has taxable subsidiaries that rent and sell durable medical equipment, provide management services to nursing homes and provide home-infusion services to nonpatients.

Under the UNICAP aggregation rules, gross receipts from all the hospital's taxable subsidiaries are aggregated with the gross receipts from all hospital unrelated business activities to determine whether gross receipts exceed $10 million. Even gross receipts from business activities that do not involve the sale of inventory (such as the management services) are included. If gross receipts exceed $10 million, the UNICAP rules must be applied to all business activities that involve the sale of inventory. In this example, the durable medical equipment, home-infusion supplies and pharmacy drugs would be subject to UNICAP.

If the hospital is part of a larger affiliated healthcare system that includes a number of exempt organizations, an additional aggregation issue is present. Are gross receipts from business activities of other exempt group members and their subsidiaries aggregated with those of the hospital for determining whether the 10 million exception applies?

To determine which entities' gross receipts are aggregated, the UNICAP regulations refer to Sec. 52(a) and (b), Sec. 414(m), regulations under Sec. 414, and Sec. 1563. In the context of Sec. 414, the IRS concluded in GCM 39616 that the ability to appoint or remove 80% of an exempt organization's directors or...