Partnership investments by public charities: tax reporting complexities.

• Author: Spencer, Gwen

Tax reporting for Sec. 501(c) (3) public charities' investments in limited partnerships (LPs) (or limited liability companies treated as partnerships for Federal income tax purposes) has become increasingly risky and complex. In recent years, investment officers and committees, chief financial officers and treasurers of tax-exempt organizations have viewed alternative investments (including LP investments) as an attractive approach to diversifying their portfolios. However, new requirements have introduced added risks and burdens for exempt organizations involved in limited partnership investments.

UBTI

Failure to report unrelated business taxable income (UBTI) may result in the imposition of interest and penalties by the IRS and state authorities. Sec. 512(c)(1) dictates that when an exempt organization is a partner in an entity treated as a partnership for Federal income tax purposes, it must analyze the partnership's activities to determine whether they would generate UBTI if the exempt organization conducted them directly. Frequently, partnership investments generate UBTI when the partnership conducts unrelated business activities (See. 512(a)(1)) or takes on certain debt (See. 514). An exempt organization reports UBTI on Form 990-T, Exempt Organization Business Income Tax Return. Further, a majority of states impose tax on unrelated business income (UBI); it is not uncommon for a partnership to generate UBTI in more than one state.

Reportable Transactions

The IRS has expressed concern that some exempt organizations participate in transactions that result in tax avoidance. When the reportable transaction final regulations were issued in February 2003 (TD 9046), exempt organizations were included, for the first time; see Regs. Sec. 1.6011-4. Such transactions are reported on Form 8886, Reportable Transaction Disclosure Statement. Similar to income reporting, information reporting requirements flow through to each limited partner; thus, if a partnership engages in a reportable transaction...