State taxation of exempt organizations' unrelated business income.

• Author: Evans, Marianne

How an organization that is exempt for federal income tax purposes under Sec. 501(a) reports unrelated business taxable income (UBTI) may appear to be straight-forward at first glance, especially in light of detailed federal statutory, regulatory, and administrative guidance. However, how an exempt organization computes UBTI for state income tax purposes varies from state to state. This item discusses various state tax treatments, focusing on whether a separate state filing is required, how the tax base is computed, and how UBTI is apportioned among states by multistate entities.

Most states conform to the federal classification of an entity as an exempt organization. However, some states require the entity to qualify for an exemption for state purposes. For example, Connecticut requires entities that have UBTI to register for state taxes by filing Form REG-1, Business Taxes Registration Application, and obtaining a tax registration number. In California, if an entity is exempt under Sec. 501(c)(3), it must submit Form 3500A, Submission of Exemption Request, and a copy of the IRS determination letter or ruling recognizing the organization's exempt status under Sec. 501(c)(3) to the Franchise Tax Board (FTB). If the entity does not have a determination letter, it must file Form 3500, Exemption Application, and pay a $25 filing fee.

A few states, such as Kentucky, New Jersey, and Texas, do not impose tax on exempt organizations even if they have UBTI. However, most states impose tax on UBTI but vary in how they calculate its base.

Most states conform in whole or in part to the federal definition of UBTI. Federal UBTI generally is defined under Sec. 512(a)(1) as gross income derived by any organization from any unrelated trade or business, less the deductions connected with that unrelated trade or business. The gross income and deductions are subject to modifications under Sec. 512(b) that exclude certain income from UBTI, such as dividends, interest, royalties, and rents from real property. Notwithstanding these exclusions, Sec. 514 includes in UBTI a portion of unrelated business income from debt-financed property.

Some states, such as Georgia, Florida, and Virginia, adopt the federal definition of UBTI without modifications. However, taxpayers should be aware of a state's conformity date. For example, California follows the federal definition of UBTI but follows the Internal Revenue Code as it existed on Jan. 1, 2009. Therefore, even though...