[NEohioPAL] Filmmaking as part of a Nonprofit Organization - Installment IV. Calculating the Unrelated Business Income

[Mary Ellen Tomazic]

         Since profits from the ministry’s YouTube channel ads would almost
surely be deemed taxable as unrelated income under the current Treasury
regulations, the next step is calculating the UBTI, or Unrelated Business
Taxable Income. Keep in mind that under the Internal Revenue Code, regular,
for-profit businesses are entitled to certain deductions from their taxes.
Expenses attributable solely to the unrelated business are fully
deductible, and that includes losses, depreciation and other items
“directly connected” with the unrelated
business.[1]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn1>An
additional advantage is that UB taxable income is taxable at the new
corporate income tax rate, just passed in January 2011, which raises the
amount of income for the lowest rate of 15% to the first $50,000 of total
income. Then the rate is still 25% for income from $50,000 to $75,000, 34%
from $75,000 to $10 million, and the top rate remains at 35% for income
over $10 million.[2]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn2>

        The exploitation of an exempt function are generally not deductible
in computing the UBTI, since the items are incidental to the conduct of an
exempt purpose and thus do not have a sufficient relationship to the
unrelated trade or
business.[3]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn3>However,
a charitable deduction is allowed for nonprofit organizations
subject to the UBIT in an amount up to ten percent of the unrelated
business income computed without the inclusion of the
contributions.[4]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn4>Expenses
attributable to the dual use of facilities or personnel by exempt
activities and the unrelated trade or business of the organization require
an allocation between exempt and business functions on a “reasonable basis”.
[5]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn5>The
allocation of expenses of the exempt activity to the taxable business
when the unrelated business “exploits” an exempt function is allowed by the
regulations in certain limited situations. For example, if the unrelated
trade or business is of a kind carried on for profit by a taxable
organization, and the exempt activity exploited by the business is
comparable to the activities normally carried on by taxable organizations
in such a business, the expenses attributable to the exempt activity are
deductible to the extent that: 1) they exceed the income (if any)
attributable to the exempt activity, and 2) the allocation of the excess
expenses to the unrelated activities does not result in a loss from the
unrelated trade or
business.[6]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn6>

        This is a very generous rule, but may it allow for the allocation
of the expenses for production of the films and videos on the ministry’s
YouTube channel be deducted against the taxable advertising income from the
ads on the channel? Within limits, yes, since the exempt activity, film
making, is of “a type normally conducted by taxable organizations in
pursuance of such [a]
business”.[7]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn7>As
previously mentioned, the regulations have elaborate rules for
allocating expenses in the advertising
area[8]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn8>,
so some further study, and advice from a tax accountant, would have to be
undertaken before attempting this allocation. Exempt function expenses
first must be allocated to the income derived from or attributable to that
function – for example, expenses from filming a movie about the ministry
must first be allocated to income from donations to make the film, if any.
Then any excess may be allocated to the unrelated business income from the
YouTube ads.

        Net operating losses (NOL) are allowable as a deduction in
computing the UBTI and may be carried back and forward as in a normal
business activity.[9]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn9>However,
only income and deduction items not excluded from the UBTI are
taken into account for NOL purposes, and any preceding years in which the
organization was not an exempt organization are ignored in computing NOLs,
including carrybacks and
carryforwards.[10]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn10>But
allocation of the excess expenses will not be permitted to the extent
that it would result in a net operating loss from the unrelated business.
Also, the excess may not be allocated to another unrelated business of the
nonprofit that does not exploit the same function of film making in this
case, such as the selling of shirts and other merchandise by the ministry.
[11]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn11>However,
the regulations permit several businesses exploiting the same
exempt function to be consolidated, so that videos not part of the main
documentary film and the film may be put together to calculate the
UBTI.[12]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn12>


        As you can imagine, the allocation of expenses between related and
unrelated activities of a dual use facility, especially if employees are
used for both the exempt and business activities, is a difficult
calculation.[13]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn13>In
*Rensselaer Polytechnic Institute v. Commissioner,* a college field house
was used for both student activities such as college ice hockey, and
commercial uses including ice shows and public ice skating. The court
affirmed the tax court’s judgment that the apportionment of the field
house’s idle time should be by the hours devoted to exempt and non exempt
uses. The regulations suggest, as in the *Rensselaer* case, that time
devoted to the various activities is a “reasonable basis” for allocation.
[14]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn14>The
depreciation on a facility used for both the exempt activities and the
unrelated taxable business can be allocated by reference to the space used
for the various activities, unless there is a more reasonable basis for the
allocation.[15]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftn15>

        Therefore, if the documentary and YouTube videos were produced in
the ministry’s facilities where other ministry activities take place, the
amount of time used in the facility by the filmmakers for those films would
have to be apportioned to the unrelated business of the advertising
vehicle. At the same time, if ministry employees or personnel are used to
help produce the videos as well as the documentary film, an exempt use,
there would have to be apportionment of their time. The “reasonable basis”
to be used for the apportionment of taxes to the unrelated business
film/video production for YouTube would be a complex formula, perhaps even
worthy of requesting a Revenue Ruling from the I.R.S.

        All this leads to the question of whether it is worth it to have
the ministry involved with the making of the YouTube ad-sponsored videos.
Would there be enough revenue from the ads to fund the actual documentary,
and would the tax deductions available to the for-profit business help in
paying for the videos there, thus freeing up funds to make the documentary
without the ministry? Since the subject matter of the documentary is
directly related to the ministry’s purpose, I would still like to find a
way to use some of the revenue from the YouTube ads to fund the video.
Perhaps the use of a joint venture or partnership with the ministry and an
unrelated entity would be a workable alternative.



© 2012 Mary Ellen Tomazic





Mary Ellen Tomazic is an attorney in Cleveland specializing in entertainment
issue such as copyright, trademarks, contracts and licenses for musical
groups and filmmakers.


------------------------------

[1]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref1>I.R.C.
§ 512(a) (1) and Treas. Reg. § 1.512(a)-1(b).

[2]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref2>I.R.C.
§ 11(b)

[3]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref3>Treas.
Reg. § 1.512(a)-1(d).

[4]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref4>I.R.C.
§ 512(b)(1o)

[5]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref5>Treas.
Reg. § 1.512(a)-1(c).

[6]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref6>Treas.
Reg. § 1.512(a)-1(d)(2).

[7]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref7>Treas.
Reg. § 1.512(a)-1(d)(2).

[8]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref8>Treas.
Reg. § 1.512(a)-1(f)(2)-(7).

[9]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref9>I.R.C.
§ 512(b) (6).

[10]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref10>Treas.
Reg. § 1.512(b)-1(e).



[11]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref11>Treas.
Reg. § 1.512(a)-1(d) (2).

[12]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref12>Treas.
Reg. § 1.512(a)-1(f)(7).

[13]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref13>732
F.2d 1058 (U.S.Ct. App. 2d Cir., 1984).

[14]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref14>Treas.
Reg. § 1.512(a)-1(c).

[15]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%234.docx#_ftnref15>Id.
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