Ezel / IRS Rulings / 201741019
Technical Advice Memorandum 201741019 Released October 13, 2017 Advice

Trust owes UBIT on partnership and debt-financed income

Apply this to your situation

This page covers one taxpayer's ruling from 2017, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.

Currency note: this determination was released in 2017
Statutory amendments, regulation changes, court decisions, or later IRS guidance may have changed the analysis since then. Treat this page as historical context, not current tax advice. Verify current law before relying on any specific rule, threshold, or position mentioned here.
Not precedent. Under 26 U.S.C. § 6110(k)(3), this written determination may not be used or cited as precedent. It resolved one taxpayer's situation on its specific facts, and identifying details were redacted by the IRS before release. The official IRS release (linked on this page as a PDF) is the authoritative source.
About this page: The plain-English summary and ruling snapshot below were written by Ezel based on the official IRS release. The full text is the IRS's own document.
View official IRS release (PDF)

Plain-English summary

An exempt trust reported unrelated business taxable income from partnership interests and debt-financed property, paid the resulting tax, and later claimed a refund. The IRS concluded that section 501(b) subjects organizations exempt under section 501(a) to the unrelated business income tax rules and that section 511(b)(2) specifically applies those rules to an exempt trust that otherwise would be taxed under subchapter J. Income passed through from a partnership is taxable when the partnership's business is not substantially related to the trust's exempt purpose, even if the trust is only a limited or passive partner. Income from debt-financed property is likewise taxable unless substantially all of the property's use is substantially related to that purpose. Because the released memorandum found no sufficient relationship beyond producing funds, the partnership and debt-financed income was UBTI, although much of the trust-specific factual analysis is redacted.

Ruling snapshot

  • Question: Is the exempt trust subject to UBIT on income from partnerships and debt-financed property?
  • Outcome: advice given
  • Key authorities: IRC §§ 501(a)-(b), 511(b), 512, 513, 514; Treas. Reg. §§ 1.512(c)-1, 1.513-1(d), 1.514-1

Full text (IRS public release)

                          INTERNAL REVENUE SERVICE
                NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

                                            June 19, 2017


Number:     201741019
Release Date:    10/13/2017
                                                 Third Party Communication: None
                                                 Date of Communication: Not Applicable

Index (UIL) No.:      511.01-00, 512.00-00, 513.00-00, 513.01-00, 514.00-00
CASE-MIS No.:         TAM-136986-16

Chief, Appeals Office
Charlotte, NC

         Taxpayer’s Name:                        ---------------------------------------------------------------
         Taxpayer’s Address:                     --------------------------
                                                 ---------------
                                                 ------
         Taxpayer’s Identification No            -----------------
         Year(s) Involved:                       ----------------------------
         Date of Conference:                     ------------------------


LEGEND:

Trust          =      ---------------------------------------------------------------
Date 1         =      ----------------------------
Date 2         =      -----------------
Date 3         =      ------------------------
Date 4         =      -----------------------
Date 5         =      -------------------
Date 6         =      -------------------
Date 7         =      ---------------------
Year 1         =      -------
Year 2         =      -------
$A             =      ------------------
$B             =      ------------------
LP 1           =      -----------------------------
LP 2           =      ----------------------------------------------
LP 3           =      ------------------------------------------------------------
TAM-136986-16                                                        2

ISSUE(S):

Whether certain income of the Trust is subject to unrelated business income tax for the
taxable year ending Date 1.

Specifically:

     (1) Whether the Trust is subject to unrelated business income tax.

     (2) If so, whether the Trust’s ---------------------------------------- activities, with respect to
         partnerships and debt-financed property, are substantially related to the Trust’s
         exempt purpose.

CONCLUSION(S):

     (1) The Trust is subject to unrelated business income tax.
     (2) The Trust’s ---------------------------------------- activities, with respect to partnerships
         and debt-financed property, are not substantially related to the Trust’s exempt
         purpose.1

Thus, certain income of the Trust is subject to unrelated business income tax for the
taxable year ending Date 1.

FACTS:

The Trust is exempt from federal income tax as an organization described under section
--------------- of the Internal Revenue Code (the Code) ----------------------------------------------
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1
  This technical advice memorandum addresses only the Trust’s ----------------------------------------- activities
related to partnerships and debt-financed property. Other ----------------------------------------- activities of the
Trust are not at issue (see generally, IRC §513(c)). ------------------------------------------------------------------------
------------------------------------------------------------------ The Internal Revenue Code (Title 26 of the United
States Code) is referenced herein as the “IRC.” Similarly, the Treasury Regulations (Title 26 of the Code
of Federal Regulations) are referenced as “Treas. Reg.”
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TAM-136986-16                                                        3

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TAM-136986-16                                                        4

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----------------------------------15 The Trust --------------------------------- assets in various
instruments; the Trust has indicated that these ---------------- include partnership interests
and debt-financed assets.16

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TAM-136986-16                                                        5

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TAM-136986-16                                                        6

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Income from Partnerships and Debt-Financed Property

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

For the taxable year ending Date 1, the Trust reported $A as unrelated business taxable
income on its Form 990-T, and paid the resulting $B in unrelated business income tax.

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--- The Trust filed an amended Form 990-T for the taxable year ending Date 1, in which
it claimed a refund of the $B paid in unrelated business income tax (the Amended
Return). ---------------------------------------------------------------------------------------------------------
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TAM-136986-16                                                        7

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The IRS denied the refund claim, the Trust filed a Letter of Protest,41 and the IRS Office
of Appeals (Appeals) held a conference. In a letter dated ------------------- the Trust asked
Appeals to request technical advice pursuant to Revenue Procedure ----------- On --------
------------ Appeals submitted a request for a technical advice pre-submission conference
and a pre-submission conference was held on -------------------------42 Appeals
subsequently submitted the request for technical advice through division counsel on
-----------------------------43

LAW AND ANALYSIS

LAW

Statutory Construction

In Hardt v. Reliance Standard Life Insurance Co., 560 U.S. 242 (2010), the Supreme
Court reiterated the long standing principle that an analysis of statutory language begins
by assuming that the ordinary meaning of that language accurately expresses the
legislative purpose.44 The Court also reiterated that the plain and unambiguous statutory
language must be enforced according to its terms.45 These canons of statutory
construction are generally referred to as the canons of ordinary meaning and ambiguity

But in King v. Burwell, 135 S. Ct. 2480 (2015), the Supreme Court noted that oftentimes
the meaning or ambiguity of certain words or phrases may only become evident when
placed in context.46 The Court further noted that when deciding whether the language is
plain, it must read the words in their context and with a view to their place in the overall
statutory scheme.47 This determination may include prior legislative consideration of the
problem, the act’s legislative history, operation, and administration.48



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   Rev. Proc. -----------, ----------------------, Section 6.
43
   Rev. Proc. -----------, Section 7.
44
   560 U.S. at 251 (2010), quoting Gross v. FBL Financial Services, 557 U.S. 167 (2009).
45
   560 U.S. at 251 (2010), citing Carcieri v. Salazar, 555 U.S. 379 (2009); Jiminez v. Quarterman, 555
U.S. 113 (2009).
46
   135 S.Ct. at 2489, quoting FDA v. Brown & Williams Tobacco Corp., 529 U.S. 120, 132 (2000).
47
   135 S.Ct. at 2489, quoting FDA v. Brown & Williams Tobacco Corp., 529 U.S. 120, 133 (2000).
48
   135 S. Ct. at 2492 (discussion of the Affordable Care Act’s passage, citing Cannan, “A Legislative
History of the Affordable Care Act: How Legislative Procedure Shapes Legislative History, 105 L. Lib. J.
131 (2013)); National Woodwork Manufacturers Association v. N.L.R.B., 386 U.S. 612 (1967).
TAM-136986-16                                            8

In, Advocate Health Care Network, et. al. v. Stapleton, 581 U.S. ___, ___ (June 5,
2017) (Slip. op. at 9) the Supreme Court reiterated a cardinal principle of statutory
construction, which requires courts to “give effect, if possible, to every clause and word
of a statute.”49

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49
   See also United States v. Menasche, 348 U.S. 528, 538-539 (1955), quoting Inhabitants of Montclair
Township v. Ramsdell, 107 U.S. 147, 152 (1883); See also Williams v. Taylor, 529 U.S. 362, 404 (2000)
(J. O’Connor, concurring).
TAM-136986-16                                                        9


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TAM-136986-16                                            10

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Internal Revenue Code

Exemptions from Tax Under Section 501(a) and Subjection of Organizations Exempt
under Section 501(a) to Certain Taxes

Section 501(a) provides that an organization described in subsection (c) or (d) or
section 401(a) shall be exempt from taxation unless such exemption is denied under
section 502 or 503.

Section 501(b) provides that an organization exempt under section 501(a) shall be
subject to tax to the extent provided in parts II, III, and VI of subchapter F, but
(notwithstanding parts II, III, and VI of subchapter F) shall be considered an
organization exempt from income taxes for the purpose of any law which refers to
organizations exempt from income taxes.

Section 501(c)(1) describes, “Any corporation organized under Act of Congress which is
an instrumentality of the United States but only if such corporation –
         (A) is exempt from Federal income taxes –
               (i)   under such Act as amended and supplemented before July 18,
                     1984, or
               (ii)  under this title without regard to any provision of law which is not
                     contained in this title and which is not contained in a revenue Act,
                     or
TAM-136986-16                                            11

           (B) is described in subsection (l).

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Imposition of the Unrelated Business Income Tax

Section 511(a)(1) imposes a tax on the unrelated business taxable income (as defined
in section 512) of every organization described in section 511(a)(2) a tax computed as
provided in section 11.

Section 511(a)(2)(A) imposes a tax on the unrelated business taxable income of any
organization that is exempt from federal income tax by reason of section 501(a) except
for a trust described in section 511(b) or an organization described in section 501(c)(1)
(a corporation organized under Act of Congress which is an instrumentality of the U.S.)

Section 511(b)(1) imposes a tax on the unrelated business taxable income of every trust
described in section 511(b)(2), computed as provided in section 1(e) [income tax on
estates and trusts]. Section 511(b)(1) further provides that in making the computation
for purposes of this section, the term “taxable income” as used in section 1 shall be read
as “unrelated business taxable income” as defined in section 512.

Section 511(b)(2) provides that the tax imposed by section 511(a)(1) applies in the case
of any trust which is exempt from taxation under subtitle A by reason of section 501(a)
and which, if it were not for such exemption, would be subject to subchapter J (section
641 and following, relating to estates, trusts, beneficiaries, and decedents).

Section 512(a)(1) states that the term “unrelated business taxable income” (UBTI)
means the gross income derived by any organization from any unrelated trade or
TAM-136986-16                                       12

business (as defined in section 513) regularly carried on by it, less the applicable
deductions, and computed with the modifications in section 512(b).
Section 512(b)(1) excludes from UBTI, all dividends, interest, payments with respect to
securities, loans (as defined in subsection (a)(5)), amounts received or accrued as
consideration for entering into agreements to make loans, and annuities, and all
deductions directly connected with such income.

Section 512(b)(4) states, in part, that in the case of “debt-financed property” (as defined
in section 514) there shall be included as an item of gross income derived from an
unrelated trade or business, the amount ascertained under section 514(a)(1).

Section 512(c) provides that if a trade or business regularly carried on by a partnership
of which an organization is a member is an unrelated trade or business with respect to
such organization, such organization in computing its unrelated business taxable
income shall, subject to the exceptions, additions, and limitations contained in section
512(b), include its share (whether or not distributed) of the gross income of the
partnership from such unrelated trade or business and its share of the partnership
deductions directly connected with such gross income. This is true regardless of
whether the organization is a limited partner or only has a passive role in the
management of the partnership.51

Section 513(a) provides that the term “unrelated trade or business” means, in the case
of any organization subject to the tax imposed by section 511, any trade or business the
conduct of which is not substantially related (aside from the need of such organization
for income or funds or the use it makes of the profits derived) to the exercise or
performance by such organization of its charitable, educational, or other purpose or
function constituting the basis for its exemption under section 501.

Section 514(a)(1) provides that in computing unrelated business taxable income under
section 512, with respect to each debt-financed property, there shall be included as an
item of gross income derived from an unrelated trade or business an amount that is the
same percentage (but not in excess of 100 percent) of the gross income derived from
the property during a taxable year as (A) the average acquisition indebtedness with
respect to the property is to (B) the average amount of the property’s adjusted basis
during the period it is held by the organization during such taxable year.

Section 514(b)(1) provides that the term “debt-financed property” means any property
which is held to produce income and with respect to which there is acquisition
indebtedness (as defined in section 514(c) of the Code) at any time during the taxable
year.



51                                                                                             th
  See Plumstead Theatre Society, Inc. v. Commissioner, 74 T.C. 1324 (1980); 675 F.2d 244 (9 Cir.
1995); Service Bolt & Nut Co. Profit Sharing Trust v. Commissioner, 724 F.2d 519 (6th Cir.1983), affg, 78
T.C. 812 (1982).
TAM-136986-16                                13

Section 514(b)(1)(A)(i) excludes from the definition of “debt-financed property” any
property substantially all the use of which is substantially related (aside from the need of
the organization for income or funds) to the exercise or performance by such
organization of the purpose or function constituting the basis for its exemption under
section 501.

Section 514(c)(2) provides that where property is acquired subject to a mortgage or
other similar lien, the amount of the indebtedness secured by such mortgage or lien
shall be considered as an indebtedness of the organization incurred in acquiring such
property even though the organization did not assume or agree to pay such
indebtedness.

Section 1.512(c)-1 of the Treasury Regulations provides that in the event an
organization to which section 511 applies is a member of a partnership regularly
engaged in a trade or business which is an unrelated trade or business with respect to
such organization, the organization shall include in computing its unrelated business
taxable income so much of its share (whether or not distributed) of the partnership gross
income as is derived from that unrelated business and its share of the deductions
attributable thereto.

Section 1.512(c)-1 of the Treasury Regulations also includes an example which
illustrates how UBTI is calculated in a situation in which an exempt organization
receives partnership income that is UBTI and partnership income that is not UBTI from
the same partnership. In the example, an exempt organization is a partner in a
partnership that operates an unrelated business and holds stock in a corporation. The
example illustrates that the exempt organization must include its share of the gross
income from the unrelated business in computing its UBTI but not its share of any
dividends as that income is excluded from UBTI under section 512(b)(1).

Section 1.513-1(d)(1) of the Treasury Regulations provides that gross income derives
from an “unrelated trade or business” within the meaning of section 513(a) of the Code
if the conduct of the trade or business which produces the income is not substantially
related (other than through the production of funds) to the purposes for which exemption
is granted.

Section 1.513-1(d)(2) of the Treasury Regulations provides that a trade or business is
“related” to exempt purposes only where the conduct of the business activities has a
causal relationship to the achievement of exempt purposes (other than through the
production of income). A trade or business is “substantially related” only if the causal
relationship is a substantial one. Thus, for the conduct of a trade or business from which
a particular amount of gross income is derived to be substantially related to purposes
for which exemption is granted, the production or distribution of the goods or the
performance of the services from which the gross income is derived must contribute
importantly to the accomplishment of those purposes.
TAM-136986-16                                14

Section 1.514(b)-1(b)(1)(i) of the Treasury Regulations provides that to the extent that
the use of any property is substantially related (aside from the need of the organization
for income or funds or the use it makes of the profits derived) to the exercise or
performance by an organization of its charitable, educational, or other purpose or
function constituting its basis for exemption under section 501 of the Code, such
property shall not be treated as “debt-financed property.” It further directs the reader to
see section 1.513-1 for principles applicable in determining whether there is a
substantial relationship to the exempt purpose of the organization.

Section 1.514-1(b)(1)(ii) of the Treasury Regulations provides that if substantially all of
any property is used in the manner described in subdivision (i), such property is not
treated as debt-financed property. In general, the preceding sentence applies if 85
percent or more of the use of such property is devoted to the organization’s exempt
purpose. The extent to which property is used for a particular purpose shall be
determined on the basis of all the facts and circumstances.

Section 1.514-1(b)(1)(ii) includes Example 2, which illustrates the application of the
rules for determining whether a given property is debt-financed property. In the
example, an exempt college owns a four story office building which has been purchased
with borrowed funds. The gross income derived from the building is $6,000 all of which
is attributable to rents paid by tenants. The bottom two stories of the building are used
to house computers which are used by the college for administrative purposes. The top
two stories are rented to the public for purposes not described in §514(b)(1)(A), (B), (C),
or (D). The example states that in accordance with §1.514-1(b)(1)(i), the bottom half of
the building is used in a manner that is substantially related to the college’s exempt
purpose (aside from the college’s need for funds). Thus, only the upper half of the
building is debt-financed property.

Section 1.514(c)-1(a)(2) cites an example (Example (4)) of an exempt organization
which enters into a partnership with two individuals. The business of the partnership
involves an office building which is leased to the public. With respect to the character of
any item realized by the partnership and included in a partner’s distributive share, the
example points out that the particular item shall be determined as if the partner realized
such item directly from the source from which it was realized by the partnership and in
the same manner.

Rev. Rul. 79-222, 1979-2 C.B. 236, holds that the investment of an exempt employees’
trust as a limited partner in a partnership carrying on an unrelated trade or business
may result in unrelated business taxable income within the meaning of section 512 of
the Code.

In Service Bolt & Nut Co. Profit Sharing Trust v. Commissioner, 724 F.2d 519 (6th
Cir.1983), confirming the IRS’s position in Rev. Rul. 79-222, the Sixth Circuit affirmed
the Tax Court’s decision that a tax-exempt limited partner was taxable under sections
TAM-136986-16                                     15

512(c) and 513(b)(2) on income derived from a partnership in the same manner as if it
were a general partner.52

Rev. Rul. 74-197, 1974-1 C.B. 143, held that the investment by an exempt employees’
trust in a partnership that was organized to invest in securities and borrowed funds for
that purpose resulted in unrelated business taxable income to the extent its share of
partnership income was derived from or on account of the debt-financed securities.

Rev. Rul. 77-72, 1977-1 C.B. 157, citing legislative history, states that the intent of
section 514 of the Code is to treat an otherwise exempt organization in the same
manner as an ordinary business enterprise to the extent that the exempt organization
purchases property through the use of borrowed funds.53 The legislative history
indicates that the purpose of the acquisition indebtedness provisions of section 514 of
the Code was to “...discourage a developing device for trading in the tax exemption of
nonprofit organizations, which now escapes unrelated business income tax.” The
Report stated that “[d]uring the past several years a device has been developing which
exploits these weaknesses in the taxation of unrelated business income of tax-exempt
organizations. The net effect is the use of the tax exemption to reduce taxes for owners
of a business by converting ordinary income to capital gain and eventually to acquire a
business for a tax-exempt organization entirely out of the earnings of that business.”
The committee indicated that it believed that “[t]his type of transaction with its damaging
consequences to the Federal revenues as well as its potential for unfair business
competition should be discouraged.”

In Elliot Knitwear Profit Sharing Plan v. Commissioner, 614 F.2d 347 (3rd Cir. 1980), the
court concluded that a section 401(a) profit-sharing plan’s purchase of securities on
margin constituted debt-financed property and income derived from the securities was
taxable as unrelated business income. The purchase of such securities on margin was
not substantially related (aside from the need of the organization for income or funds) to
the performance of the plan’s exempt purpose of providing deferred compensation
because purchasing securities on margin was only “a means to accomplish the purpose
of deferred compensation[,] ... not the purpose itself of the Plan.”54

In Alabama Central Credit Union v. United States, 646 F. Supp. 1199 (N.D. Ala.
1986), the court held that the securities bought on margin with borrowed funds in order
to maximize yield or income was debt-financed property within the meaning of section

514. The indebtedness incurred in the purchase of the securities constituted “acquisition
indebtedness,” as defined in section 514(c). Additionally, the transactions did not fall
within the exception for debt incurred in performing an exempt purpose set forth in
section 514(c)(4), because the securities purchases were not inherent in the
performance or exercise of the credit union’s tax-exempt function, but rather were

52
   78 T.C. 812 (1982).
53
   H.R. Rep. No. 91-413, 91st Cong., 1st Sess. 46 (1969), 1969-3 C.B. 200, 230; H.R. Rep. No. 91-413,
91st Cong., 1st Sess. 46 (1969); 1969-3 C.B. 200, 228-230.
54
   614 F.2d at 350.
TAM-136986-16                                           16

undertaken in order to obtain favorable return on investment money. Therefore, the
proceeds were properly characterized as unrelated business income taxable under
section 512(b)(4). The credit union was permitted to make such investments, but the
income derived from them was taxable.

In Ocean Cove Corporation Retirement Plan and Trust v. United States, 657 F. Supp.
776 (S.D. Fla. 1987), the court found that securities purchased on margin by a section
401(a) pension plan constituted debt-financed property and therefore income derived
from the securities was taxable as unrelated business income. Such securities were not
property substantially all the use of which was substantially related (aside from the need
of the organization for income or funds) to the performance of the plan’s exempt
purpose because the exempt “purpose of a pension retirement plan is to provide for the
future retirement of existing employees” and “[i]nvesting in securities, particularly those
that are purchased on margin, is merely one way of accomplishing th[ose] intended
purposes.”55

In Kern County Electrical Pension Fund v. Commissioner, 96 T.C. 845 (1991), aff’d, 988
F.2d 120 (9th Cir. 1993), the court concluded that the exempt trust of a section 401(a)
employee pension plan had to pay UBIT on interest earned on certificates of deposit
purchased with borrowed funds because the interest qualified as debt-financed income.

In Henry E. & Nancy Horton Bartels Trust for the Benefit of University of New Haven v.
United States, 209 F.3d 147 (2d Cir. 2000), the court considered a tax-exempt trust that
engaged in investment activities, including the purchase of securities on margin, to
provide support for a university. The court determined that the purchase of such
securities was not substantially related (aside from the need of the organization for
income or funds) to the performance of the plan’s exempt purpose because the
taxpayer’s exempt purpose was not to invest but rather to provide funds to support the
university’s educational programs.

In Henry E. & Nancy Horton Bartels Trust for the Benefit of Cornell University v. United
States, 617 F.3d 1357 (Fed. Cir. 2010), the court considered another tax-exempt trust
that invested by purchasing securities on margin, to provide support for a university. To
begin, the court observed that sections 512(b)(4) and 514(a) together define an
additional category of UBTI, debt-financed property, which is accordingly subject to
UBIT. The court further observed that for debt-financed property, “section 514 nullifies
section 512(b)’s general exemption of dividends, interest, royalties, and the like from
UBIT.”56 With respect to the trust at hand, the court determined that securities
purchased on margin (money borrowed from the trust’s broker to complete the stock
purchases) constituted debt-financed property and, therefore, income derived from the
purchase of securities on margin constituted UBTI.



55
     657 F. Supp. at 779-80.
56
     Bartels Trust for the Benefit of Cornell University v. U.S., 617 F.3d 1357, 1360 (Fed. Cir. 2010).
TAM-136986-16                                        17

In Southwest Texas Electric Coop. v. Commissioner, T.C. Memo 1994-363, aff’d, 67
F.3d 87 (5th Cir. 1995), the court held that Treasury notes acquired with tax-exempt
bond proceeds were not substantially related to the organization’s exempt purpose. The
court reasoned that the indebtedness used to purchase Treasury notes would not have
been incurred except to purchase them.

ANALYSIS

I. The Trust is Subject to UBIT


A. The Trust is Exempt from Federal Income Tax Under Section 501(a) and Subject to
   Unrelated Business Income Tax Under Section 501(b)

Section 501(a) provides for exemption from federal income taxes for an organization
described in subsection (c) or (d) or section 401(a). Statutory language which is plain
and unambiguous language such as the language in section 501(a) must be enforced
according to its terms.57 Because the Trust is --------------------------------------, it is an
organization described in section 501(c). Therefore, section 501(a) exempts the Trust
from federal income tax.

Section 501(b) provides in relevant part that an organization exempt from tax under
section 501(a) shall be subject to tax to the extent provided in parts II, III, and VI of
subchapter F. Section 501(b)’s language is also plain and unambiguous in its subjection
of organizations exempt from tax under section 501(a) to tax under parts II, III, and VI of
subchapter F.58 Accordingly, section 501(b) must be “enforced” according to its terms.59

Part III of subchapter F is entitled “Taxation of business income of certain exempt
organizations.” Part III lists its sections as follows:

        Section 511              Imposition of tax on unrelated business income of charitable,
                                 etc. organizations.
        Section 512              Unrelated business taxable income.
        Section 513              Unrelated trade or business.
        Section 514              Unrelated debt-financed income.
        Section 515              Taxes of foreign countries and possessions of the
                                 United States



57
   Hardt v. Reliance Standard Life Ins. Co., 560 U.S. at 251 (2010), citing Carcieri v. Salazar, 555 U.S.
379 (2009); Jiminez v. Quarterman, 555 U.S. 113 (2009).
58
   Hardt v. Reliance Standard Life Ins. Co., 560 U.S. at 251 (2010), citing Carcieri v. Salazar, 555 U.S.
379 (2009); Jiminez v. Quarterman, 555 U.S. 113 (2009).
59
   Hardt v. Reliance Standard Life Ins. Co., 560 U.S. at 251 (2010), citing Carcieri v. Salazar, 555 U.S.
379 (2009); Jiminez v. Quarterman, 555 U.S. 113 (2009).
TAM-136986-16                                            18

As a general matter, section 501(b) unambiguously subjects the Trust to tax in part III of
subchapter F because the Trust is an organization exempt from tax under section
501(a).60 Because Part III includes imposition of the unrelated business income tax
(sections 511 – 514), the Trust is generally subject to the unrelated business income tax
(UBIT).

B. ----------------------------------------------------------------------------------------------------------------
   --------------------------------------------------

Section 511(a)(2)(A) applies UBIT to any organization that is exempt from federal
income tax by reason of section 501(a) except for a trust described in section 511(b) or
an organization described in section 501(c)(1). As discussed further below, the Trust is
subject to UBIT under section 511(b).

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           ---------------------------------------------------------------------------------------
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           (A) -----------------------------------------------------
                  (i)      ------------------------------------------------------------------------
                           --------------------------------
                  (ii)     ---------------------------------------------------------------------------------
                           ---------------------------------------------------------------------------------
                           ---------------------
           (B) ----------------------------------------

To be exempt under section 501(c)(1)(A) or (B), the organization must first be, “a
corporation organized under Act of Congress which is an instrumentality of the United
States.” ---------------------------------------------------------------------------------------------------------
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-----------------------61

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60
   Hardt v. Reliance Standard Life Ins. Co., 560 U.S. at 251 (2010), citing Carcieri v. Salazar, 555 U.S.
379 (2009); Jiminez v. Quarterman, 555 U.S. 113 (2009).
61
   See Hardt v. Reliance Standard Life Ins. Co., 560 U.S. at 251 (2010), citing Carcieri v. Salazar, 555
U.S. 379 (2009); Jiminez v. Quarterman, 555 U.S. 113 (2009).
TAM-136986-16                                                        19

---------------------------------------------------------------------------62 ---------------------------------------
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          (1) -------------------------------------------------------------------------------------------------------
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          (2) -------------------------------------------------------------------------------------------------------
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62
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TAM-136986-16                                                        20

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C. Section 511(b) Imposes UBIT on the Trust, ------------------------------------------------------
   -----------------------------------------------------------------------------------------------


1.        Section 511(b)(2) Imposes UBIT on the Trust

Section 511(b)(2) of the Code imposes UBIT on the Trust. Section 511(b)(2) provides
that the tax imposed by section 511(b)(1) applies in the case of any trust which is
exempt from taxation under subtitle A by reason of section 501(a) and which, if it were
not for such exemption, would be subject to subchapter J (sec. 641 and following,
relating to estates, trusts, beneficiaries, and decedents). The plain and unambiguous
language in section 511(b)(2) imposes UBIT on a trust that is exempt from taxation
under subtitle A by reason of section 501(a) and, if it were not for that exemption, would
be subject to subchapter J. Accordingly, the language in section 511(b) must be
“enforced” according to its terms.66

As discussed above, the Trust is exempt from tax under subtitle A by reason of section
501(a). Thus, it satisfies this first requirement to be subject to UBIT under section
511(b)(2).

Second, the Trust would be subject to subchapter J (sec. 641 and following) were it not
for its exemption ----------------------------------. Section 641 in relevant part applies the tax
imposed by section 1(e) to the taxable income “of any kind of property held in trust.”
Because the Trust -------------------------------------------------------------------------------------------
---------------------------------------------------- the Trust would be subject to subchapter J were
it not for its exemption ---------------------------------- Thus, it satisfies the second
requirement and is subject to UBIT by direct application of section 511(b)(2).


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65
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66
   Hardt v. Reliance Standard Life Ins. Co., 560 U.S. at 251 (2010), citing Carcieri v. Salazar, 555 U.S.
379 (2009); Jiminez v. Quarterman, 555 U.S. 113 (2009).
TAM-136986-16                                                 21


2.       ------------------------------------------------------------------------------------------------------------
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67
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68
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TAM-136986-16                                            22


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D. ----------------------------------------------------------------------------------------------------------------
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Generally, tax exemptions are matters of legislative grace that must be narrowly
construed and unambiguously proven.69 --------------------------------------------------------------
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1.       ----------------------------------------------------------------------------------------------------

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69
   See, e.g., United States v. Wells Fargo Bank, 485 U.S. 351, 354 (1988); Bingler v. Johnson, 394 U.S.
741, 752 (1969); New Colonial Ice v. Helvering, 292 U.S. 435, 440 (1934); and Kile v. Comm’r, 739 F. 2d
               th
265, 268 (7 Cir. 1984).
70
   ------------------------------
71
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TAM-136986-16                                                        23

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72
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75
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78
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TAM-136986-16                                            24

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79
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80
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83
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84
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85
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TAM-136986-16                                            25

----------------------86 --------------------------------------------------------------------------------------------
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86
   Advocate Health Care Network, 581 U.S. ___, ___ (June 5, 2017) (Slip. op. at 9); Corley v. U.S., 556
U.S. 303 (2009); Moneygram International, Inc. and Subsidiaries v. Commissioner, 118 A.F.T.R.2d 2016-
6652.
87
   ---------------------------------
88
   -------------------------------------------
89
   -------------------------------------
TAM-136986-16                                                        26

---------------------------------------------------------------------90 ---------------------------------------------
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--------------------------------------------------------------------------------------------------------91 ----------
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However, Congress provided exemption from federal income tax and UBIT for these
organizations under sections 501(c)(1) and 511(a)(2)(A). -----------------------------------------
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------------------92 ------------------------------------------------------------------------------------------------
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---------------------------------------------

E.        Conclusion of Part I

Section 501 subjects the Trust to UBIT and section 511 imposes the tax on the Trust. ---
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----------------------------------------------------------------------------------------- Therefore, the Trust
is subject to UBIT. -------------------------------------------------------------------------------------------
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90
   -----------------------------------------------------------------------------------------------------------------------------------------
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91
   ------------------------------------------
92
   ----------------------------------------------------------------------------------------------------------------------------------------
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--------------
TAM-136986-16                                                        27

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-------------------------------------------------------------------------------------93

II. The Trust’s -----------------------------------------Activities, with Respect to Partnerships
    and Debt-Financed Property, Are Not Substantially Related to its Exempt Purpose

Section 513 of the Code provides that income from a trade or business operated by an
exempt organization is UBTI to the exempt organization unless the trade or business is
substantially related to the exempt purpose of the exempt organization. With respect to
a partnership in which an exempt organization is a member, the trade or business
operated by the partnership must be substantially related to the exempt purpose of the
organization in order for the exempt organization’s income from the partnership that is
attributable to the trade or business of the partnership to be exempt from UBIT.

With respect to property purchased with debt, section 514 of the Code automatically
treats income from such property as income from an unrelated trade or business unless
substantially all of the use of the property is substantially related to the exempt purpose
of the organization. The same rule applies to the extent that an exempt organization is a
member of a partnership that holds property purchased with debt.94

Because these analyses begin with the organization’s exempt purpose, establishment
of that purpose is a crucial first step.

A. ---------------- Exempt Purpose ------------------------------------------------------------------------
   ----------------------------

Because the treatment of the Trust’s income from partnerships and debt-financed
property – i.e., whether or not such income is UBTI – depends upon whether there is a
substantial relationship between the Trust’s exempt purpose and the businesses of the
partnerships, or the use of the property, it is essential to establish what the Trust’s
exempt purpose is. ------------------------------------------------------------------------------------------
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1. -----------------------------------------------------------------------------------------------------------

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93
   -----------------------------------------------------------------------------------------------------------------------------------------
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94
   IRC §512(c); Treas. Reg. §1.512(c)-1; Service Bolt & Nut Co. Profit Sharing Trust v. Commissioner,
                     th
724 F.2d 519 (6 Cir. 1983); Rev. Rul. 79-222, 1979-2 C.B. 236.
TAM-136986-16                                                        28

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--------------------------------------95

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2. ----------------------------------------------------------------------------------------------------------------
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a. ------------------------------------------------

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----------------------------96 --------------------------------------------------------------------------------------
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More specifically, in the context of partnerships, section 513(a) requires a “substantial
relationship” between the businesses of the partnerships in which the Trust holds
membership interests and the exempt purpose of the Trust, -------------------------------------

95
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96
   -----------------------------------------
TAM-136986-16                                                        29

------------------------------------------------------------------------------------------------, in order to
avoid UBIT.97 ----------------------------- In the context of debt-financed property, section
514(b) requires that substantially all of the use of the property be substantially related to
the Trust’s exempt purpose, aside from the Trust’s need for income or funds.98 ------------
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----------------100

b. ----------------------------------------------------------------------------------------------------------------
   --------


i. ------------------------------------------

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

          ------------------------------------------------------------------------------------------------------
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          -------------------------------------------------------101 --
                   --------------------------------------------------------------------------------------

97
   IRC §513(a).
98
   IRC §514(b).
99
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100
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101
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TAM-136986-16                                               30

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102
      ------------------------------------------------
TAM-136986-16                                                        31

ii. ----------------------------------------------------------------------------------------------------------------
    -----------------------------------------------------------------------

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--------------------------------------------------------------103 --------------------------------------------------
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--------------------------------------------

B. The Trust’s -----------------------------------------Activities, with Respect to Partnerships
   and Debt-Financed Property, Do Not Satisfy the Substantial Relationship Tests
   Under Sections 513 and 514 of the Code


1.        The Substantial Relationship Tests of Sections 513 and 514 of the Code

          a. The Substantial Relationship Test of Section 513

Section 513(a) of the Code excludes conduct that merely meets, “the need of [an]
organization for income or funds” from being considered “substantially related” to that
organization’s exempt purpose or function.104 The substantial relationship must be
established aside from the need of the organization for income or funds or the use it
makes of the profits derived from the trade or business.105 Section 1.513-1(d)(2) of the
regulations states that a trade or business is substantially related to an organization’s
exempt purposes only where the conduct of the business activities has a substantial
causal relationship to the achievement of those purposes – other than through the
production of funds – and contributes importantly to the accomplishment of those
purposes.

          b. The Substantial Relationship Test of Section 514

With respect to section 514, section 514(a)(1) automatically treats income from debt-
financed property as income derived from an unrelated trade or business. Section
514(b)(1)(A)(i) provides that debt-financed property does not include, “any property
substantially all the use of which is substantially related (aside from the need of the
organization for income or funds) to the exercise or performance” of its exempt
purpose.106 The relevant sections of the Code and the Treasury Regulations

103
    ----------------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------
104
    IRC §513(a); Treas. Reg. §1.513-1(d)(1).
105
    IRC §513(a); Treas. Reg. §1.513-1(d)(1).
106
    IRC § 514(b)(1)(A)(i).
TAM-136986-16                                          32

unanimously provide that a trade or business is related to exempt purposes only where
the conduct of the business activities has a causal relationship to the achievement of
exempt purposes other than through the production of income. Otherwise, such
property is “debt-financed property” under section 514(b).

In the context of income from property acquired with debt, the Treasury Regulations
provide that at least 85% of each relevant property must be used in a manner that is
substantially related to the Trust’s exempt purpose or function, aside from the Trust’s
need for income or funds.107 For example, the portion of an office building purchased
with borrowed funds by an exempt college and used to house computers which are
used by the college for administrative purposes, would not be debt-financed property.108
But the portion of that office building used simply to generate income, such as rental
income, would be debt-financed property.109

        c. Sections 513 and 514 in the Context of Partnerships

In general, exempt organizations may serve as general or limited partners in a
partnership, as long as certain parameters are met.110 For UBIT purposes, income an
exempt organization derives from participation in general or limited partnerships is not
taxable as UBTI if the trade or business of the partnership is substantially related to the
organization’s exempt purpose.111 Because partnerships are pass-through entities,112
the activity of the partnership is attributed to the exempt organization as if the exempt
organization were conducting the activity itself in situations in which an exempt
organization is a general or limited partner.113 If the organization receives income from
the trade or business of a partnership that is not substantially related to the
organization’s exempt purpose, then that income is taxable as UBTI.114 Similarly, if the
organization receives income from debt-financed property that it holds directly or
through a partnership and substantially all the use of that property is not substantially
related to the organization’s exempt purpose, then that income is taxable as UBTI.115

According to the requirements of sections 513 and 514 described above, we address
the issue of whether there is a substantial relationship between the Trust’s exempt
purpose ---------------------------------------------------------------------------------------------------------
107
    IRC § 514(b)(1)(A)(i); Henry E. & Nancy Horton Bartels Trust for the Benefit of University of New
                              nd
Haven, 209 F.3d 147, 155 (2 Cir. 2000); Elliot Knitwear Profit Sharing Plan v. Commissioner, 614 F. 2d
347, 350 (3rd Cir. 1980); Southwest Texas Elec. Co-op., Inc. v. Commissioner, T.C. Memo 1994-363
(1994).
108
    Treas. Reg. § 1.514-1(b)(1)(ii) (Example 2).
109
    Treas. Reg. § 1.514-1(b)(1)(ii) (Example 2).
110
    See generally Plumstead Theatre, Service Bolt & Nut; Rev. Rul. 98-15, 1998-1 C.B. 718.
111
    IRC §§ 512(c), 513(a); Treas. Reg. §§ 1.513-1(d)(1) and (2); Plumstead Theatre, Service Bolt & Nut;
Rev. Rul. 98-15.
112
    IRC § 512(c); Treas. Reg. § 1.512(c)-1; Plumstead Theatre and Service Bolt & Nut.
113
    IRC § 512(c); Treas. Reg. §§ 1.512(c)-1, 1.514(c)-1(a)(2); Plumstead Theatre, Service Bolt & Nut;
Rev. Rul. 98-15.
114
    IRC § 512(c).
115
    IRC §§ 512(b)(4), 512(c), 514(a), 514(b)(1)(A)(i); Rev. Rul. 79-222.
TAM-136986-16                                                        33

-----------------------------------------------------and the businesses of the partnerships in which
it holds interests. Likewise, we address whether there is a substantial relationship
between the Trust’s exempt purpose and the use of any debt-financed property it holds
directly or indirectly through a partnership.116

2.        ------------------------------------------------------------------------------------------------------------
          ------------------------------------------------------------------------------------------------------------
          -------------------------------------------------------------


a. Detailed Review of the Relevant Facts

The Trust has indicated that the $A of income on which it paid UBIT for the tax year
ending Date 1, was income from partnerships in which the Trust held membership
interests and debt-financed assets.117

On its Original Return, the Trust reported $A of UBTI from LP 1.118 It paid UBIT of $B on
this UBTI. ------------------------------------------------------------------------------------------------------
------------------LP 1 119 ---------------------------------------------------------------------------------------
--------------------------------120

On its Amended Return, the Trust reported income from ------------------------------------- LP
1, LP 2, and LP 3.121 ----------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-------------------- The Trust stated its belief that income earned from -------------- was not
UBTI because the ----------------------------------------activities giving rise to the income were
substantially related to the Trust’s exempt purpose. But the Amended Return did not
explain how the businesses of the partnerships -----------------------------------------------------
------------------------------------------------------------------------were substantially related to the
Trust’s exempt purpose ------------------------------------------------------. -----------------------------




116
    ----------------------------------------------------------------------------------------------------------------------------------------
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117
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118
    --------------------------------------------------------------------------------------------------------------
119
    -------------------------------------------------------
120
    -------------------------------------------------------------
121
    ----------------------------------------------------------------------------------------------------------------------------------------
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-------------------
TAM-136986-16                                                        34

-------------------------------------------------------------------- LP 1, LP 2, or LP 3.122 -----------------
--------------------------------------------------------------------------------------------------123

-----------------Year 1 ------------------------------------------------------------------------------------------
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--------------------------------------------------------124 --------------------------------------------------------
-------------------------------------------------------------------------------125 ---------------------------------
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------------------Year 1 -----------------------------------------------------------------------------------------
----------------------------

--------------------------------------------------------------------------------the Trust stated that
investing in certain debt-financed assets and partnership interests contributes
importantly to the achievement of the Trust’s exempt purpose ----------------------------------
----------------------------------------------------------------------------126 ------------------------------------
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-----------------------------------------------------127

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--------------------------------------------------------------------------128 --------------------------------------
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-----------------------------------------------------------------------------------------LP 1, LP 2, and LP 3
-----------------------------------------129 -----------------------------------------------------------------------
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--------------------------------------




122
    ----------------------------------------------------------------------------------------------------------------------------------------
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123
    ---------------------------------------------------------------
124
    --------------------------------------------
125
    ----------------------------------------------
126
    ----------------------------------------------------------------------------------------------------------------------------------
127
    ----------------------------------------------------------------------------------------------------------------------------------------
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128
    --------------------------------------------------------
129
    ----------------------------------------------------------------------------------------------------------------------------------------
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TAM-136986-16                                                        35

b.       ------------------------------------------------------------------------------------------------------------
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-------------------------------------------------------------------

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----------------------------------------------------130

To the extent that the partnerships in question hold debt-financed property -----------------
------------------------------------------------------------------------------the Trust has not met the
requirement of section 514(b)(1)(A)(i) because it has not shown that the use of its debt-
financed properties is substantially related to the achievement of its exempt purpose
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---------------------------------------------------------------------

c. In Addition to the Code and the Treasury Regulations, the Case Law Makes Clear
   that a Substantial Relationship Must be Established -------------------------------------------
   -----------

The only relationship between the Trust’s exempt function and the businesses of the
partnerships, and the use of properties purchased with debt, appears to be -----------------
----------------------------------- In addition to the Code and the Treasury Regulations, the
case law makes clear that such a relationship is insufficient for ---------------- activities to
be considered substantially related to the purposes of -------- section 501(c)
organizations or trusts exempt from tax under section 501(a) -----------------------------------
---------------------------------------------------------------------------------------------------------------------
----------

For example, courts have determined that for purposes of section 514, the exempt
purpose of a qualified retirement trust is not to invest assets but to provide retirement


130
    ----------------------------------------------------------------------------------------------------------------------------------------
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-----------------------------------------------------------------------------------
TAM-136986-16                                            36

benefits or deferred compensation.131 Thus, courts have rejected the argument that the
purchase or use of debt-financed investments is substantially related to the exempt
purpose of qualified retirement trusts and other exempt organizations that manage and
invest assets to support the program of separate organizations.132 ----------------------------
---------------------------------------------------------------------------------------------------------------------
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----------------------------------------------------------------------------------------------------------133 The
IRS reached a similar conclusion in Rev. Rul. 74-197 in which it held that the investment
property acquired by an exempt employees’ trust through a partnership that borrowed
funds to invest in the property was not substantially related (aside from the need of the
trust for funds) to the organization’s exempt purpose.

------------------------------------------------------------------------------------------------------- but courts
have held that the exempt purpose of --------------- entities was to support the program of
the separate organization, and the ---------------- activities were just a means to that end.
For example, in Henry E. & Nancy Horton Bartels Trust for the Benefit of University of
New Haven, the Second Circuit considered a tax-exempt trust that engaged in
---------------- activities including the purchase of securities on margin to provide support
for a university. The court determined that the taxpayer’s exempt purpose was not to
invest but rather to provide funds to support the university’s educational programs.
While margin-financed securities “may be useful to accomplish that exempt purpose by
their ability to generate income,” the court concluded that “their purchase and use was
not otherwise substantially related to the taxpayer’s tax-exempt purpose.”134

Similarly, in Elliot Knitwear Profit Sharing Plan v. Commissioner, the Third Circuit found
that the taxpayer’s purpose was not investing but, “to provide for employee participation
in the profits of the employer.”135 The court stated that investment for the additional
accumulation of income and gains is certainly a “desirable function” of a profit-sharing
plan, but that the plan’s purpose could be accomplished without borrowing.136
Accordingly, the court rejected the taxpayer’s argument that the purchase of securities
on margin was substantially related to the organization’s exempt purpose.137

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131
    Elliot Knitwear Profit Sharing Plan v. Commissioner, 614 F.2d 347, 350 (3rd Cir. 1980); Ocean Cove
Corporation Retirement Plan and Trust v. United States, 657 F. Supp. 776, 779-780 (S.D. Fla. 1987);
Kern County Electrical Pension Fund v. Commissioner, 96 T.C. 845, 853 (1991).
132
    Henry E. & Nancy Horton Bartels Trust for the Benefit of the University of New Haven v. U.S., 209
                       nd
F.3d 147, 155-156 (2 Cir. 2000); Ocean Cove Corp. Retirement Plan and Trust v. U.S., 657 F. Supp.
776, 779-780 (S.D. Fla. 1987); Alabama Central Credit Union v. U.S., 646 F. Supp. 1199, 1205 (1986).
133
    Ocean Cove Corp. Retirement Plan and Trust v. U.S., 657 F. Supp. 776, 780 (S.D. Fla. 1987).
134
    209 F.3d at 156.
135
    614 F.2d at 350.
136
    614 F.2d at 350. See also Ala. Cent. Credit Union v. United States, and Southwest Tex. Elec. Coop. v.
Commissioner.
137
    Elliot Knitwear, 614 F.2d at 350.
TAM-136986-16                                                        37

---------------------------------------------------------------138 -------------------------------------------------
-----------------------------------139 -------------------------------------------140 -------------------------
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----------------------------------------------------------------------------------142 ------------------------------
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----------------------------------------------------------------------------------143

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------------------------------------------------ the businesses of the partnerships are not
substantially related under section 513(a) and the use of the properties does not meet
the requirements of section 514(b)(1)(A)(i).

---------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------- Citing legislative history, Rev.
Rul. 77-72 states that the intent of section 514 is to treat an otherwise exempt
organization in the same manner as an ordinary business enterprise to the extent that
the exempt organization purchases property through the use of borrowed funds.
Congress has seen fit to treat the Trust in the exact same manner as the trust in Rev.
Rul. 74-197 that was subject to UBIT on debt-financed income. Rev. Rul. 74-197 cites
legislative history for the proposition that section 514 cannot be circumvented where
investment property is also acquired and the borrowing would not have occurred but for
the investment property acquisition.144

While -------------------------------------- activities constitute at least a part of the activities of
arguably all section 501(c) exempt organizations -------------------------------------------- and
138
    ----------------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------
139
    ----------------------------------------------------------------------------------------------------------------------------------------
140
    Ocean Cove Corp. Retirement Plan and Trust v. U.S., 657 F. Supp. 776 (S.D. Fla 1987).
141
    -----------------------------------------------
142
    --------------------------------------------------------------------------------.
143
    --------------------------------------------------------------------------------------------------------------------------------
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144                                                                        st
    Rev. Rul. 74-197, citing Senate Report No. 91-552 (1 Session), 1969-3 C.B. 423, at page 465.
TAM-136986-16                                            38

sometimes the major part of these organizations’ activities, that fact in itself does not
render the UBIT rules superfluous. Rather, the UBIT rules apply to section 501(c)
organizations --------------------------------------------------------------------------------------------------
including the Trust, -------------------------------------------------

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145
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146
      Ocean Cove Corp. Retirement Plan, 657 F. Supp. at 779.
TAM-136986-16                                                        39

e. ----------------------------------------------------------------------------------------------------
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TAM-136986-16                                               40

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C. Conclusion – Part II

The Trust’s exempt purpose ------------------------------------------------------------------------------
--------------------------------------------------------------------------------------- The Trust holds
interests in partnerships, including partnerships that hold debt-financed property. The
only relationship between the Trust’s exempt purpose and the businesses of the
partnerships, and the use of property purchased with debt, --------------------------------------
----------- Because such a relationship is not sufficient for purposes of sections 513 and
514, income from the partnerships or from property purchased with debt, is UBTI to the
Trust.

CONCLUSION(S):

(1)       The Trust is subject to unrelated business income tax.
(2)       The Trust’s ---------------------------------------- activities, with respect to
          partnerships and debt-financed property, are not substantially related to the
          Trust’s exempt purpose.

CAVEAT(S):

A copy of this technical advice memorandum is to be given to the taxpayer(s). Section
6110(k)(3) of the Code provides that it may not be used or cited as precedent.




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