September 21, 1998
The Honorable Charles O. Rossotti
Commissioner of Internal Revenue
Internal Revenue Service
1111 Constitution Avenue
Washington, D.C. 20224
Proposed Rulemaking to clarify the Application of the Unrelated Business Income Tax to Tax Exempt Organizations CC:DOM:CORP:R (Reg. 121268-97)
Dear Commissioner Rossotti:
The Internal Revenue Service recently issued proposed regulations that seek to clarify the current state of the law regarding the tax treatment of income that is generated by travel and tour activities of tax exempt organizations. In a letter on June 27, 1996, the Office of Advocacy requested then acting Assistant Secretary Lubick to place on the Department of Treasury business plan a rulemaking to clarify the issue. Although we are gratified that the IRS took action on the rule, judging by the comments that have been filed, it is clear that there are still many areas that need to be addressed. Most of the small business comments have asked that the rulemaking be expanded, or withdrawn and re-proposed in a form that covers the needs of the travel and tour industry adequately. Our Office supports the idea of having a hearing and giving all parties a chance to be heard so that the Service can clarify its own position.
In this case, perhaps the IRS should consider a more encompassing process, with the active involvement of all parties to explore the boundaries of a more complete proposed regulation. The hope would be that this would give all sides added insight into the type of regulation that is needed and what must be done to address the problem both from the perspective of the Service and of the travel industry.
To place this issue in context, competition between small firms, government sponsored entities and tax-exempt organizations is a serious problem for some small businesses, a problem that has increased in intensity in the last 20 years. This was one of the top issues addressed by the 2000 delegates to the 1995 White House Conference on Small Business, a national Conference authorized by Congress and representing millions of small businesses, that resulted in a recommendation that the government take action to prevent unfair competition by tax-exempt organizations. This recommendation was not surprising since 9 years earlier the 1986 White House Conference made a similar recommendation.
The Unrelated Business Income Tax (UBIT) was designed to require taxation for commercial activities undertaken by tax-exempts outside their recognized activities. Small businesses, unsubsidized by tax breaks, do not view the current system as a fair one. The Department of the Treasury has expressed this same concern:
The crux of the problem that has generated these complaints is the inadequacy of the UBIT to spell out precisely what is and is not taxable. More specifically, the difficulty is in determining what types of activities are "substantially related" and therefore exempt. As we made clear in our last letter, the lack of useful guidance to clarify the gray areas where most nonprofit travel and tour activities occur, the lack of objective standards, the shear number of nonprofits and their increasing emphasis on commercial activity, have fueled the debate. Unfortunately, small travel and tour providers are concerned that the absence of meaningful regulations laying out the parameters of the "substantially related test" allow tax-exempt organizations to compete freely against small businesses but without the same tax load.
As we have mentioned, this lack of adequate guidance has been a long-standing concern of the Office of Advocacy. Finally, we understand that even the Service itself has complained the standard offers little enforcement guidance for field agents and, by issuing regulations, the Service is showing its concern for the problem.
In this regard, a hearing and further outreach and discussion with all parties would offer the Service an opportunity discuss other options. The soft shoulders of the "substantially related" test make doing business uncertain for the small firms that complain about unfair competition, for the Service which must enforce the law and even for the nonprofits which must comply with the law.
We are, therefore, pleased that the Service has agreed to address this issue through a proposed regulation. However, we share the view of many commentators that any proposed rule should lay out solid ground-rules. The proposed rule iterates current technical advise memoranda and private letter rulings without listing factors that lead to taxation or documentation that tax-exempts should provide to justify the exemption of income from their travel tour program.
In conclusion, we hope that the Service will hold a hearing on the issue. We would like to encourage that hearing as a strong first step that would allow all parties, including the Service, to explain more fully the applicable problems and the suggested solutions. As always, my office will be happy to assist this effort in any way. Please feel free to contact me or Russell Orban on my staff if there is anything we can do to help.
Sincerely,
Jere W. Glover
Chief Counsel
Encl: Letter to Asst. Secretary Lubick – June 27 1998
Cc: Robin Ehrenberg,
Office of Associate Chief Counsel
(Employee Benefits and Exempt Organizations).
Internal Revenue Service
1111 Constitution Avenue
Washington, D.C. 20224
Kathy Livingston,
Attorney-Advisor,
Office of Tax Policy,
U.S. Department of Treasury.
1500 Pennsylvania Ave. NW
Washington, DC 20220
Sue Sottile
Small Business Affairs
Internal Revenue Service
CL:SB
1111 Constitution Ave. NW
Washington DC20224
ENDNOTES
1. Hearings before the Subcommittee on Oversight, Ways and Means Committee, June 22. Serial 100-26 (1987).