Chapter 23

Question 1

An organization qualifies for exempt status only if it fits into one of the categories provided in the Code.

True
False

Answer 1

True

An organization qualifies for exempt status only if it fits into one of the categories provided in the Code. Most entities are exempt under § 501.

Question 2

The tax-exempt sector is an important component of the U.S. economy.

True
False

Answer 2

True

The tax-exempt sector is an important component of the U.S. economy. At least 1.6 million entities hold Federal income tax exempt status. These entities employ almost 12 million workers, representing over 9 percent of the nongovernment U.S. workforce and wages paid.

Question 3

A college fraternity is an exempt organization under:

a. § 501(c)(3).
b. § 501(c)(1).
c. § 501(c)(5).
d. § 501(c)(7).
e. § 501(c)(9).

Answer 3

D

Section 501(c)(7) covers social clubs.

Question 4

The Red Cross is an exempt organization under:

a. § 501(c)(3).
b. § 501(c)(1).
c. § 501(c)(5).
d. § 501(c)(7).
e. § 501(c)(9).

Answer 4

A

Section 501(c)(3) covers religious, charitable, educational, scientific, literary, and other such organizations.

Question 5

When an individual who is related to a § 501(c)(3) organization receives inappropriate benefits from the charity:

a. The Code applies intermediate sanctions.
b. An excise tax of 20% is imposed.
c. A second-level tax of 50% of the excess benefit can be imposed.
d. The entity’s exempt status is revoked.
e. None of these choices are correct.

Answer 5

A

When an individual who is related to a § 501(c)(3) organization receives inappropriate benefits from the charity, the Code applies intermediate sanctions, rather than revoking the entity’s exempt status.

Question 6

Anemone, Inc., a qualifying § 501(c)(3) organization, incurs lobbying expenditures of $145,000 during the taxable year. Exempt purpose expenditures are $500,000. If Anemone makes the election under § 501(h) to make lobbying expenditures on a limited basis, its tax liability resulting from the lobbying expenditures is:

a. $11,250.
b. $7,250.
c. $36,250.
d. $0.
e. None of these choices are correct.

Answer 6

A

The lobbying nontaxable amount is $100,000 ($500,000 × 20%). Therefore, the ceiling on lobbying expenditures is $150,000 ($100,000 × 150%). Since Anemone did not exceed the ceiling, the tax imposed is only on the amount of the lobbying expenditures in excess of $100,000 ($145,000 – $100,000 = $45,000). The tax is imposed at a rate of 25 percent. Thus, the tax liability is $11,250.

Question 7

Congress is debating a bill that the members of Hillside Church adamantly oppose. They would like to lobby against its passage. If the church makes a § 501(h) election, it can engage in limited lobbying activities.

True
False

Answer 7

False

Most § 501(c)(3) organizations are eligible for the § 501(h) election; however, churches are not eligible for the election.

Question 8

When determining if an entity qualifies as a public charity:

a. Disqualified persons include significant members of the governing body of the exempt entity.
b. Support includes unusual grants.
c. The general public must provide over 90% of the entity’s support.
d. Either the external support test or the internal support test must be satisfied.
e. None of these choices are correct.

Answer 8

A

Disqualified persons include significant members of the governing body of the exempt entity, including officers, directors, trustees, and their families. Amounts received from disqualified persons are not included in the numerator of the support fraction.

Question 9

Paradise, Inc., receives its support from the following sources:

Governmental unit A, for services rendered $18,000
General public, for services rendered 45,000
Gross investment income 8,000
Contributions from individual substantial contributors (disqualified persons) 40,000

Which of the following statements is correct?

a. Paradise, Inc., is a private foundation because it satisfies both the external support test and the internal support test.
b. Paradise, Inc., is not a private foundation because it fails both the internal and external support tests.
c. Paradise, Inc., is not a private foundation because it satisfies both the external support test and the internal support test.
d. Paradise, Inc., is a private foundation because it satisfies the external support test and fails the internal support test.
e. None of these choices are correct.

Answer 9

C

Paradise, Inc., would prefer not to be labeled a private foundation. Therefore, the entity needs to receive broad public support. To meet this requirement, it must receive more than one-third of its support in this case from governmental unit A and the general public. However, for this purpose, only $5,000 of the amount received from governmental unit A is counted. Therefore, of the $111,000 support received by Paradise, $50,000 ($5,000 + $45,000) is from qualifying sources. So the external support test is satisfied (1/3 × $111,000 = $37,000).

In addition, Paradise, Inc., must not receive greater than one-third of its support from gross investment income and net unrelated business taxable income. The internal support test is also satisfied, because only $8,000 of the $111,000 (7.2%) support is from these sources.

Question 10

A university that is exempt under § 501(c)(3) cannot be classified as a private foundation.

True
False

Answer 10

True

All § 501(c)(3) organizations are private foundations by default, but a statutory exception applies to churches, educational institutions, hospitals, medical research organizations, and governmental units.

Question 11

Under § 4944, the tax on jeopardizing investments in a private foundation can only be imposed on the foundation manager.

True
False

Answer 11

False

The tax on jeopardizing investments can be imposed on the private foundation and the foundation manager.

Question 12

Regarding taxes imposed on private foundations, the second-level taxes are imposed only if the prohibited transactions are not corrected within a statutory time period.

True
False

Answer 12

True

The additional taxes (second-level) are imposed only if the activities are not corrected within a statutory time period.

Question 13

Family, Inc., a private foundation, records undistributed income of $100,000 for the 2016 taxable year. It distributes $20,000 of this amount during 2017 and an additional $50,000 during 2018. An IRS deficiency notice is mailed to Family on September 1, 2019. As a result of these transactions, the initial tax is:

a. $30,000.
b. $9,000.
c. $33,000.
d. $0.
e. None of these choices are correct.

Answer 13

C

The initial (first-level) tax is 30 percent on the undistributed income for the taxable year that is not distributed by the end of the following taxable year. The tax applies on this undistributed income for each year until the tax is assessed by the IRS. The initial tax is $33,000 ($80,000 × .30) + ($30,000 × .30) = $33,000.

Question 14

An exempt organization does not generate unrelated business income when it sells merchandise that has been produced as part of the accomplishment of the exempt purpose.

True
False

Answer 14

True

The trade or business may sell merchandise that has been produced as part of the accomplishment of the exempt purpose. However, income derived by the organization from use of its property for a nonexempt purpose is UBI.

Question 15

Periwinkle, Inc., a tax-exempt organization, leases a building and equipment to Blue Corporation. The rental income from the building is $160,000 and from the equipment is $12,000. Rental expenses are $100,000 for the building and $11,000 for the equipment. What adjustment must be made to net unrelated business income?

a. ($12,000).
b. ($11,000).
c. ($61,000).
d. $0.
e. None of these choices are correct.

Answer 15

C

Since not more than 50 percent of the rental income under the lease is from personal property (the equipment), and the personal property rent income is incidental (i.e., does not exceed 10 percent of the total rent income under the lease), neither the net rental income from the real property of $60,000 ($160,000 – $100,000) nor the net rental income from the personal property of $1,000 ($12,000 – $11,000) is included in unrelated business taxable income. Thus, a negative adjustment of $61,000 ($60,000 + $1,000) is made in converting net unrelated business income to unrelated business taxable income.

Question 16

Income from dividends is a negative adjustment from unrelated business income.

True
False

Answer 16

True

When a taxable subsidiary remits its after-tax profits to an exempt organization in the form of dividends, the dividends will not be taxable to the exempt organization because dividends are eliminated from UBTI by a negative adjustment. This is one approach that can be used by exempt organizations to avoid the UBIT.

Question 17

Churches and entities with gross receipts of up to _____ need not apply for exempt status.

a. $3,000.
b. $1,000.
c. $5,000.
d. $7,000.
e. $9,000.

Answer 17

C

The threshold is $5,000. The IRS approves about 40,000 applications for exempt status every year.

Question 18

The due date for both Form 990 (Return of Organization Exempt from Income Tax) and Form 990–PF (Return of Private Foundation) is the fifteenth day of the third month after the end of the taxable year.

True
False

Answer 18

False

It is due on the fifteenth day of the fifth month after the end of the taxable year.

Question 19

An exempt organization is never subject to Federal income tax.

True
False

Answer 19

False

An exempt organization generally is not subject to Federal income taxation. An exempt organization that engages in a prohibited transaction or is a so-called feeder organization is subject to tax. If the organization is classified as a private foundation, it may be partially subject to tax. Finally, an exempt organization is subject to tax on its unrelated business taxable income.

Question 20

A taxable subsidiary can be used to avoid the UBIT.

True
False

Answer 20

True

One approach that can be used to avoid the UBIT is for the organization to establish a taxable subsidiary to conduct the unrelated trade or business. With a subsidiary, the revenues and expenses of the exempt organization can be separated from those of the unrelated business.

Question 21

A regular for-profit entity can partially qualify for exempt status.

True
False

Answer 21

False

To be eligible for exempt status, the organization must not be a for-profit entity.

Question 22

In order to obtain exempt status, the term common good must be interpreted narrowly.

True
False

Answer 22

False

Depending on the type of exempt organization, the term common good may be interpreted broadly or narrowly. If the test is interpreted broadly, the group being served is the general public (or a large subgroup of that population). If it is interpreted narrowly, the group being served may be a specific neighborhood or interest group.

Question 23

Organizations exempt under § 501(c)(3) use Form 1024 to file for exempt status.

True
False

Answer 23

False

Organizations exempt under § 501(c)(3) use Form 1023 [Application for Recognition of Exemption under § 501(c)(3)]; small organizations file Form 1023–EZ, which requires a smaller application fee. Form 1024 [Application for Recognition of Exemption under Section 501(a)] is used by most other types of exempt organizations.

Question 24

Which of the following is a disclosure requirement for an exempt entity?

a. If an individual requests the entity’s tax form in person, the entity must provide the form within twenty days.
b. If a request for the entity’s tax form is received in writing, a fee of up to $100 can be charged.
c. Copies of the five most recent Forms 990 must be made available.
d. If the entity has made the forms widely available to the general public, it is not required to fill individual requests.
e. All of these choices are correct.

Answer 24

D

If the exempt entity has made the forms widely available to the general public, it is not required to fill individual requests. Putting the forms on the organization’s website meets this standard.

Question 25

All exempt organizations that are subject to the unrelated business income tax must file Form 990–T (Exempt Organization Business Income Tax Return) if gross income is at least $5,000.

True
False

Answer 25

False

This form must be filed by an exempt organization only if the organization has gross income of at least $1,000 from an unrelated trade or business.

Question 26

Coverdell Education Savings Accounts.

Answer 26

§ 530

Question 27

Religious, charitable, educational, scientific, and literary organizations.

Answer 27

§ 501(c)(3)

Question 28

Business leagues, chambers of commerce, real estate boards, etc.

Answer 28

§ 501(c)(6)

Question 29

Qualified tuition programs.

Answer 29

§ 529

Question 30

Armed forces members’ posts or organizations.

Answer 30

§ 501(c)(19)

Question 31

An entity that carries on a trade or business for the benefit of an exempt organization.

Answer 31

Feeder Organization

Question 32

Gross income generated from property supported by a liability.

Answer 32

Debt Financed Income

Question 33

An organization that must serve a type of common good, be not-for-profit, not have net earnings that benefit its members and not exert political influence.

Answer 33

Exempt Organization

Question 34

Made for the purpose of influencing legislation by attempting to affect the opinions of the general public or any segment thereof.

Answer 34

Grass roots expenditure

Question 35

An excise tax is applied on otherwise tax-exempt organizations with respect to certain payments over grass roots expenditures for the year.

Answer 35

Excess Lobbying expenditure

Question 36

Designed to treat charitable entities as if they were subject to the corporate income tax, chiefly because they compete with taxable enterprises.

Answer 36

Unrelated business income tax (UBIT)

Question 37

Derived from activities not associated with the exempt purpose of the exempt organization.

Answer 37

Unrelated business income (UBI)

Question 38

Take the form of excise taxes imposed on disqualified persons who engage in excess benefit transactions.

Answer 38

Intermediate sanctions

Question 39

An exempt organization subject to additional statutory restrictions on its activities and on contributions made to it.

Answer 39

Private foundation

Question 40

Made for the purpose of influencing legislation by communicating with any legislator or staff member or with any government official or staff member who may participate in the formulation of legislation.

Answer 40

Lobbying expenditure

Question 41

An organization that is either partially or completely exempt from Federal income taxation. § 501.

Answer 41

exempt organizations

Question 42

An expenditure made for the purpose of influencing legislation. Such payments can result in the loss of the exempt status of, and the imposition of Federal income tax on, an exempt organization. Lobby expenditures are not deductible.

Answer 42

lobbying expenditures

Question 43

Definition: Exempt organizations are prohibited from engaging in political activities, but spending incurred to influence the opinions of the general public relative to specific legislation is permitted by the law.

Answer 43

grass roots expenditures

Question 44

An excise tax is applied on otherwise tax-exempt organizations with respect to the excess of total lobbying expenditures over grass roots lobbying expenditures for the year.

Answer 44

excess lobbying expenditures

Question 45

The IRS can assess excise taxes on disqualified persons and organization management associated with so-called public charities engaging in excess benefit transactions. An excess benefit transaction is one in which a disqualified person engages in a non-fair market value transaction with the exempt organization or receives unreasonable compensation. Prior to the idea of intermediate sanctions, the only option available to the IRS was to revoke the organization’s exempt status.

Answer 45

intermediate sanctions

Question 46

An entity that carries on a trade or business for the benefit of an exempt organization. However, such a relationship does not result in the feeder organization itself being tax-exempt. § 502.

Answer 46

feeder organization

Question 47

An exempt organization that is subject to additional statutory restrictions on its activities and on contributions made to it. Excise taxes may be levied on certain prohibited transactions, and the Code places more stringent restrictions on the deductibility of contributions to private foundations. § 509.

Answer 47

private foundations

Question 48

Levied on the unrelated business income of an exempt organization.

Answer 48

unrelated business income tax (UBIT)

Question 49

Income recognized by an exempt organization that is generated from activities not related to the exempt purpose of the entity. For instance, the gift shop located in a hospital may generate unrelated business income. §§ 511 and 512.

Answer 49

unrelated business income (UBI)

Question 50

Included in computations of the unrelated business income of an exempt organization, the gross income generated from debt-financed property.

Answer 50

Debt-financed income