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Exempt organizations and SWAPS.

Often the phrase "tax-exempt organization" is a misnomer. Such entities (including pension funds, individual retirement accounts and so on) pay tax on their unrelated business taxable income (UBTI)--net income from a trade or business regularly carried on.

Several exceptions, however, permit an exempt organization to earn, free of UBTI, "passive" investment income: dividends; interest; payments with respect to securities loans; and gains on the disposition of noninventory property and on the lapse of options (to buy or sell securities) written in connection with the organization's investment activities. These exceptions, however, are themselves inapplicable when income is earned on "debt-financed" property.

Recently. the IRS expanded the types of passive income that can be safely earned by an exempt organization. The new category is broadly defined as "substantially similar income from routine and ordinary investments in connection with a securities portfolio."

Observation: The initial example of this new category is income derived from interest rate and currency swaps (that is, the sale of one security and the purchase of another). Thus, such income will be free of an UBTI taint if the exempt organization does not incur indebtedness in connection with the acquisition or carrying of the swap contract.
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Author:Dionne, Marylouise
Publication:Journal of Accountancy
Date:Nov 1, 1991
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