A private charitable foundation has federal 'unrelated business taxable income' solely because of debt-financed investment income (interest, dividends, capital gains under IRC section 514) -- does that alone make it subject to New York's unrelated business income tax, and if so, can it deduct 50% of dividends or use an investment-based allocation instead of the standard three-factor formula?

Plain-English summary

George & Elizabeth F. Frankel Foundation, Inc. is a New York not-for-profit corporation that qualifies federally as a private charitable foundation. Under IRC section 514, it's required to report certain "unrelated debt-financed income" -- interest, dividends, and capital gains tied to debt-financed property -- as federal unrelated business taxable income, even though the Foundation argued this income isn't literally derived from an "unrelated trade or business" in the ordinary sense.

The Foundation asked whether it's subject to New York's Article 13 tax on unrelated business income at all, since Article 13 doesn't define "unrelated trade or business" and the Foundation's only qualifying income comes from debt-financed investments, not any active business. The Department looked past the statutory text to the LEGISLATIVE HISTORY behind Article 13's 1970 enactment (the Ways and Means Committee's tax-reform report), which shows the Legislature specifically intended debt-financed property income to be treated as unrelated-trade-or-business income. So the Foundation IS subject to Article 13 tax, despite the absence of any traditional "business" activity.

Having established taxability, the Department addressed two follow-on questions. First, the Foundation wanted to subtract 50% of dividends received from non-subsidiary corporations before computing New York unrelated business taxable income -- but Article 13's modification list (section 292(a)(1)-(3)) contains no such deduction, so it's simply not available, regardless of federal treatment. Second, the Foundation wanted to classify its interest, dividends, and capital gains as "investment income" allocated by an investment-allocation percentage tied to its securities holdings, rather than New York's standard three-factor (property/receipts/payroll) allocation formula under section 293(a) -- Article 13 doesn't provide for that business/investment income split the way Article 9-A does. However, the Department exercised its DISCRETIONARY authority under section 293(b) to grant essentially the same practical result: because the Foundation's entire unrelated business taxable income consists of debt-financed investment income (with no real property, payroll, or business receipts footprint that the standard formula assumes), the standard three-factor formula "does not properly reflect" its activity, so the Department authorized use of an investment allocation percentage computed consistently with the business-capital regulations (20 NYCRR 4-8.3, 4-7.2) instead. This authorization is expressly limited to this Petitioner and only lasts as long as its facts and circumstances don't materially change.

What this means for you

Private foundations and other exempt organizations with debt-financed investment income

New York taxes IRC section 514 debt-financed income as unrelated business income even though it isn't a traditional "trade or business" -- this flows from Article 13's 1970 legislative history, not from the statute's plain text, so don't assume purely investment-driven UBTI escapes New York tax just because there's no active business.

Requesting a discretionary allocation adjustment for pure investment income

If your organization's unrelated business income is ENTIRELY investment-derived (no real operating footprint), the standard three-factor allocation formula may badly overstate or understate your New York exposure -- section 293(b) lets the Department grant a tailored investment-based allocation, but only case-by-case and only for as long as your facts remain the same. This isn't a blanket rule other taxpayers can invoke.

Common questions

Q: Does a foundation need to be running an active "trade or business" to owe New York's Article 13 tax?
A: No -- debt-financed investment income under IRC section 514 counts as unrelated business income for New York purposes based on the 1970 legislative history, even with no active business activity.

Q: Can a foundation deduct 50% of dividends from non-subsidiary corporations against its unrelated business income?
A: No -- Article 13's modification provisions don't include that deduction, unlike some other parts of the Tax Law.

Q: Does Article 13 let taxpayers split income into "business" and "investment" categories like Article 9-A does?
A: No -- but the Department can grant a discretionary allocation-percentage adjustment under section 293(b) that achieves a similar practical result where the standard formula doesn't fairly reflect a taxpayer's activity.

Q: Can another foundation rely on this specific ruling's investment-allocation authorization?
A: No. It binds the Department only for this petitioner's specific facts and is expressly not intended to apply to any other taxpayer.

Citations and references

Statutes and regulations:

• Tax Law § 290(a), § 292(a)(1)-(3), § 293(a), § 293(b)
• Internal Revenue Code § 514
• 20 NYCRR 4-8.3, 4-7.2

Related rulings:

• TSB-A-86(7)C -- a title-holding corporation exempt from Article 9-A but flagged for the same potential Article 13 unrelated-business-income exposure

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1986.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a86_15c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-86 (15) C
Corporation Tax
August 1, 1986

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C850904A

On September 4, 1985, a Petition for Advisory Opinion was received from George &
Elizabeth F. Frankel Foundation, Inc., 60 East 42nd Street, New York, New York 10017.
The issue raised is whether Petitioner is carrying on an unrelated trade or business in New
York State and is, thereby, subject to the tax on unrelated business income imposed pursuant to
Article 13 of the Tax Law. In the event that it is determined that Petitioner is subject to taxation
under Article 13 of the Tax Law, Petitioner raises two additional issues. Petitioner inquires whether
it is entitled to subtract 50% of dividends from non-subsidiary corporations from federal unrelated
business taxable income in determining unrelated business taxable income for purposes of Article
13 of the Tax Law. Petitioner also requests to be allowed to characterize interest, dividends, and
capital gains as investment income and to allocate such income by the use of an investment allo­
cation percentage computed with regard to the securities held by Petitioner.
Petitioner is a not-for-profit corporation, organized under the laws of New York State, that
qualifies for federal income tax purposes as a private charitable foundation. In accordance with
Section 514 of the Internal Revenue Code of 1954 (hereinafter IRC), Petitioner is required to report
certain unrelated debt-financed income as unrelated business income. The debt-financed income at
issue consists of interest, dividends, and capital gains. Petitioner also contends that for federal
income tax purposes although such income is included in unrelated business taxable income, it is
not specifically defined as constituting an unrelated trade or business. Petitioner contends that
although it has unrelated business taxable income for federal income tax purposes, it is not carrying
on an unrelated trade or business in New York State and thus should not be subject to the tax
imposed under Article 13 of the Tax Law.
Section 290(a) of the Tax Law, in part, imposes a tax on the unrelated business income of
the following:
"...every organization described in section 511(a)(2) of the Internal Revenue Code...
carrying on an unrelated trade or business in New York..."
Article 13 of the Tax Law does not contain a definition of the term "unrelated trade or
business." However, the legislative history of Chapter 1005 of the Laws of 1970, which enacted
Article 13 of the Tax Law, makes clear that the Legislature intended to treat income from unrelated
debt financed property as income from an unrelated trade or business. (see: Report of the Ways and
Means Committee on Suggested 1970 Tax Reform Legislation). Accordingly, it must be concluded
that Petitioner is engaged in an unrelated trade or business in New York State within the meaning
of section 290 of the Tax Law and is subject to tax under Article 13 of the Tax Law.

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

-2­
TSB-A-86 (15) C
Corporation Tax
August 1, 1986

As it has been determined that Petitioner is subject to Article 13 of the Tax Law, Petitioner
requests an opinion as to whether it may be entitled subtract 50% of dividends from non-subsidiary
corporations from federal unrelated business taxable income in determining unrelated business
taxable income for purposes of Article 13 of the Tax Law. Petitioner also requests that it be allowed
to classify interest, dividends, and capital gains as investment income to be allocated at an
investment allocation percentage to be computed with regard to the securities held. Petitioner refers
to section 293(b) of the Tax Law which, in part, provides:
"If it shall appear to the tax commission that the allocation percentage determined in
subdivision (a) of this section does not properly reflect the activity, business or
income of a taxpayer's unrelated trade or business within the state, the tax
commission shall be authorized, in its discretion, to adjust it by (1) excluding one or
more of the factors therein, (2) including one or more other factors,... (3) excluding
one or more assets in computing such allocation percentage, provided the income
therefrom is also excluded in determining unrelated business taxable income or (4)
any other similar or different method calculated to effect a fair and proper allocation
of the income reasonably attributable to this state..."
It is Petitioner's contention that only by the use of the requested methods would the activity, business
or income of Petitioner be properly reflected within New York State.
Section 292(a)(1) through (3) of Article 13 of the Tax Law provides for the modifications
to be made to federal unrelated business taxable income in the computation of unrelated business
taxable income. However, there is no modification to allow a deduction for 50% of dividends from
non-subsidiary corporations. Accordingly, Petitioner is not entitled to deduct 50% of dividends from
non-subsidiary corporations from federal unrelated business taxable income in the computation of
unrelated business taxable income for purposes of Article 13 of the Tax Law.
Article 13 of the Tax Law does not provide for the classification of unrelated business taxable
income as business and investment income. The total unrelated business taxable income is allocated
within New York State in accordance with section 293(a) of the Tax Law. The allocation percentage
required to be used is determined by a three-factor formula consisting of property, receipts, and
payroll.
However, section 293(b) of the Tax Law authorizes the Tax Commission to make a
discretionary adjustment to the allocation percentage computed in accordance with section 293(a)
of the Tax Law if it appears that such percentage does not properly reflect the activity, business, or

-3­
TSB-A-86 (15) C
Corporation Tax
August 1, 1986

income of a taxpayer's unrelated trade or business in New York State. In light of the fact that
Petitioner's unrelated business taxable income consists entirely of unrelated debt-financed income,
the Tax Commission, pursuant to the provisions of section 293(b) of the Tax Law, hereby determines
that the allocation percentage determined in section 293(a) of the Tax Law does not properly reflect
the activity, business or income of Petitioner's unrelated trade or business within the state and
authorizes the Petitioner to allocate its unrelated business taxable income by use of an investment
allocation percentage to be computed in a manner consistent with the provisions of franchise tax
regulation sections 4-8.3 and 4-7.2.
This authorization is not intended to apply to any other taxpayer and will apply to Petitioner
only so long as its facts and circumstances do not materially change.

DATED: August 1, 1986

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.