I have heard that some nonprofit museums have started to haul freight for pay for online industries, and have no problem doing so provided they funnel all "profits" after costs of operating that service back in to their nonprofit activities. Is this acomplished by setting up a seperate corporation of which the NFP is the only shareholder and taking a dividend, much as if the NFP invested in any investment? What specific regulations apply? What pitfalls?

dave

Anytime a tax-exempt organization engages in business or reaps income from a purpose that is not related directly to the reason for which the organization was originally granted tax-exempt status, they open themselves to paying tax on that income. See the topic "Unrelated Business Income" at irs.gov. Discuss issues such as this carefully with your tax accountant/attorney.

Thanks

Scott Cessna

If a museum operation is handling freight for more than one customer it is technically a common carrier and must be registered with the Surface Transportation Board, which is generally done by adopting the provisions of the previous for profit carrier as far as they pertain to the particular segment of track. For a single customer, it is possible to arrange a "lease" of the line for freight only to the customer, making it a private siding.

I dealt with the ICC and its successor on a variety of issues for a short line for almost two decades, and there is no requirment that a rail carrier be a for profit entity. Generally such a carrier would collect its compensation from the Class I connection rather than the customer.

As to the 501c(3), I don't think the IRS differentiates between sources of income, so that ticket sales for a passenger train would be viewed the same as compensation for moving freight.

"I have heard that some nonprofit museums have started to haul freight for pay for online industries, and have no problem doing so provided they funnel all "profits" after costs of operating that service back in to their nonprofit activities. Is this acomplished by setting up a seperate corporation of which the NFP is the only shareholder and taking a dividend, much as if the NFP invested in any investment? What specific regulations apply? What pitfalls?"

Scott's answer is the best but here's the full deal.

It doesn't matter how you use the income-using your profits to further your exempt purpose doesn't recharacterize non-exempt income as tax exempt. This is called enaging in an unrelated trade or business. NFP's can engage in any legal activity allowed by their charter and by-laws, if its unrelated to their "exempt purpose"-they need to report on Unrelated Business Income on Form 990-T and pay the appropriate tax.

A separate corporation may (perhaps trainlawyer could address this) be useful in firewalling the NFP from liability associated with the freight operation, but it wouldn't automatically eliminate a tax liability, unless some of the more exotic aspects of the tax code such as the "dividends received" deduction apply.

In general, there's three safe harbors from income derived from an unrelated trade or business. The full discussion is here: http://www.irs.gov/charities/charitable/article/0,,id=123415,00.html
Volunteer Labor: Any trade or business is excluded in which substantially all the work is performed for the organization without compensation. Some fundraising activities, such as volunteer operated bake sales, may meet this exception

Convenience of Members: Any trade or business is excluded that is carried on by an organization described in section 501(c)(3) or by a governmental college or university primarily for the convenience of its members, students, patients, officers, or employees. A typical example of this is a school cafeteria.

Selling Donated Merchandise: Any trade or business is excluded that consists of selling merchandise, substantially all of which the organization received as gifts or contributions. Many thrift shop operations of exempt organizations would meet this exception.

If you can staff your trains with "substantially" all volunteer labor, you might be exempt from UBIT.

A fuller explanation is contained in Publication 598.

http://www.irs.gov/pub/irs-pdf/p598.pdf

Prior to beginning any contemplated commercial activities, consult a "circular 230" qualified advisor-which can be an attorney, a certified public accountant or an enrolled agent.

When we won the contract to rebuild CHS's Porter 1203, we consulted an attorney. He advised us to set up a seperate and independent corporation, an LLC, to do the work. The contract is still between CHS and SVRy, but most of the heavy work is sub'd out to the new corporation Sumpter Valley Machine Works, LLC. Although totally independent, SVMW leases SVRy shops and tools. Any money SVMW elects to donate SVRy are welcomed. Any profits are theirs. SVRy is not in the for profit business this way, and this arrangement does not jepordize our 501(c)3 status in any way.

Our original intent was to make the contract between SVMW and CHS, but CHS would not permit this, so SVRy had to remain the primary contracter.

I strongly urge you to consult an attorney who knows the corporate laws in your state before venturing into the for profit world.

dan

Thanks - again - for the great assemblage of experience and brain power on this forum.

It sounds to me like the simplest solution might be to charter a second for profit corporation to run the railroad, which it would lease from the NFP, and which would pay taxes on its income like any oher business. I wasn't concerned about tax liability on income generated, but about insulating the 501C3 from any question about its exempt status. Rents recieved for lease of assets and dividends recieved from investments by the NFP are just like income from ticket sales and gift shops then - if I am reading correctly.

dave

Another point to consider is that if you shift as many expresses to the for-profit as the IRS will allow, (loco maintenance, track maintenance, office expenses, payroll, etc.) it may not have very much profit to tax. Just be sure you can justify the amount of burden shifted to the for-profit operation.

TVRM is doing the very thing you are talking about, operating freight on the museum trackage. They also operate freight on 2 other lines. I suggest you contact them.

Railroad Museum of New England is also a common carrier. You could ask how they handle their situation.

Bottom line is you need to consult your attorney and determine what is legal in your state.

John Bohon

There's nothing wrong with a non profit having (taxable) unrelated business income and as long as you don't have "too much" of it, there's no risk of losing your 501c3 tax exemption and depending on how the numbers shake out on the deduction side, you may not even have to pay any tax on it.

Any good CPA with experience with tax exempt organization can help you with the calculations etc,

Bob H

If an NFP owns a viable of stretch of rail with possible shippers on it, what are some of the options available to them:
-can they own the real estate and lease the operations to
a common carrier to serve the possible shippers?

-can the lease be structured in such a manner that would
allow the carrier to 'pay' the lease by building additional
track and operating trains for the NFP and reporting the
'payments' as a tax deductible donation?

-how does the commercial operation impact the insurance
requirements for the preservation group and vice versa?

Thanks for your feedback.

Kareful

[url]There's nothing wrong with a non profit having (taxable) unrelated business income and as long as you don't have "too much" of it, there's no risk of losing your 501c3 tax exemption and depending on how the numbers shake out on the deduction side, you may not even have to pay any tax on it.[/url]

The above is incorrect. You do not risk losing your exemption by earning "too much" UBIT, you lose it for failing declare in on a 990-T and paying the proper tax.

This is also the second post that suggests shifting expenses from the NFP side to the profit side. Don't play games or get aggressive on this. There is a lot more attention being paid to 501c3's by the IRS. The feds have an insatiable appetite for revenue- they don't like getting cheated out of "their" money.

Anybody considering venturing into a commercial endeavor should assume that it will give rise to taxable income. Go see a lawyer and a CPA, discuss your thoughts. By and large, the non-profit sector has far too little contact with legal and accounting/tax professionals.

If an NFP owns a viable of stretch of rail with possible shippers on it, what are some of the options available to them:
-can they own the real estate and lease the operations to
a common carrier to serve the possible shippers?

-can the lease be structured in such a manner that would
allow the carrier to 'pay' the lease by building additional
track and operating trains for the NFP and reporting the
'payments' as a tax deductible donation?

-how does the commercial operation impact the insurance
requirements for the preservation group and vice versa?

These questions entail extremely complicated issues, especially the first paragraph. Railroad property issues are notoriously complicated-involve regulatory issues and should be discussed with a lawyer experienced in these matters.

I can tell you that with regard to the second issue-there's no advantage to getting in-kind (non cash) payments, unless the payor is broke and not likely to send cash. Under the economic benefit doctrine-such payments need to be accounted for at fair market value. That of course involves the use of an independent appraiser to validate that amount and even then the IRS can dispute and disallow the amount. Also, unless there's some weird exemption, the IRS isn't going to allow your service provider to classify payments (even if that's in-kind) as charitable deductions. You can be sure that what you've described would certainly raise your friendly revenue agent's suspicion. Moreover your operator is on safer grounds reporting the payments as business deductions-which are deductible anyway.

As for the third paragraph, doesn't this kind of depend on your current operation and what you intend to carry? I'm thinking a 100 carloads of grain involves less insurance premiums than 100 carloads of chlorine gas.

Be "Kareful" go discuss this stuff with an attorney, a CPA (one licensed in your state, not posting pseudononymously here and with an active NFP practice) and your insurance broker/agent. (That's all three, not pick one)

What you're discussing here requires the personal attention of professionals advising you with full knowledge of your current and proposed circumstances.

I am not a tax attorney; in fact I have quite enough headache doing my own that I hire an expert to do my personal taxes, not just the firm’s. There are some very well thought out questions here growing out of very valid concerns for tax liability. There are also some very good answers. Unfortunately, my trying to answer some of the questions skates very close to the line that I do not want to cross of giving what might be construed as specific legal advice.

Superheater is absolutely correct, the best thing that the Not-for-Profit can do here is to retain good, knowledgeable help, i.e.: an attorney versed in the corporate laws of your State; a tax attorney or accountant who deals in NFPs; and, if you think you are going to be moving freight cars commercially, a Surface Transportation Board practitioner.

Note to Third Rail: It is possible, though not at all frequent, to have more than one customer and remain a contract (as opposed to common) carrier. This is usually where a non-carrier entity has acquired the track in order to maintain its own rail service and there are other companies impacted. These arrangements are based on the contracts between the local industries and generally fall under contract switching within an industrial park setting.

An anecdote that I cannot resist in a discussion about the Internal Revenue Service: Many centuries ago when I was an officer in the National Guard, one of my Battery Commanders was a criminal investigator for the IRS and one of the Lieutenants in Headquarters Battery was a partner in a small (family run) consulting firm. One weekend at the post-field-exercise Officer and NCO Call (to those unfamiliar with this facet of military life, these sessions sometimes tend to be held in a room having as its primary furnishing a long counter with several stools on one side and a row of bottles on the other) the lieutenant, thinking it was amusing, was telling how his mother had one day brought the mail inside and was sorting it between family and firm when she found an IRS Audit Notice. There was a flurry of motion outside the back window and when she raised her head to look there was a magnificent specimen of the unofficial New Jersey State Bird, Cathartes Aura, better known as the Turkey Buzzard, perched on the back porch railing staring in at her. The C Battery Commander looked over at him and, completely deadpan, replied, “Who did you think delivered it?”

GME

For trainlawyer:

Would there (generally) be any value in running a freight enterprise under the auspices of a separate corporation in terms of insulating liability? Would a wholly owned subsidiary "firewall" any liability from the parent or does the "corporate veil" get pierced in such a situation.

Would it matter if there was common control?

Gentlemen,

Thank you for taking the time to point me in the appropriate
direction. I appreciate your replies and the depth of useful
knowledge that goes into them.

Kareful