What Exempt Organizations Need to Know About Unrelated Business Income Tax (UBIT)
Posted by Guidestar.org, 5/9/17
Most organizations exempt from tax under Internal Revenue Code (“IRC”) Section 501(a), including charitable, religious, scientific, and other organizations described in IRC Section 501(c), may be subject to tax on unrelated business income (UBIT), depending on the nature of the activities producing that income. It is important for an organization to distinguish between its tax-exempt purpose and its business activities.
IDENTIFYING UNRELATED BUSINESS ACTIVITIES
Generally, income derived from a trade or business regularly conducted by an exempt organization that is not substantially related to its exempt purpose or function, except that the organization may use the profits to support its mission, is considered unrelated business income. All three of the following components must apply for the activity to be considered unrelated business activity:
- Trade or business—This includes any activity conducted for the production of income, including selling goods and/or performing services, with the intent of generating a profit.
- Regularly conducted—Activities are considered regularly conducted if they show frequency and continuity that would be comparable to the activities of a nonexempt provider. For example, an annual bake sale conducted by volunteers of an organization would not be considered a regular trade or business. However, if the same organization maintained an ongoing bake shop with customary business hours and permanent employees this would be considered a regular trade or business.
- Not substantially related to the organization’s exempt purpose or function—The business activity isn’t substantially related to the organization’s exempt purpose if it doesn’t contribute significantly to accomplishing that purpose. It doesn’t matter that the profits generated provide support for the exempt purpose.
Determining if your organization has unrelated business activities may require careful analysis of all income sources, particularly those sources that are not substantially tied to your core mission. Certain activities that are comparable to other commercial enterprises such as food concessions, book stores, and parking lot services are activities that are commonly considered unrelated activities and subject to UBIT. Some activities are not so clear-cut, and there are many activities specifically excluded from the definition of unrelated trade or business. These include activities such as bingo games (if legal where played), those intended for the convenience of members, convention or trade show activity, and qualified sponsorship payments.
SOME SOURCES OF INCOME ARE EXCLUDED
All dividends, interest, annuities, payments with respect to securities loans, income from national principal contracts, and other income from an exempt organization’s ordinary and routine investments that the IRS determines are substantially similar to these types of income, are excluded in computing unrelated business taxable income. Most royalties are also excluded.
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