What IRS Considers Unrelated Business Income Tax (UBIT)
Generally, a section 501c3 organization may have some unrelated trade or business income without any adverse impact on its exempt status. If, however, a 501c3 organization’s unrelated trade or business activity is no longer insubstantial, the organization jeopardizes its exempt status.
A section 501c3 tax-exempt nonprofit organization may engage in income-producing activities unrelated to its tax-exempt purposes as long as the unrelated activities are not a substantial part of the organization’s activities overall.
However, the net income from such activities will be subject to the IRS Unrelated Business Income Tax (UBIT) if the following three conditions are met:
- The activity constitutes a trade or business,
- The trade or business is regularly carried on, and
- The trade or business is not substantially related to the exercise or performance of the organization’s exempt
An exempt organization must file Form 990-T, Exempt Organization Business Income Tax Return, for any taxable year in which it has gross income from unrelated trade or business of $1,000 or more. The requirement to file Form 990-T is in addition to the requirement to file Form 990, 990-EZ, 990-N, or 990-PF.
What is considered a Trade or Business?
The term “trade or business” generally includes any activity carried on for the production of income from selling goods or performing services.
An activity does not lose its identity as a trade or business merely because it is carried on within a larger group of similar activities.
Example: The regular sale of pharmaceutical supplies to the public by a hospital pharmacy that also furnishes supplies to the hospital and its patients is a trade or business.
What is “Business That is Regularly Carried On”?
Business activities are considered regularly carried on if they show a frequency and continuity and are pursued in a manner similar to commercial activities of for-profit organizations.
Example: A hospital auxiliary’s operation of a sandwich stand for 2 weeks at a state fair would not be the regular conduct of a trade or business. However, operating the sandwich stand daily at the hospital would be the regular conduct of a trade or business.
Business that is not Substantially Related
A business activity is not substantially related to an organization’s exempt purpose if it does not contribute importantly to accomplishing that purpose (other than through the production of income or funds). The fact that the organization used the income to further its charitable purposes does not make the activity substantially related to its exempt purposes. Whether an activity contributes importantly depends upon on the facts of each case.
In determining if activities contribute importantly to accomplishing an exempt purpose, the size and extent of the activities involved must be considered in relation to the nature and extent of the exempt function they serve. If an activity is conducted on a larger scale than is reasonably necessary to perform an exempt purpose, it does not contribute importantly to accomplishing the organization’s exempt purposes. An activity does not lose its identity as a trade or business merely because it is carried on within a larger group of similar activities that may be related to the organization’s exempt purposes.
Example: The hospital sandwich stand that operates daily would generate both related and unrelated business income. Income from sales to hospital staff and patients would be related (because of the “convenience” exception, explained below), while income from sales to the general public would be unrelated. Only income from sales to the public would be subject to Unrelated Business Income Tax (UBIT).
Examples of Unrelated Trade or Business Activities
Examples of some of the more common forms of unrelated trade or business activities include:
- Sale of merchandise and publications
- Rental income
- Parking lots
- Debt management plan services
Advertising activities of a nonprofit
Many tax-exempt nonprofit organizations sell advertising in their publications or other forms of public communication. Generally, the sale of advertising will generate unrelated trade or business income. This may include the sale of advertising space in bulletins, magazines, and journals, or on the organization’s website.
Gaming activities of a nonprofit
Most forms of gaming, if regularly carried on, may be considered the conduct of an unrelated trade or business. This can include Beano, raffles, lotteries, pull-tabs, scratch-offs, pari-mutuel betting, Calcutta wagering, pickle jars, punchboards, tip boards, tip jars, “instant” bingo, and certain video games.
(Bingo, defined and discussed below, does not generate UBI for 501c3 nonprofit organizations.)
For more information on how not lose your exempt status if you decide to pickup gaming as a fundraising activity, please refer to Gaming and Gambling Rules and Laws for 501c3 Nonprofits.
Sale of Merchandise and Publications
The sale of merchandise and publications as well as the actual publication of materials is considered to be an unrelated trade or business if the items involved do not have a substantial relationship to the exempt purposes of the organization.
Generally, income derived from the rental of real property and incidental personal property is excluded from unrelated business income. However, there are certain situations in which rental income may be unrelated business taxable income:
- If an organization rents out property on which there is a debt outstanding (for example, a mortgage note), the rental income may constitute unrelated debt-financed income subject to Unrelated Business Income Tax (UBIT), or
- If personal services are rendered in connection with the rental, then the income may be unrelated business taxable
Operation of Parking Lots by Nonprofits
Scenario 1: An organization owns a parking lot that is used by organization members and visitors while attending organization activities. Any income from parking fees would not be subject to Unrelated Business Income Tax (UBIT).
Scenario 2: An organization operates a parking lot that is used by members of the general public. Parking fees would be taxable, because providing parking to the general public is not substantially related to the organization’s exempt purpose, and parking fees are not treated as rent from real property.
Scenario 3: An organization enters into a lease with a third party who operates the organization’s parking lot and pays rent to the organization. If the organization did not have a mortgage on the parking lot, such payments would not be subject to tax as they would constitute rent from real property.
Debt Management Plan Services
Providing debt management plan services is considered unrelated trade or business when conducted by any organization other than a credit counseling organization that meets the requirements of section 501(q). Debt management plan services are services related to the repayment, consolidation, or restructuring of a consumer’s debt. They include marketing and processing debt management plans and negotiating with creditors to lower interest rates or to waive or reduce fees.
Are there Exceptions to IRS Unrelated Business Activities?
The term “unrelated trade or business” is subject to several exceptions under which certain business activities that may otherwise constitute unrelated business are removed from the scope of the unrelated business income tax (UBIT).
The main exceptions to the definition of unrelated trade or business are:
- Activities conducted substantially by volunteers
- Activities conducted for the convenience of members, students, patients, officers, or employees
- Sales of donated merchandise
- Distribution of “low-cost” articles that is incidental to the solicitation of charitable contributions
- Convention and trade show activity
- Qualified sponsorship income
- Bingo income
Activities Conducted by Volunteers
The term “unrelated trade or business” does not include a trade or business in which substantially all the work in carrying on the trade or business is performed for an organization by a worker who does not receive compensation; i.e., a volunteer.
Example: A gift shop operated by an exempt orphanage in which all of the clerks are volunteers would not be considered an unrelated trade or business even though the operation of the store does not contribute importantly to any exempt purpose or function of the orphanage.
The term “unrelated trade or business” does not include a trade or business which is carried on by either a 501c3 organization or a state college or university primarily for the convenience of its members, students, patients, officers, or employees.
Example: A cafeteria operated by an exempt 501c3 hospital to provide food for hospital staff, visitors, and patients would not be considered an unrelated trade or business.
Sale of Donated Merchandise to nonprofits
The term “unrelated trade or business” does not include the trade or business of selling merchandise if substantially all of the merchandise has been received as gifts or contributions.
Example: A thrift store operated by an exempt nonprofit organization that sells clothes and other goods donated by members of the general public would not be considered an unrelated trade or business.
Distribution of Low-Cost Articles
The term “unrelated trade or business” does not include activities conducted by 501c3 nonprofit organizations and veterans’ organizations that involve the distribution of low-cost items in conjunction with the solicitation of charitable contributions. Under the 2009 rate, an item is considered low cost if it is not valued at more than $9.50. This threshold is adjusted annually for inflation.
Example: Contributions received by an exempt nonprofit organization that distributes mailing labels with its solicitations for contributions would meet this exception because the mailing labels typically would cost less than the threshold amount.
Convention or Trade Show
The term “unrelated trade or business” does not include activities conducted by a section 501(c)(3), (4), (5), or (6) organization at a convention, annual meeting, or trade show if one of the purposes of sponsoring the activity is to promote the products or services of an industry or educate attendees of new industry developments, products, and services, and the nonprofit organization regularly conducts such trade shows as one of its exempt purposes.
Example: Renting display space to exhibitors at an annual meeting of a 501c3 organization would meet this exception.
Sponsorship Payments to nonprofits
Payments to an exempt nonprofit organization by a person engaged in a trade or business are not considered income from an unrelated trade or business if there is no arrangement or expectation that the payor will receive any return benefit other than the use or acknowledgement of the payor’s name or logo in connection with the exempt nonprofit organization’s activities, or goods or services of insubstantial value.
“Use or acknowledgment” does not include advertising, but may include exclusive sponsorship arrangements, logos and slogans, a list of the payor’s locations, contact numbers, or Internet address, and value-neutral descriptions, displays, or depictions of the payor’s products or services.
Example: An exempt nonprofit organization organizes an amateur sports team. A major pizza chain supplies the team uniforms and pays the team’s operational expenses. The uniforms bear the name and logo of the pizza chain. The use of the name and logo of the pizza chain constitutes acknowledgment of the sponsorship. Consequently, the funding and supplied uniforms are not considered income from an unrelated trade or business.
Bingo activities of a nonprofit
Income from the conduct of bingo games is not subject to unrelated business income tax if the bingo game is:
- The traditional type of bingo,
- Legal under state and local law, and
- Not ordinarily carried out on a commercial basis.
Traditional: A bingo game is a game of chance played with cards that are generally printed with five rows of five squares each. Participants place markers over randomly called numbers on the cards in an attempt to form a preselected pattern such as a horizontal, vertical, or diagonal line, or all four corners. The first participant to form the reselected pattern wins the game. Wagers must be placed, winners must be determined, and prizes must be distributed in the presence of all persons placing wagers in that game.
Satellite and Internet bingo do not qualify because these games are conducted in many different places simultaneously and the participants are not all present when the wagers are placed, the winners determined, and the prizes distributed. Instant bingo, Mini bingo, and similar scratch off cards are pull- tab games, not bingo.
Legal under state and local law: The exception only applies if the conduct of the bingo game does not violate any state or local law. If bingo is expressly prohibited under state or local law, it is immaterial whether state or local officials enforce the law.
Not ordinarily carried out on a commercial basis: The bingo exception also does not apply to bingo games conducted in a jurisdiction in which the games are ordinarily carried out on a commercial basis. Therefore, if for-profit businesses regularly conduct bingo games in any part of the jurisdiction, the bingo exception does not apply. Ordinarily, the jurisdiction is the entire state.
If, however, state law permits local jurisdictions to determine whether for- profit businesses may conduct bingo, or if state law limits or confines the conduct of bingo games by for-profit entities to specific local jurisdictions, then the local jurisdiction is the appropriate jurisdiction for determining whether bingo games are ordinarily carried out in a commercial manner.
Dual Use of Assets or Personnel of nonprofits
If assets or personnel of an organization are employed both in an unrelated trade or business and in exempt activities, then items of deduction attributable to such assets or personnel are allocated between the two uses on a reasonable basis. The portion of an item of deduction attributable to the unrelated business use is deductible in computing unrelated business taxable income.
Example: An organization owns a parking lot that is used by organization members and visitors during the day, but is rented out to patrons of a movie theater in the evening. Any income from parking fees collected during the day would not be subject to Unrelated Business Income Tax (UBIT). However, parking fees collected from the evening movie-goers would be taxable, because providing parking to the general public is not substantially related to the organization’s exempt purpose.
Expense Allocation Methods: Example 1
A school recognized as a tax-exempt nonprofit organization contracts with an individual to conduct a summer tennis camp, an activity unrelated to the school’s tax-exempt purpose. The school provides the tennis courts, housing, and dining facilities. The contracted individual hires the instructors, recruits campers, and provides supervision. The income the school receives from this activity is from a dual use of the facilities and personnel. The school, in computing its unrelated business taxable income, may deduct an allocable part of the expenses attributable to the facilities and personnel. The school determined that the summer revenues were 40 percent student and 60 percent non-student (i.e., camper). School expenses (e.g., real estate taxes, building insurance, and personnel) totaled $20,000.
Since only half of the school’s facilities were used for an unrelated trade or business activity (tennis courts, housing, dining facilities, and personnel), 50 percent of these expenses can be allocated to this activity ($20,000 x .5 =
$10,000). However, since the student use is not subject to tax, expenses attributable to them are not deductible. Therefore, only 60 percent of the
$10,000 expense allocated to the activity is deductible on Form 990-T ($10,000 x .60 = $6,000).
Expense Allocation Methods: Example 2
XYZ Charity has an employee who spends 70 percent of his time on gaming activities and 30 percent on activities related to the charity’s exempt purpose. The organization may allocate 70 percent of the employee’s wages to unrelated business taxable income on Form 990-T.
NOTE: The organization should maintain adequate records and contemporaneous documentation to support how the employee’s time was spent.
Can you deduct Unrelated Business Income for nonprofits?
Yes you can but in very limited cases such as:
Net Operating Loss: A net operating loss deduction is allowed in computing unrelated business taxable income. This deduction is allowed in one tax year based on a loss generated in either a previous or subsequent tax year.
Example: During the first year of operation, a tax-exempt nonprofit organization had a net operating loss of $10,000 from an unrelated trade or business activity. During its second year, net income from its unrelated trade or business activity was
$12,000. The organization may claim a net operating loss deduction of $10,000 in the second year, based on the prior year loss, and reduce the unrelated trade or business income for the second year from $12,000 to $2,000.
Charitable Contributions: A tax-exempt nonprofit organization is allowed a deduction for charitable contributions. This deduction is limited to 10 percent of its unrelated business taxable income computed without regard to the deduction for contributions. To be deductible, the contribution must be paid to another qualified organization.
Example: A tax-exempt university that operates an unrelated trade or business producing taxable income of $100,000 may deduct up to $10,000 of a charitable contribution to another university for educational work.
“Specific” Deduction: A specific deduction of $1,000 is allowed in computing unrelated business taxable income. Only one specific deduction is allowed for each tax year, regardless of the number of unrelated businesses carried on by the organization.
Example: An organization with taxable income from an unrelated trade or business of $15,000 pays tax on $14,000.
- Nonprofit Articles of Incorporation,
- Nonprofit Bylaws,
- Nonprofit Conflict of Interest Policy,
- Conflict of Interest Policy Acknowledgment,
- Form 1023 Attachment with all the answers,
- Form 1023 Expedite Letter template,
- and Donor Contribution Form
in Microsoft Word Document format, please consider making a donation and you’ll get to download them immediately. Not only they're worth well over $1000 in value, they will save you weeks of copy pasting and formatting as they are ready to go templates which only need changing names and addresses.
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