Many not-for-profit organizations engage in activities that generate tax; for example, a museum that has a gift shop, a school that rents its facilities, or a social service organization that rents out its conference rooms. While not uncommon, these activities (and many others) create instances where the organization generates unrelated business income. This taxable income is widely misunderstood and can cause headaches for organizations that are unfamiliar with the rules and filing requirements.

What Is UBIT?

Exempt organizations were the first subject to a tax on unrelated business income in 1950. Congress wanted to ensure that these organizations couldn’t use their tax-exempt status to avoid paying their fair share of certain activities.

Unrelated business income is “the income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity. Certain trade or business activities aren’t treated as an unrelated trade or business.”

To qualify as unrelated business income, an activity generally must be a trade or business that is regularly carried out and not directly related to the organization’s mission.

An organization with more than 15 to 20 percent of unrelated business income relative to gross revenue may be in jeopardy of losing its tax-exempt status. In those cases, a UBIT analysis may be necessary to see if all activities are recorded properly, and if so, whether it makes sense to create a separate taxable subsidiary.

A flat 21 percent tax is levied on unrelated business income of more than $1,000 per year. Estimated taxes are due throughout the year if the organization expects to pay $500 or more in taxes on unrelated business income. UBIT can be reduced by any applicable business tax credits, like the investment credit on alternative investment income.

Common Activities That Generate UBIT

What constitutes unrelated business income depends on the organization and its own unique facts and circumstances. This isn’t an exhaustive list, but generally, the following examples would generate unrelated business income and would therefore be taxable.

  • Parking and bus services
  • Magazine publishing
  • Gift shop or café
  • Member directory or list sales
  • Broadcasting rights

More specifically, the IRS may scrutinize these activities more than others.

Rental income from real property

Debt-financed real property rentals and personal property rentals are subject to UBIT based on how much debt is used to finance it. Schools are excluded; however, dual-use property – when the property is rented for unrelated purposes but generally used for both mission-supporting and unrelated activities – can be subject to UBIT if the organization provides substantial services. Mixed lease rental property can be excluded from UBIT.

Advertising

Income from advertising is a common activity subject to UBIT. The IRS considers advertising to imply endorsements, include messages of savings or value, and promote the purchase or sale of goods or services. This is different from sponsorship income, where the sponsor doesn’t receive any significant value or benefit.

Alternative investments

It’s important to check the K-1s for alternative investments that may be subject to unrelated income, expenses, losses, credits, or deductions. This information can be difficult to find, and it’s recommended that organizations check with an outside advisor to be sure.

These are common exclusions from UBIT:

  • Interest, dividends, and royalties
  • Gains or losses from selling property
  • Donated goods or services
  • Volunteer hours
  • Trade shows and conventions
  • Bingo games
  • Member convenience

For more information on unrelated business income specific to social clubs, click here.

How to Report Unrelated Business Income

Organizations will use Form 990-T to report unrelated business income, using a separate Schedule A to list each unrelated trade or business.  Form 990-T is due for organizations with a calendar-year end by April 15, or November 15 for June 30 year-end.

In 2021, the IRS Inspector General recommended increasing enforcement of unrelated business income for exempt organizations. Especially as the IRS gets more funding for enforcement activities, organizations need to make sure their income-generating activities that rise to the level of UBIT are properly identified and accounted for.

For questions about unrelated business income tax for exempt organizations, contact Jonny Rosch, CPA, a Partner in PBMares’ Not-for-Profit group.