Decoding Unrelated Business Income Tax

The financial operations of non-profit organizations are distinct from for-profit entities. Primarily funded by donations and grants, the focus of non-profits is on their mission rather than on generating profits. Another major difference from their for-profit counterparts is the tax-exempt status of non-profits. However, even with their tax exemption, there are instances when non-profits engage in activities unrelated to their exempt purpose that may generate income and may be subject to tax. This concept, known as Unrelated Business Income Tax (UBIT), is a critical yet often misunderstood component of non-profit financial management.

What is UBIT?

UBIT is a tax imposed on the net income earned from certain unrelated trade or business activities regularly conducted by tax-exempt entities. The concept serves a dual purpose: it safeguards the integrity of the tax code by ensuring that tax-exempt organizations pay tax on unrelated business income (activities that are not substantially related to the organization’s tax-exempt purpose) and it promotes fair competition between taxable businesses and non-profit organizations. This creates a level playing field for all entities, regardless of their tax status.

When Does UBIT Trigger Filing Requirements?

A tax-exempt organization is obligated to adhere to Unrelated Business Income Tax (UBIT) provisions when its gross income from unrelated business activities is $1,000 or more. In such instances, the organization must file Form 990-T with the IRS. If the non-profit operates in a state with a UBIT filing requirement, they may need to file a state income tax return also.  For example, in Georgia a Form 600-T is required when there is a Form 990-T filing requirement. Additionally, if the organization forecasts its tax for the year to surpass $500, it must remit quarterly estimated tax payments.

The requirement to file a Form 990-T and possibly a state return is in addition to the annual duty of filing an information return, such as Form 990, 990-EZ, or 990-PF.

What Is the IRS’s Three-Pronged Test?

1. The income must be from a trade or business.
2. The trade or business must be carried on regularly.
3. The trade or business is not substantially related to the organization’s exempt purpose.

If an organization’s income meets all three of these conditions and the gross income equals or exceeds $1,000, then it is subject to UBIT and must file Form 990-T.

What Are Some Examples of UBTI?

Some common examples of unrelated business tax income (UBTI) encountered with non-profit entities include income generated from:

• Unrelated debt-financed activities
• Rental activities
• Advertising activities
• Investment activities

What Are Some Exemptions for UBIT?

Certain exceptions exist where Unrelated Business Income Tax (UBIT) is concerned, offering relief from taxes on some forms of unrelated activities for non-profit organizations. These exemptions typically include passive income such as interest, dividends, rents, royalties, and certain capital gains. Furthermore, income from activities primarily conducted by unpaid volunteers or for the sale of merchandise that has been donated are also usually exempt from UBIT. These exemptions aim to allow non-profit entities to conduct some level of unrelated activities without the burden of tax, provided those activities align with the specific guidelines outlined in the Internal Revenue Code. As always, each situation is unique, and non-profit organizations should consult with a tax advisor to ensure the correct interpretation and application of these exemptions.

What Happens if You Fail to Comply With UBIT Filing Requirements?

The impact of UBIT on non-profit entities can be significant. It can influence decision-making related to generating revenue beyond traditional fundraising activities. Non-profits must weigh the potential income from unrelated activities against the administrative burden of calculating, reporting, and paying UBIT. Failure to accurately report unrelated business income can lead to penalties and endanger the organization’s tax-exempt status.

While navigating the complex landscape of UBIT can be challenging, with the proper guidance and a solid understanding, you can confidently steer your organization toward mission fulfillment without compromising your tax-exempt status. Contact your CRI advisor with questions or concerns about UBIT or if you need help determining whether your non-profit’s activities might generate unrelated business income. We’re ready to provide expert advice tailored to your unique circumstances, helping you embrace the journey of understanding UBIT and safeguarding your non-profit’s financial health.