If you are involved with any type of nonprofit organization, you’ve no doubt heard of unrelated business income tax, or UBIT. This area of tax law is broad and somewhat murky, creating annual headaches for NFP leaders. While you probably don’t need (or want!) a deep dive into the many nuances of this area of the tax code, you should strive to understand the basic principles that underlie UBIT and how it affects your not-for-profit organization.
Fundamental concepts
The IRS states that “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.”
In general terms, UBI occurs when organizations generate income through ongoing or regularly occurring business activities that are not substantially related to the entity’s basic purpose, as defined by its status as a tax-exempt organization.
By “trade or business” the agency means providing goods or services for the purpose of generating revenue. To help identify these activities, consider this question: Does the organization separately market, track revenue or account for income produced by this activity? If so, the proceeds are probably UBIT. If the answer is unclear, examine the motive behind the activity. Does the organization initiate the activity in hopes of generating income beyond that necessary to cover its costs? Here again, a positive response indicates a likelihood of UBIT. A third element to consider is whether
for-profit business exist that offer a similar product or service.
Determining whether an activity is “regular” or “substantially related” to its purpose can be challenging as well. Each situation will have very specific facts and circumstances that govern the determination. Two facts to keep in mind while evaluating these questions are:
- The IRS and the courts often differ significantly in how they define “regularly carried on”
- The way organizations generate funds matters more than how the funds are used, when determining whether an activity is related to the organization’s exempt purpose
Reporting & documentation
Nonprofits must use Form 990-T for reporting UBIT to the IRS and calculating the tax due on it. The filing deadline for Form 990-T is the 15th day of the fifth month following the end of the organization’s tax year. The paper form is the only format available, but organizations may request an automatic
6-month filing extension via Form 8868.
The Tax Cuts and Jobs Act enacted in late 2017 made meaningful changes to how this income is treated. Notably, in Section 512(a)(6) the federal tax code now requires organizations with multiple trades businesses to calculate UBIT separately for each entity and pay tax based on that amount, rather than offsetting that income by losses from others. Because of TCJA’s changes, the form was redesigned for tax year 2018 and a new schedule was added: Form 990-T Schedule M. This additional form handles separate calculations for organizations that have income from multiple trades or businesses.
Key considerations
It’s important to be aware that while many nonprofits do produce UBI, too much of this income can threaten the organization’s status as tax-exempt. UBI that constitutes 15-20% of a nonprofit’s gross revenue may indicate in some cases that these unrelated activities are taking precedent over the exempt purpose. NFP leaders should be alert to this possibility and closely monitor the amount of UBIT generated each year.
They should also be aware that certain activities are more likely to trigger UBIT. Income generated through real property rentals, advertising (as opposed to true sponsorships) and alternative investments requires especially close scrutiny.
Finally, it is important to know that the regulations regarding UBI are complex and contain numerous exclusions for specific revenue sources. A wealth of helpful information can be found in Publication 598, Tax on Unrelated Business Income of Exempt Organizations.
Nevertheless, determining which activities should be considered to generate UBI can be complex and requires careful analysis by highly qualified tax professionals. Rigorous documentation and references to related tax rulings are invaluable for supporting the organization’s position in this determination as a reasonable one.
Keeping revenue streams strong is a critical need for nonprofits as they work to fulfill their mission. That need, however, must be carefully balanced against the risks of excessive UBIT and the responsibility to account for such income accurately. Consider seeking expert advice as you move forward; please reach out to the experienced nonprofit consultants at Mauldin & Jenkins for assistance.
