February 26, 2019

Unrelated Business Income Tax (UBIT) Primer for Nonprofits

In the U.S., charitable organizations are relieved from the burden of paying taxes if they organize themselves as nonprofits in the eyes of the IRS – that is, until they deviate from their charitable missions. When a nonprofit organization carries on a business activity that is unrelated to their mission, the profits they earn from that activity will be taxable. This “unrelated business income tax” (UBIT) may come as a surprise and can place a filing burden on unprepared taxpayers. Below is a list of FAQs to help you learn more about UBIT so that you understand this unique subsection of our tax code.

What is unrelated business income (UBIT)?

Unrelated business income is any income generated from business activities that are not substantially related to the organization’s charitable purpose. The IRS will classify a business activity as an “unrelated business” when it meets three requirements: (1) it is a trade or business; (2) it is regularly carried on; and, (3) it is not substantially related to furthering the exempt purpose of the organization. A church that rents out its parking spaces during the week must classify its parking revenue as unrelated business income because parking is not substantially related to the church’s mission.

Is unrelated business income still taxable if the profits are cycled back into the organization?

Yes. When determining whether or not a business activity will be subject to UBIT, the IRS will look to the activities themselves. It is of no consequence where those profits end up.

Who is subject to UBIT?

Any exempt organization that has unrelated business income of $1,000 or more per year will be subject to the UBIT.

What is explicitly excluded from UBIT?

UBIT should not be assessed on the following types of income:

• passive income (such as dividends and interest)
• thrift shop income
• income from activities that are for the convenience of the nonprofit’s members or employees
  • A school’s cafeteria sales will not be subject to UBIT because the cafeteria is in place for the convenience of its staff and students.
• income from bingo or charitable gambling games
• sales of inconsequential items like t-shirts or coffee mugs
• sales of membership lists to other nonprofit organizations
• revenue from activities substantially performed by volunteers

Are fundraising activities unrelated to businesses?

Typically, no. Thus far, the IRS has not considered fundraising efforts to be taxable. Congress initially wrote UBIT into the tax code to push back on nonprofits whose side businesses were creating “unfair competition” for their for-profit counterparts. Fundraising efforts have thus far not posed a significant threat to business competition, and the IRS chooses to instead see fundraising efforts as solicitations for donations.

How is UBIT calculated?

UBIT is calculated in much the same way that for-profit entities calculate their own taxes – revenues, less expenses, multiplied by a tax rate. In fact, UBIT tax rates are equivalent to corporate tax rates which, for 2018 and 2019, is a flat 21% across the board. The IRS even allows nonprofits to take many of the same tax credits approved for for-profit entities.

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UBIT is one of those pesky rules that nonprofits should not overlook – especially this year. The Tax Cuts and Jobs Act changed how fringe benefits are taxed, and as a result, more nonprofits than ever before will be subject to UBIT. Failing to pay this tax timely will incur you a 5% penalty of the unpaid tax each month, up to a maximum of 25%. And if your tax bill exceeds $1,000 for the year, you are required to pre-pay your taxes each quarter. Forgetting to pay these quarterly estimated taxes will leave you with additional penalties and interest. If you have any questions about UBIT and would like to talk to one of our tax experts about your nonprofit’s business activities, contact us as soon as possible. We look forward to speaking with you soon.