Unrelated Business Income Tax
Understanding Unrelated Business Income Tax (UBIT)
Even though an organization is recognized as tax-exempt, it still may be liable for tax on its unrelated business income.
What is Unrelated Business Income?
For most organizations, unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption. An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T. An organization must pay estimated tax if it expects its tax for the year to be $500 or more.
The obligation to file Form 990-T is in addition to the obligation to file the annual information return, Form 990, 990-EZ or 990-PF. Each organization must file a separate Form 990-T, except title holding corporations and organizations receiving their earnings that file a consolidated return under Internal Revenue Code section 1501.
Unrelated Business Income Tax Returns
For most exempt organizations, Form 990-T is due annually by the 15th day of the 5th month after the end of its tax year. For more detailed information about filing requirements and procedures, see the Form 990-T instructions.
Rate of Tax:
All organizations subject to UBIT, except trusts, are taxable at corporate rates on that income. All exempt trusts that are subject to these provisions, and that, if not exempt, would be taxable as trusts, are taxable at trust rates on unrelated business taxable income. However, an exempt trust may not claim the deduction for a personal exemption that is normally allowed to a trust.
An organization exempt under Internal Revenue Code section 501(c)(3) must make available for public inspection and copying any Form 990-T filed after August 17, 2006 . These returns are also available from the Internal Revenue Service. Returns must be available for a three-year period beginning with the due date of the return (including any extension of time for filing). For this purpose, the return includes any schedules, attachments, or supporting documents that relate to the imposition of tax on the charity’s unrelated business income (and not to a form filed for another purpose, such as to obtain a refund of erroneous back-up withholding or a small business health care credit).
Filing Form 990 and Form 990-T:
The IRS advises exempt organizations and persons who prepare returns for them that an organization’s annual return and its unrelated business income tax return should be mailed in separate envelopes.
Unrelated Business Income Tax Exceptions and Exclusions
The Internal Revenue Code contains a number of modifications, exclusions, and exceptions to unrelated business income. For example, dividends, interest, certain other investment income, royalties, certain rental income, certain income from research activities, and gains or losses from the disposition of property are excluded when computing unrelated business income. In addition, the following activities are specifically excluded from the definition of unrelated trade or business:
Volunteer Labor: Any trade or business in which substantially all the work is performed for the organization without compensation is excluded. Some fundraising activities, such as volunteer operated bake sales, may meet this exception.
Convenience of Members: Any trade or business that is carried on by an organization described in section 501(c)(3) or by a governmental college or university primarily for the convenience of its members, students, patients, officers, or employees is excluded. A typical example of this type of business is a school cafeteria.
Selling Donated Merchandise: Any trade or business that consists of selling merchandise, substantially all of which the organization received as gifts or contributions is excluded. Many thrift shop operations of exempt organizations would meet this exception.
Bingo: Certain bingo games are not unrelated trade or business.
For additional information, see IRS Publication 598 Tax on Unrelated Business Income of Exempt Organizations, and the IRS’ Internal Revenue Manual regarding Unrelated Trade or Business (https://www.irs.gov/irm/part7/irm_07-027-005.html) and Taxation of Unrelated Business Income (https://www.irs.gov/irm/part7/irm_07-027-004.html). You may also visit the IRS’ Stay Exempt website to view the Unrelated Business Income Course (https://www.stayexempt.irs.gov/Existing-Organizations/unrelated-business-income-1).
Contact California Nonprofit Attorneys About UBIT
If you have questions regarding unrelated business income tax (UBIT) and your nonprofit organization, please contact the California nonprofit attorneys at Henderson, Caverly & Pum, LLP for more information.