Many nonprofit organizations are finding new ways to generate additional income to fund their missions. While doing this, it is important to determine if any new revenue would meet the criteria for unrelated business income subject to federal income taxation. Unrelated business income is subjected to unrelated business income tax (UBIT), if it meets the following three criteria: is a trade or business, is regularly carried on, and is not substantially related to furthering the exempt purpose of the organization. Keep in mind that there are a number of modifications, exclusions, and exceptions to the general definition of unrelated business income.
Let’s examine the three criteria in more detail. First, the Internal Revenue Service (IRS) considers a trade or business to be any activity carried on for the production of income from selling goods or performing services. That is pretty clear. But, as noted above, there are exceptions. For instance, any trade or business in which substantially all of the work is performed for the organization without compensation (i.e., using volunteers) is not an unrelated trade or business and not subject to UBIT.
Second, regularly carried on is defined by the IRS as showing frequency and continuity and is pursued in a manner similar to comparable commercial activities of nonexempt organizations. So, having an impressive food stand selling unique international dishes at a local fair for two weeks in the summer would not be considered a regularly carried on business; therefore, it is not subject to UBIT. However, if that food stand was open most Saturday’s year-round at a farmers’ market, it would be subject to UBIT.
Lastly, the activity being unrelated to the mission of the organization means an argument cannot be made that the activity generates income that is used directly to fund program activities.
With this criterion set for unrelated business income, here are a few examples where an organization might be generating unrelated business income.
- An organization rents out space in a building that that organization owns to the general public to hold weddings and other events. This is an activity that may be unrelated to the mission of the organization and would be considered unrelated business income.
- An organization has decided to start selling merchandise on its website that contains the organization’s popular logo. This can get tricky. Items that are of an educational nature might be related to one’s mission. Other items that are sold with one’s logo may clearly not be mission related.
IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations provides specific guidance on UBIT, including numerous exceptions to the UBIT established criteria.
Keeping the above criteria in mind, nonprofit organizations engaging in new ways to generate revenue should complete an analysis for each new income generating activity and document the conclusion. If a nonprofit organization generates $1,000 or more of gross income during a tax year from unrelated business, Form 990-T, Exempt Organization Business Income Tax must be filed.
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