Not-For-Profit Unrelated Business Income

Not-For-Profit Unrelated Business Income

Not for Profit (“NFP”) organizations that are recognized as tax exempt under IRC 501(c)(3) are generally exempt from Federal income tax unless they participate in certain activities that generate unrelated business income (“UBI”). Using the profits for exempt activities does not make the income non-taxable.

Not only does an organization need to be careful about the income tax effects, they also need to be aware that too much UBI can jeopardize the organization’s tax exempt status. The rules concerning when income generating activities are taxable or non-taxable are quite complicated and each stream of revenue should be analyzed with due care.

UBI is net income from a trade or business regularly conducted by an exempt organization that is not substantially related to the performance by the organization of its exempt purpose or function. There are three key items to take away from the definition of UBI:

• A business activity is not substantially related to an organization’s exempt purpose if it does not contribute importantly to accomplishing the Organization’s mission and reason for tax exempt status as initially established with the IRS through the determination letter. Whether an activity contributes importantly depends in each case on the facts involved. The size and extent of activities should be considered in relation to the nature of the exempt function they intend to serve.
• A trade or business is any activity conducted for the production of income from selling goods or performing services. It is irrelevant whether the activity generates a profit for purposes of determining whether the gross revenue derived from the activity is subject to UBI rules.
• Business activities are regularly conducted if they show a frequency and continuity and are pursued in a manner similar to comparable commercial activity.

Not all unrelated activities, however, are considered taxable income. Examples of excluded trade or business activities include the following:

• Any trade or business in which substantially all the work is performed for the organization by volunteers without compensation
• A trade or business conducted for the convenience of the members is not an unrelated trade or business
• Any payment made by a person engaged in a trade or business for which that person will receive no substantial benefit other than the use or acknowledgement of the business name, log or product lines
• A trade or business that consists of selling merchandise which the organization received as donations, gifts or contributions is not UBI
• Bingo games
• Convention or trade show activities
• Certain investment income (interest, dividends and capital gains)
• Royalty income
• Rents from real property (not debt-financed property) if certain restrictions are met

When a NFP has a revenue stream that meets the criteria above, it should be reported on IRS Tax Form 990-T. The net income from the unrelated activity is subject to taxation. The 990-T is a separate tax filing from Form 990 and follows the same due dates. It is advisable to contact your accountant or tax preparer related to matters of UBI.

Brad Caruso, CPA, Senior manager in our Not-for-Profit and Education Service Group assisted in the preparation of this blog. If you have any questions you can contact Brad directly at 732 828-1614.