Unrelated Business Income Tax (UBIT) is an area of increasing confusion for many nonprofits. In particular, many charities aren’t sure how to ascertain whether or not a current or future revenue-generating activity might be subject to additional tax and/or throw their exempt status into question.
Many nonprofits seek to supplement their income with retail activities; while these may be connected to their charitable mission (such as a museum gift shop), interpreting whether or not a nonprofit must pay tax on these business activities is an area subject to some interpretation.
On the whole, generating income through a business activity is an appropriate method of helping your nonprofit carry out its exempt purposes. But in doing so, you must be able to fit certain IRS criteria.
What Exactly is Unrelated Business Income Tax (UBIT)?
As defined by the IRS, “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.”
While this may seem rather straightforward, what constitutes this “substantial” relationship is subject to a fair amount of interpretation. Frequently, the IRS has used the “commerciality doctrine” to assess nonprofit retail operations. In doing so, they place business activities that are unrelated to a nonprofit’s mission on the same tax basis as businesses with which they compete. In such cases, it’s possible a nonprofit’s tax exempt status may be jeopardized or revoked.
How Do I Determine UBIT for My Nonprofit?
In cases where the organization is still considered tax-exempt by the IRS, you’ll want to determine whether or not you’re subject to UBIT. According to the IRS’ website, an activity is an unrelated business (and subject to unrelated business income tax) if it meets all of the following three requirements:
- Is a trade or business: any activity carried on for the production of income from selling goods or performing services;
- Is regularly carried on: frequently or continually pursued and is comparable to commercial activities; and
- Is not substantially related to furthering the exempt purpose of the organization.
Additionally, the following types of income are specifically excluded from UBIT:
- Volunteer labor;
- Convenience of members (activities carried on for the convenience of its members, students, patients, officers, or employees i.e. a cafeteria);
- Selling donated merchandise; and
- Certain types of bingo.
You can learn more about the specifics of these excluded activities on the IRS’ website.
Using Your Judgment to Determine UBIT
If you’re considering starting a retail venture, or are unsure whether or not your current revenue-generating activities subject you to UBIT, your best route is to work with a nonprofit CPA . Because nonprofits need to use their own judgment to interpret the IRS rulings, this can get tricky and confusing.
As a general guideline, if the income is related to the performance of your exempt functions (i.e. your charitable mission) you should be in the clear. However, if the IRS determines that these activities are larger in scale than reasonably necessary to carry out your exempt functions, you have UBIT, making this income taxable.
In interpreting the UBIT guidelines, and to avoid these liabilities, you should ensure that your revenue-generating endeavor is:
- Substantially related to your exempt purpose; and
- Conducted on a scale that’s appropriate to your charitable mission.
If you’re still unsure how these guidelines affect your nonprofit, or would like assistance in determining UBIT status for a current or future revenue generating activity, contact ESP. We’d be happy to consult with you in better understanding how Unrelated Business Income Tax might effect your nonprofit.