UBIT: A Walker & Armstrong Primer for Not-for-Profit Entities
Walker & Armstrong can help prevent income from activities outside your tax-exempt purpose becoming subject to unrelated business income tax.
Not-for-profit entities conduct a wide range of activities that
benefit not only their constituents, but society as a whole. In recognition of
those benefits, income derived from the products and services that are within
the scope of a not-for-profit’s stated purpose is deemed to be exempt from
However, income obtained from activities that are outside the
organization’s tax-exempt purpose may be subject to unrelated business income
tax (UBIT). It is important that persons who hold leadership or management
positions in a not-for-profit entity understand what UBIT is and how it is
In general, there are two types of unrelated business income (UBI):
debt-financed income, and
income from regularly conducted, unrelated trade or
Debt-financed income is relatively narrow in scope,
typically consisting of such sources as rent, interest, dividends or royalties
generated by financed property.
In contrast, unrelated trade or business income can take a wide
variety of forms. Examples include income from: the sale of advertising in the
organization’s regular publications or website1; insurance programs sold to
members; booth rental at trade shows2; and the ongoing sale of merchandise
(e.g., mass-market clothing) that is unrelated to the organization’s purpose,
even those the profits benefit the organization.
To be considered UBI, the source of the income must meet three
It is a trade or business.
It is regularly carried on.
It is not substantially related to furthering the exempt
purpose of the organization.
There are exceptions to these requirements, such as
when the unrelated business activity is conducted primarily for the convenience
of the organization’s members, students, patients, employees, etc.; when income
is generated from the sale of low-cost items, donated property or, similarly,
from work performed by volunteers; or when the organization earns dividends,
royalties, interest, capital gains, etc., from passive investments.
Calculating and Reporting UBIT
Similar to a for-profit enterprise, taxable UBI is derived from
the gross income generated by the unrelated activity, less allowable deductions.
“Allowable deductions” are expenses directly connected with the unrelated
In generating taxable and non-taxable income, it is common to
make “dual use” of facilities, operating costs and employee-related costs. That
is, some of the people, equipment, etc., that are necessary to carry out the
organization’s tax-exempt purpose are also used to generate UBI. In those cases,
costs must be allocated between the uses. For example, if an employee earns
$50,000 per year and devotes 10% of her time to an unrelated business activity,
then $5,000 of her salary is deductible from gross UBI.
UBI is taxed at corporate income tax rates and is reported on
U.S. Form 990-T and the applicable state income tax form. An organization with
$1,000 or more of gross income from unrelated business is required to file its
Form 990-T by the 15th day of the fifth month after the end of its tax year. If
the organization anticipates paying $500 or more of UBIT for the year, it is
required to pay the tax in quarterly estimated payments.
Excessive Unrelated Business Income
If UBI comprises a substantial portion of its income, an exempt
organization risks losing its tax-exempt status. This is because the unrelated
business activities of the organization will have gone beyond those that are
merely incidental to the organization’s tax-exempt purpose. In such
circumstances, the organization may wish to establish a taxable subsidiary. That
allows the subsidiary to freely engage in commercial activity without
threatening the tax-exempt status of the parent organization.
To complicate this issue, neither the courts nor the IRS clearly
defines what constitutes a “substantial” or “excessive” portion of an
organization’s income. Guidance might be gained from recent court decisions in
which UBI totaling 30% of an organization’s overall income was sufficient to
trigger revocation of its tax-exempt status. In 2002 the IRS issued a private
letter ruling referencing courts’ denial of exemptions to organizations where
their UBI exceeded 25% of their total.