UBIT: Scientific Purposes and Scientific Research

In the context of scientific organizations, the IRS states that unrelated business income tax (UBIT) issues generally occur in two situations: (1) a scientific research organization (SRO) engaging in various projects or (2) a tax-exempt non-SRO engaging in research. “Scientific purpose” and “scientific research” are commonly seen phrases in the governing documents for 501(c)(3) tax-exempt scientific organizations.  However, these terms can have different meanings in the eyes of the IRS and have important consequences regarding UBIT.


“Scientific Purpose”

For scientific organizations, the first hurdle is qualifying as a 501(c)(3) tax-exempt scientific purpose organization.  An SRO (i.e., engaging primarily in scientific research) is one example of a 501(c)(3) tax-exempt scientific purpose organization. Non-SRO examples provided by the IRS include “medical research projects of hospitals and the ongoing research programs of major colleges and universities.” See also Washington Research Foundation v. C.I.R., T.C. Memo 1985-570, decided on November 21, 1985 (recognizing that an organization could qualify as “scientific” under 501(c)(3) for promoting scientific research).  

“Scientific Research” UBIT Inquiry

An organization engaging in scientific research is recognized as a tax-exempt SRO under 501(c)(3) so long as it is “scientific research in the public interest.”  This guidance is not very helpful because the IRS does not provide us with a straightforward definition of permissible “scientific research.”  Instead, the IRS provides a simplified three-part test.  Only if all three parts are answered in the affirmative can research be a tax-exempt SRO activity under 501(c)(3):

1.    Is the questioned activity scientific? 

There is no strict definition of “scientific” in the Internal Revenue Code (IRC).  Understanding the term “scientific” within the IRC begins with, but is not solely decided upon, a dictionary definition.  See IIT Research Institute v. U.S., No. 655-80T (October 15, 1985). Furthermore, no distinction is made between hard and social sciences for purposes of defining “scientific.”  See Rev. Rul. 65-50, 1965-1 C.B. 231.  

2.     Is it research? 

There is also no strict definition for “research” in the IRC.  It will generally not include “activities of a type ordinarily carried on as an incident to commercial or industrial operations, as, for example, the ordinary testing or inspection of materials or products or the designing or construction of equipment, buildings, etc.”  See Treas. Reg. 1.501(c)(3)-1(d)(5)(ii).  This is by no means clear and various revenue rulings and courts have debated over the interpretation of this guidance.

3.    Is it in the public interest? 

Scientific research is considered carried on in the public interest if: (a) the results of the research are made available to the public on a nondiscriminatory basis; (b) the research is performed for the United States, or any of its agencies or instrumentalities, or for a State or political subdivision thereof; or (c) the research is directed toward benefiting the public.  Treas. Reg. 1.501(c)(3)-1(d)(5)(iii).  The IRS states most of the debate occurs over the definition of being “directed toward benefiting the public” beyond the IRS’ examples such as research for finding a cure for a disease or for aiding a community or geographical area by attracting new industry to the area. See Treas. Reg. 1.501(c)(3)-1(d)(5)(iii)(c). 

However, what is clear is that an SRO will not qualify as a 501(c)(3) scientific organization if: (a) such organization will perform research only for persons which are (directly or indirectly) its creators and which are not described in section 501(c)(3), or (b) such organization retains (directly or indirectly) the ownership or control of more than an insubstantial portion of the patents, copyrights, processes, or formulae resulting from its research and does not make such patents, copyrights, processes, or formulae available to the public.  Treas. Reg. 1.501(c)(3)-1(d)(5)(iv).

General UBIT Inquiry

Generally, income derived from an activity that substantially contributes to the tax-exempt purposes of the organization is not subject to UBIT. See IRC 513(a).

Most of the activities of a tax-exempt SRO will likely qualify as “scientific research in the public interest” but this is not an automatic conclusion. If the research does not qualify as “scientific research in the public interest,” than that activity is subject to the general UBIT inquiry. This is the same inquiry that a tax-exempt, non-SRO is subject to for its research activity. The general UBIT inquiry is: (1) whether the activity unrelated to the attainment of the organization's exempt purpose; (2) whether it is trade or business; and (3) whether it is regularly carried on. If all three elements are answered affirmatively, UBIT generally applies.

Exclusions From UBIT

For both an SRO and non-SRO tax-exempt organization, there are three exclusions under IRC 512(b)(7),(8), and (9) that will protect the following from UBIT:

•    All income derived from research performed for a government entity – i.e., the United States, or any of its agencies or instrumentalities, or any State or political subdivision thereof – regardless of whether the research activities further an exempt purpose.  IRC 512(b)(7).

•    All income derived from research performed by a college, university, or hospital, regardless whether the research activities further an exempt purpose of such organization. IRC 512(b)(8).

•    All income derived from research performed by an organization operated primarily for the purpose of carrying on fundamental research, rather than applied research.  The results of the research must be freely available to the general public. IRC 512(b)(9).

The IRS’ explanation of scientific organizations is available here.

The IRS provides additional guidance on scientific research and UBIT in the “Income from Research” section of the Internal Revenue Manual

For more detailed explanations and examples regarding SROs, please view the IRS publication, “Scientific Research Under IRC 501(c)(3),” available here.

A general explanation of UBIT is available in a previous post, “Evans & Rosen on Unrelated Business Income Tax”.

-    Emily Chan