Revenues created by business ventures of nonprofits can result in unrelated business taxable income (“UBTI”) subject to the unrelated business income tax (“UBIT”), but it’s important to understand that not all revenues generated by unrelated businesses are subject to UBIT. And to be clear, if you have no UBTI, you owe no UBIT. We have included a few examples below of unrelated business revenues that are not likely to be subject to UBIT.
Net income from unrelated business activities will generally be subject to UBIT if the activity constitutes (1) a trade or business, (2) that is regularly carried on, and (3) is not substantially related to the furtherance of the organization’s exempt purpose.
Activity not regularly carried on
Activities that are carried on for only a limited duration or on an infrequent basis are unlikely to be considered regularly carried on and therefore are not likely to generate UBTI. For example, if a charity sells ads to be included in a program of its annual gala or holds a fundraising concert a few times each year, the net income from such activities would not be subject to UBIT.
Activities for the convenience of an organization’s members
Income generated by a trade or business carried on by a 501(c)(3) organization or a state college primarily for the convenience of its members, students, patients, officers, or employees is excepted from UBTI and is not subject to UBIT. For instance, if a charity generates revenues from vending machines intended for use by its employees and certain beneficiaries of the charity’s services, the net income from such vending machines would not likely be subject to UBIT.
Rental Income from Real Property
Generally, income derived from the rental of real property and incidental personal property is not subject to UBIT unless there is an outstanding debt on the property at issue (such as a mortgage note). This may not be the case, however, if personal services are rendered in connection with the rental. Take for example, a parking lot owned by a charity and acquired without debt-financing. If the charity regularly operates the lot for the use of the general public in exchange for parking fees, such parking fees would not be treated as rent from real property and would likely be subject to UBIT. If, however, the organization leases the lot to a vendor who operates the lot as a parking lot, the lease payments to the charity would constitute rent on real property and would not be subject to UBIT. Take as another example an exempt organization that regularly rents out its hall to be used for weddings. If the building’s mortgage has been paid in full and no services (such as bartending or catering) are provided by the organization in connection with the rental, the rental income for the hall would not be subject to UBIT.
By statute, certain bingo games do not constitute unrelated trade or business and the income from such games is therefore not subject to UBIT. In order to be excluded, the bingo game must meet the legal definition of bingo, be legal where it is played (be careful to be aware of and comply with any state and local laws governing bingo and other gambling activities, including any registration requirements), and be played in a jurisdiction where bingo games are not regularly conducted by for-profit organizations. Assuming a bingo game meets these requirements, income generated from the game will not be subject to UBIT.
We’ve done a fair amount of writing about UBTI and UBIT here at the Nonprofit Law Blog (see, for example, our prior posts on UBIT explained, earned income and UBIT, and unrelated business income and the commerciality doctrine). Nonetheless, we think it’s an important topic that warrants further discussion. The current movement towards social enterprises is reshaping both the nonprofit and for-profit sectors and we believe that UBIT issues will remain at the forefront of federal tax concerns for exempt organizations for the foreseeable future. As the differences in the activities of nonprofit and for-profit organizations continue to blur with the increasing commercialization of charities and the growth of socially-purposed taxable entities, the nonprofit sector will see stronger pushback from regulators and critics, and the Internal Revenue Service will likely place greater scrutiny on UBTI. The IRS’s increasing focus on UBTI was recently demonstrated by its Colleges and Universities Compliance Project, a multi-year project evaluating tax-exempt colleges and universities for compliance in the areas of UBTI and executive compensation, which resulted in the IRS identifying approximately $90 million worth of additional UBTI that had been underreported by the 34 colleges and universities it examined.
For more examples and more information, see IRS Publication 598.