UBTI: Unrelated Business Taxable Income Explained

UBTI, or unrelated business taxable income, is revenue a tax-exempt entity brings in that is unrelated to its tax-exempt mission. The tax-exempt organization must pay taxes on that income, and the Internal Revenue Service, or IRS, has specific rules for UBTI. Money from unrelated trade or business activities that does not correlate to the tax-exempt purpose of an organization is UBTI. An organization, collective, or nonprofit’s income becomes a tax liability, so the entity must analyze its gross income to make proper tax payments on taxable income.

The Internal Revenue Code (IRC) grants tax-exempt status to specific companies, such as educational companies or nonprofits. These organizations perform beneficial services to society and do not have to obey the same tax laws as commercial (for-profit) organizations. The IRS introduced UBTI in 1950 to ensure fair competition between taxable and tax-exempt businesses and to keep tax-exempt companies from deviating from their primary business engagements.

The IRC considers real estate sales, sales generated through a pass-through entity (such as a limited liability company), and alternative investments that generate investment income as UBTI. Passive income, such as dividends, rental income, or capital gains, are also UBTI and subject to income tax. Any activity a commercial business carries on regularly that does not serve the organization’s mission becomes a part of UBTI tax. The organization must file Form 990-T and pay taxes at corporate or trust tax rates to keep its tax-exempt status.

The IRS defines the below activities as UBTI exclusions, meaning organizations do not need to pay taxes on them:

1. 1. Conveniences of members: When a nonprofit conducts business for the convenience of its employees, that is a UBTI exclusion. An example is a library or cafeteria at a 501c3 organization or government college or university.
2. 2. Sales of donated merchandise: If an organization sells donated goods, such as gifts at a gala serving as a fundraiser, that does not qualify as a UBTI.
3. 3. Volunteer work: Another UBTI exclusion includes volunteer labor. If all the labor at an event or campaign is on a volunteer basis, the related expenses are not taxable. A volunteer-run bake sale is an example of a UBTI exclusion.

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