Does Your Organization Have Unrelated Business Income?

Posted on Wednesday, July 20, 2022

During the pandemic many nonprofit organizations have gotten creative in generating revenue from new activities.  Some of these activities may be considered unrelated business income (UBI).

• Tax-exempt entities do not have to pay federal income tax.
• Tax-exempt entities do have to pay unrelated business income taxes (UBIT).

UBIT helps ensure that nonprofit organization focus on their tax-exempt purpose and also eliminates unfair competitive advantages that a nonprofit may have over a for-profit-business that is subject to income taxes.  Unrelated business income determinations are almost always based on the specific facts and circumstances.  What is considered UBI for one nonprofit may not be for another.  It is very important to review your organization’s specific circumstances to determine whether the activity is unrelated for your organization.

In order to be considered unrelated business income, all three of the following must occur.

1. A trade or business;
2. Regularly carried on; and
3. Not substantially related to the exempt purpose

A Trade or Business

When determining whether the activity is a trade or business, the commerciality doctrine is often used.  This compares the activities of the nonprofit to a for-profit that has a similar type of activity.  If the two activities are similar enough in nature (marketing strategies, similar pricing, customers, a profit motive, etc.) then the nonprofit is likely in competition with the for-profit and the activity is normally considered a trade or business.

Regularly Carried On

Regularly carried on looks at the frequency and continuity of the activity.  Is the activity pursued in the same or similar manner to that of a for-profit entity with a similar activity?  An annual fundraiser is likely not considered UBI, whereas an activity that is held quarterly may be considered UBI.  Again, the determination depends on the facts and circumstances of each case.

Not Substantially Related

An activity is not substantially related to an organization’s exempt purpose if it does not contribute importantly to the accomplishment of the exempt purpose.  An activity is not related just because it raises funds that will be spent on exempt activities.  The IRS has ruled that the nature of the activity is what must be considered to be substantially related to the mission, not how the money will be spent.

Exceptions to UBI

There are certain revenue streams that are specifically exempt from being considered UBI even if they meet the three-part test above.  These activities are generally passive in nature and include the following.

• Interest
• Dividends
• Royalties
• Gains and losses from the disposal of capital assets and investments
• Rental from real property (if not debt-financed)

Exempt Activities from UBI

There are also certain types of activities that may be exempt from UBIT even though they are not substantially related to a nonprofit’s exempt purpose.  These include the following.

• Substantially all of the work is done by volunteers.
• The activity is carried on for the convenience of members, students, patients, officers, or employees.
• Selling donated merchandise or items.
• Activities related to the distribution of low-cost items incidental to  soliciting contributions.
• Qualified sponsorships.

Common UBI Activities

Common activities of nonprofit organizations that may be considered UBI are as follows.  If your organization has any of these, you may want to evaluate the activity to determine whether you are correctly reporting UBI to the IRS.  If an organization has a gross unrelated business income of $1,000 or more, it must file Form 990-T with the IRS.

• Advertising
• Debt-financed rental income
• Administrative services
• Sale of logo merchandise
• Online stores
• Website banners/links
• Coffee shops
• Operating a parking facility/lot

Generating some unrelated business income is allowable and helpful in supplementing an organization’s revenue; however, if an organization has a substantial amount of UBI, it may risk losing its tax-exempt status.  Unfortunately, the IRS does not specifically state was “substantial” is.  The primary activities of a nonprofit organization must be related to its exempt purpose.  To determine whether your organization has UBI, you need to evaluate your specific activities and how they relate to your specific mission and purpose. 

Contributed by Carrie Minnich, MAcct, CPA | Partner | DWD CPAs & Advisors

Posted in Mission Minded Nonprofits

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.