IRS Exempt Organizations TG 48: Unrelated Business Income Tax

Public charities are tax-exempt organizations as long as they operate for charitable or other beneficial purposes. However, public charities that engage in income-producing activities unrelated to their exempt purpose(s) are subject to federal taxes on any income they produce from those activities. Therefore, charities need to be aware of their responsibilities and obligations under federal tax laws when they choose to earn income through business endeavors unrelated to the exempt purpose of their organizations.

Public charities are tax-exempt organizations as long as they operate for charitable or other beneficial purposes. However, public charities that engage in income-producing activities unrelated to their exempt purpose(s) are subject to federal taxes on any income they produce from those activities. Therefore, charities need to be aware of their responsibilities and obligations under federal tax laws when they choose to earn income through business endeavors unrelated to the exempt purpose of their organizations. The California Center for Nonprofit Law is here to advise you on all legal requirements that impact your public charity, including those related to federal tax law. Call our office when you have questions about these important issues to keep your charity compliant with federal and state law.

Defining Unrelated Business Income Taxation

As per the IRS Exempt Organizations TG 48: Unrelated Business Income, a charitable organization earns unrelated business income from engaging in a trade or business not substantially related to the exempt purposes they regularly carry on. A trade or business is “regularly carried on” if the organization performs it with regularity, frequency, and in a manner similar to the activities of a commercial, non-exempt organization. Unrelated business income taxation (UBTI) applies to the gross income from an unrelated trade or business, less any deductions directly connected with carrying on the trade or business.

The use of profits from unrelated activities by the organization does not, alone, cause the activity to become substantially related to the organization’s exempt purpose. Therefore, even if the organization uses all the profits from a commercial activity to benefit the exempt mission of the organization, the activity doesn’t lose its character as a taxable trade or business. For instance, according to IRS Publication 598, “soliciting, selling, and publishing commercial advertising is a trade or business even though the advertising is published in an exempt organization’s periodical that contains editorial matter related to the organization’s exempt purpose.”

Exclusions from Unrelated Business Income

Some activities are specifically exempt from the definition of unrelated trade or business:

· Gaming;

· Bingo games;

· Gambling activities other than bingo;

· Activities for the convenience of members;

· Convention or trade show activities;

· Distribution of low-cost articles;

· Employee association sales;

· Exchange or rental of member lists;

· Hospital services;

· Pole rentals;

· Public entertainment activities; and

· Qualified sponsorship activities.

Furthermore, some types of income are excludable when calculating unrelated business income. For instance, dividends, interest, annuities, and other investment income are generally excluded from unrelated business income when figuring UBTI. Likewise, royalties from valuable rights and rents from real property are excluded from unrelated business income calculations.

Deductions from Unrelated Business Income

When calculating unrelated business income, charitable organizations can deduct expenses that are generally allowable as income tax deductions. However, the

deductions are only allowable so long as they are directly connected with the carrying on of the unrelated trade or business to which they are related. These deductions include:

· Expenses solely attributable to unrelated business, such as personnel employed full-time to conduct the unrelated business;

· Expenses attributable to dual use of facilities or personnel, which must be reasonably allocated between the exempt and non-exempt uses;

Generally, expenses attributable to exploiting exempt activities aren’t deductible when computing unrelated business income for UBTI. These expenses are not proximately related to the unrelated business or trade and, therefore, do not qualify as directly connected to it. The only circumstances under which these expenses can be treated as directly connected to the unrelated business or trade and thus deductible from unrelated business income are if they meet all the following conditions:

· The unrelated business exploits the exempt activity;

· The unrelated business is a type normally conducted for profit by taxable organizations; and

· Exempt activity is normally conducted by taxable organizations to carry on that type of business.

In this situation, the amount treated as directly connected is the smaller of:

· The excess of these expenses, depreciation, and similar items over the income from, or attributable to, the exempt activity; or

· The gross unrelated business income reduced by all other expenses, depreciation, and other items that are directly connected.

The rules concerning the sale of advertising in exempt organization periodicals are complex and involve calculating various types of income and expenses. For instance, if the direct advertising costs are more than the gross advertising costs, the excess costs are allowable as a deduction in determining UBTI. However, if the gross advertising costs exceed the directing advertising costs, the deductions differ.

Different rules also apply to the income and losses of S corporations and partnerships. Foreign organizations, social clubs, voluntary employees’

beneficiary associations (VEBAs), supplemental unemployment compensation trusts (SUBs), and veteran’s organizations also are subject to different rules.

Special rules also exist for:

· Income from controlled organizations;

· Income from property financed with qualified 501(c)(3) bonds;

· Disposition of property received from taxable subsidiaries and used in unrelated businesses; and

· Debt-financed property and income from debt-financed property.

Reporting UBTI

The Internal Revenue Service (IRS) requires public charities with more than one unrelated trade or business to calculate and report UBTI and deductible business expenses related to that trade or business separately. In other words, a charity cannot aggregate its UBTI from all trades or businesses and report it together; it must attribute the UBTI separately to the individual trade or business that generated the income.

Charities with a total UBTI of $1,000 or more must report it using IRS Form 990-T, which must be mandatorily filed. Form 990-T contains a separate Schedule A to be completed for each unrelated trade or business that produces UBTI.

Tax on unrelated business income is set at corporate rates for that income, except for trusts, which are taxed differently. The UBTI for each unrelated business or trade cannot be less than zero but is subject to applicable tax credits.

Contact Us Today for Legal Assistance

The California Center for Nonprofit Law focuses its practice on legal matters that affect charities and other nonprofit organizations in California. This unique focus allows us to concentrate on keeping abreast of the ever-changing laws and policies as they develop over time. We are here to represent the interests of your nonprofit organization throughout every stage of your legal matter. Call us at (949) 892-1221, email us at info@npolawyers.com, or fill out our contact form online and schedule a consultation about your nonprofit organization today.

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