Definition
Unrelated Business Income (UBI) refers to income earned by a tax-exempt organization through activities that are not substantially related to its primary exempt purpose. According to the Internal Revenue Service (IRS), the income must meet three conditions to be classified as UBI:
- It is from a trade or business.
- It is regularly carried on.
- It is not substantially related to furthering the exempt purpose of the organization.
Examples
- University Bookstore: A university runs a bookstore that sells items like clothing, souvenirs, and snacks. The sales related to educational materials may be exempt, but sales from other items might be considered UBI.
- Hospitals Leasing Real Estate: If a hospital leases out a portion of its property to a business not related to healthcare, the income from leasing could be viewed as UBI.
- Charitable Organization: A charity running a regularly-scheduled bingo game, where the winnings are not donated back to the cause, may have to report the proceeds as UBI.
Frequently Asked Questions
Q1: Why is Unrelated Business Income taxable for tax-exempt organizations?
A1: UBI is taxable to prevent tax-exempt organizations from having an unfair advantage over for-profit businesses in the marketplace.
Q2: How is Unrelated Business Income reported?
A2: UBI must be reported on IRS Form 990-T, Exempt Organization Business Income Tax Return.
Q3: Are there any exclusions to what is considered UBI?
A3: Yes, several exclusions exist, including volunteer labor, convenience of members or employees, and sales in substantial part of donated goods.
Q4: What happens if a nonprofit fails to report UBI?
A4: Failing to accurately report UBI can result in penalties, interest, and potential revocation of the tax-exempt status.
Q5: Can income from a passive income source be considered UBI?
A5: Generally, passive income from investments, such as dividends, interest, and certain rents, is excluded from UBI.
- Nonprofit Organization: An organization recognized by law as a public charity, private foundation, or other exempt organization.
- IRS Form 990-T: The tax form used by tax-exempt organizations to report and pay taxes on UBI.
- Tax-Exempt Status: The status a nonprofit organization holds which exempts it from paying certain federal income taxes.
- Trade or Business: Any activity carried out for the production of income from selling goods or services.
Online References
Suggested Books for Further Studies
- “Tax-Exempt Organizations and Constitutional Law” by Bruce R. Hopkins
- “Nonprofit Law Made Easy” by Bruce R. Hopkins
- “The Law of Tax-Exempt Organizations” by Bruce R. Hopkins
### Which of the following is NOT a condition required for income to be considered UBI?
- [ ] Income from a trade or business
- [ ] Income that is regularly carried on
- [ ] Income that is not related to the exempt purpose
- [x] Income used for charitable donations
> **Explanation:** UBI must meet three conditions: it must be from a trade or business, regularly carried on, and not related to the organization's exempt purpose. Using income for charitable donations does not preclude it from being classified as UBI.
### What form must nonprofits use to report UBI?
- [ ] IRS Form 990
- [x] IRS Form 990-T
- [ ] IRS Form 1023
- [ ] IRS Form 8889
> **Explanation:** Nonprofits must report UBI using IRS Form 990-T, the Exempt Organization Business Income Tax Return.
### Which of the following activities might generate UBI for a university?
- [x] Operating a bookstore selling souvenirs
- [ ] Offering classes in person and online
- [ ] Providing library access to students and faculty
- [ ] Conducting educational research
> **Explanation:** Operating a bookstore selling souvenirs can generate UBI, as it is not substantially related to the university’s educational purpose.
### Are all passive income sources subject to UBI rules?
- [ ] Yes, all forms of income by a nonprofit are subject to UBI.
- [x] No, certain passive income sources like dividends and interest are excluded.
- [ ] Yes, except donations.
- [ ] No, passive income is never subject to UBI rules.
> **Explanation:** Certain passive income sources such as dividends, interest, and specific rents are generally excluded from UBI.
### What consequence can a nonprofit face for failing to report UBI correctly?
- [ ] Loss of licenses
- [x] Penalties, interest, and potential revocation of tax-exempt status
- [ ] Banned from future tax-exempt status
- [ ] None
> **Explanation:** Nonprofits that fail to accurately report UBI may face penalties, interest charges, and possibly the revocation of their tax-exempt status.
### What IRS publication provides detailed guidance on UBI?
- [ ] Pub 501
- [ ] Pub 555
- [x] Pub 598
- [ ] Pub 990
> **Explanation:** IRS Publication 598, "Unrelated Business Taxable Income of Exempt Organizations," provides detailed guidance on UBI.
### Can revenue generated from a one-time, infrequent activity be considered UBI?
- [ ] Yes
- [ ] Both yes and no
- [x] No
- [ ] Not always
> **Explanation:** UBI must be from activities that are "regularly carried on." A one-time, infrequent event typically would not be considered regularly carried on and therefore would not be UBI.
### If a nonprofit operates a business entirely by volunteers, is the income UBI?
- [x] No
- [ ] Yes
- [ ] Only if it exceeds $1000
- [ ] Partially
> **Explanation:** Income from activities operated by substantially all volunteer labor is excluded from UBI.
### Does leasing part of a hospital's facility to a non-healthcare business generate UBI?
- [x] Yes
- [ ] No
- [ ] Only if the rent is above market rate
- [ ] Never
> **Explanation:** Leasing part of a hospital’s facility to a non-healthcare business generates UBI because it's not related to the hospital’s primary healthcare purpose.
### What legislation governs the tax-exempt status and related UBI rules for nonprofits?
- [ ] Sarbanes-Oxley Act
- [ ] Gibson Public Law
- [ ] Dodd-Frank Act
- [x] Internal Revenue Code
> **Explanation:** The tax-exempt status and UBI rules for nonprofits are governed by the Internal Revenue Code.
Thank you for exploring the intricacies of Unrelated Business Income (UBI) through our detailed explanations and comprehensive quiz. Continue to expand your knowledge in taxation and nonprofit management!
