Unrelated Business Income

Although 501(c) organizations are generally exempt from federal income tax, they do have to pay tax when carrying on regular business activities which are unrelated to their exempt purposes. The law governing unrelated business income (UBI) is a complex maze of exceptions, exclusions and modifications. The following list of "threshold" questions can be used to narrow down the field.

1. Is the income producing activity a trade or business?
A "no" answer means the income is not taxed as UBI.

2. Is the activity regularly carried on?
A "no" answer means the income is not taxed as UBI.

3. Does the activity contribute importantly to the accomplishment of the organization's exempt purpose?
A "yes" answer means the income is not taxed as UBI.

4. Is the activity carried on with substantially all volunteer help?
A "yes" answer means the income is not taxed as UBI.

5. If the activity involves the sale of merchandise, has substantially all of the merchandise been donated?
A "yes" answer means the income is not taxed as UBI.

6. Is the activity carried on primarily for the convenience of the organization's members, students, patients, officers or employees? (This exception applies only to 501(c)(3) organizations.)
A "yes" answer means the income is not taxed as UBI.

If, after answering these questions, it appears the income under discussion might still be UBI, consider the following "modifications," set forth in section 512(b) of the Internal Revenue Code. Generally, none of these types of income is taxable.

• interest
• dividends
  
• rents (from real property only)
  
• royalties
  
• annuities
  
• gains and losses.
  

Of course, there are a few exceptions within each category. A major overriding exception is "debt-financed" income. If there is an outstanding indebtedness with respect to the income producing property (such as a mortgage), the income produced will be taxed in proportion to the debt.

Finally, there are miscellaneous exclusions for certain trade shows, and for bingo, but not for any other type of gambling activity. And 501(c)(3)s who rent their mailing lists to other 501(c)(3)s are not taxed.

Ordinary and necessary expenses, as defined by normal income tax rules, may be deducted in determining net income from an unrelated business, and the tax rate is the same as regular corporate rates (or trust rates for non-profits organized as trusts). Some special rules apply to the computation of charitable contributions and net operating losses, and there is a $1,000 "specific deduction" - the exempt organization equivalent of a personal exemption.

The form used to pay unrelated business income tax is Form 990-T, due at the same time as the Form 990 (the 15th day of the fifth month after the close of the accounting period). Exempt organizations are required to make estimated tax deposits if they expect to owe $500 or more of UBI tax. Caution: Form 990-T must be filed if gross unrelated income is $1,000 or more, whether there is any tax due or not.

In my experience, the most common form of unrelated business taxable income for small 501(c)(3) organizations is paid advertising in a newsletter or other periodical. Fortunately, this type of income is only taxed if the publication as a whole is operated at a profit.