Unrelated Business Income Background and Statistics
However, if a tax-exempt organization regularly carries on a trade or business not substantially related to its exempt purpose, the organization may generate unrelated business income (“UBI”). The tax-exempt organization is subject to and required to pay tax on its UBI. Tax-exempt organizations need to be mindful of whether or not they are generating UBI.
UBI Defined
UBI is defined by the Internal Revenue Service (“IRS”) as income that is deemed to be not substantially related to the purpose for which tax-exempt status is granted to the organization. For most tax-exempt organizations, an activity is considered UBI if it meets three requirements. To be considered UBI, income must be:
- Derived from a “trade or business”;
- Not “regularly carried on”; and
- Not “substantially related” to the tax exempt organization’s primary purpose and operations.
The IRS further defines these requirements in the following manner:
A “trade or business” generally includes an activity carried on for the production of income from selling goods or performing services. Whether or not the activity produces a profit is irrelevant for purposes of determining whether the gross revenue from the activity is subject to UBI.
Business activities of an exempt organization ordinarily are considered “regularly carried on” if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations.
Determining whether or not a business activity is “substantially related” requires examining the relationship between the activities that generate income and the accomplishment of the organization’s exempt purpose. Trade or business is related to exempt purposes, in the statutory sense, only when the conduct of the business activities has a causal relationship to achieving exempt purposes (other than through the production of income). The causal relationship must be substantial. The activities that generate the income must significantly contribute to accomplishing the organization’s exempt purposes to be substantially related.
Calculating UBI, Directly Connected and Dual Use Expenses
An organization calculates unrelated business taxable income (“UBTI”) by netting UBI and “directly connected” business expenses on an activity-by-activity basis. The IRS generally takes the position that a taxpayer cannot offset net UBI generated from an unrelated business activity with net unrelated business losses incurred by a different unrelated business activity.
“Directly connected” business expenses are those that are incurred solely as a result of the unrelated business activity. Therefore, these costs are permitted to be allocated against UBI. “Dual use” expenses are those expenses that are incurred to carry on both the organization’s exempt functions and to conduct an unrelated business activity. Dual use expenses must be apportioned based upon the respective use of the related and unrelated activity. When allocating dual use expenses, an organization should maintain a clear and concise accounting trail of how the allocation was determined.
UBI Reporting
All activities that generate UBI are required to be reported, on an activity-by-activity basis, on Federal Form 990-T, Exempt Organization Business Income Tax Return. Tax-exempt organizations with gross UBI of $1,000 or more for the current tax year must prepare and file a Form 990-T. The calculated net UBTI reported on a Form 990-T is subject to Federal income tax using regular corporation rates as prescribed by the IRS.
IRS UBI Tax Statistics, Publications & Other Data
The IRS includes data from various studies that provide detail with respect to income, deductions, and tax imposed on tax-exempt corporate and trust entities’ UBI on a page its website which can be accessed via the link below.
The Statistics of Income Division of the IRS (“SOI”) collects data from a sample of Forms 990-T filed by organizations described in IRC §§ 220(e), 401(a), 408(e), 408A, 501(c)(2)–(27), 529(a), and 530(a). The information currently available includes statistical tables for tax years 1992 through 2013 as well as various publications and papers and “other IRS data”. The statistical tables classify information by the following categories: IRC §, size of gross UBI, size of UBTI and primary UBI activity or industry grouping.
For instance, the following highlights were reported as a result of the 2012 UBI data collected:
- More than 46,000 tax-exempt organizations filed a Form 990-T in 2012;
- Over half of all organizations that were required to file Form 990-T did not report unrelated business income tax liability after subtracting deductions from gross unrelated business income;
- Charitable organizations, exempt under IRC §501(c)(3), were the most common Form 990-T filers; and
- Organizations classified as 501(c)(3) accounted for nearly two-thirds (65 percent) of all unrelated business income, two-thirds (67 percent) of all deductions, and over half (58 percent) of all unrelated business income tax liability.
Conclusion
All tax-exempt organizations should carefully consider reviewing their new and existing business activities on at least an annual basis to determine if any constitute UBI. Additionally, tax-exempt organizations should take advantage of the SOI Tax Stats – Exempt Organizations’ Unrelated Business Income Tax Statistics webpage outlined above for various UBI tax statistics, publications and other data compiled annually by the IRS. This information is available free of charge and may be a valuable resource for continuous knowledge on this important subject as well as a benchmark within the tax-exempt organization sector.
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