What to Know about Unrelated Business Taxable Income
By Katie A. Ahern
Nonprofits, increasingly, are looking to augment traditional sources of income with new revenue-generating activities. While this activity is allowable to some extent, nonprofits need to be aware of potential tax liabilities, as well as the potential effect on their exempt status.
Here are key points that 501(c)(3) organizations need to keep in mind.
What Unrelated Business Taxable Income Is
Unrelated business taxable income, commonly known as UBTI, generally means any income that an exempt organization earns through business that is unrelated to its tax-exempt purpose.
For example, let's say a 501(c)(3) organization with the tax-exempt purpose of prevention of cruelty to animals runs an animal shelter to care for and place animals in need of homes. If the organization starts providing pet grooming and boarding services for the general public, the income it earns from doing so will typically be UBTI.
Why UBTI Matters
UBTI matters for two main reasons. First, the UBTI of a 501(c)(3) organization is subject to tax, even though a 501(c)(3) is not generally taxed on its income. If a 501(c)(3) has too much unrelated business activity, it may lose its 501(c)(3) status. However, there is no clear threshold level of unrelated business that compromises tax-exempt status. (In addition, UBTI may present significant issues for 501(c)(3) organizations with outstanding tax-exempt bonds.)
Why Using UBTI to Support the Organizations Mission is Not Enough
What if the animal shelter in #1 above uses the income it earns from grooming animals for the general public to fund the care of additional unwanted animals? Does that mean the income is now related to the exempt purpose? No, generating income to support the tax-exempt purpose of the organization is not enough to show a relationship to its purpose.
Sponsorship Can Create UBTI Issues
Frequently, 501(c)(3) entities will receive payments from sponsors. Although a straightforward sponsorship arrangement does not generally create UBTI issues, the arrangement may move from sponsorship to advertisement, causing a UBTI problem.
The difference between sponsorship and advertisement: Sponsorship is payment by someone engaged in a trade or business without expectation of substantial return. A tax-exempt organization may generally acknowledge a sponsor through the use of logos or distribution of the sponsor's contact information but may not advertise the sponsor's goods or services without triggering potential UBTI issues.
UBTI May Require Your Organization to File an Additional Tax Form
Although a 501(c)(3) is not generally taxed on its income, its UBTI is subject to tax, which is reported on the IRS Form 990-T.
Katie A. Ahern is an associate with Hinckley Allen, a multiservice law firm offering a full range of legal services and business advice to regional, national, and international clients. Email her at firstname.lastname@example.org.
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