Key Takeaways
- Income from unrelated trade or business is taxable.
- UBTI excludes income related to exempt purpose.
- Must file Form 990-T if UBTI exceeds $1,000.
- UBTI taxed at corporate income tax rates.
What is Unrelated Business Taxable Income (UBTI)?
Unrelated Business Taxable Income (UBTI) is the income earned by tax-exempt organizations from business activities that are unrelated to their exempt purpose and is subject to federal income tax. This concept applies to entities like charities, educational institutions, and retirement accounts such as 401(k) plans and IRAs.
UBTI is designed to prevent tax-exempt groups from gaining an unfair advantage over taxable businesses by taxing income generated from unrelated trade or business activities.
Key Characteristics
Understanding UBTI involves recognizing its defining features:
- Trade or Business: The activity must be a trade or business, meaning it produces income through selling goods or services actively.
- Regularly Carried On: The business is conducted frequently and continuously, similar to comparable for-profit operations.
- Unrelated to Exempt Purpose: Income must come from activities not substantially related to the organization's tax-exempt mission, even if profits support that mission.
- Taxation: UBTI is taxed at corporate rates, similar to a C corporation, with applicable deductions allowed.
- Filing Requirement: Organizations with $1,000 or more in gross unrelated business income must file Form 990-T to report UBTI.
How It Works
UBTI is calculated by subtracting allowable deductions directly connected to the unrelated business from the gross income generated by that business. If a tax-exempt entity operates multiple unrelated businesses, each business’s income is computed separately without netting losses against gains, then aggregated for tax purposes.
Tax-exempt organizations, including retirement accounts, must pay tax on UBTI at regular corporate rates and submit quarterly estimated payments. Certain types of income like dividends and interest are excluded, as well as income from volunteer-run activities.
Examples and Use Cases
UBTI applies in various practical contexts where tax-exempt and retirement entities engage in unrelated business activities:
- Airlines: While not typical UBTI generators, some investments in companies like EPD or EQT held within IRAs could produce UBTI if derived from pass-through entities with leveraged debt.
- Nonprofit Commercial Activity: A charity operating a retail store selling unrelated commercial goods regularly would incur UBTI.
- Retirement Accounts: An IRA investing in master limited partnerships (MLPs) that generate business income may owe tax on UBTI exceeding $1,000 annually.
- Museum Cafeterias: If run commercially without advancing the educational purpose, the income is considered UBTI.
Important Considerations
When managing UBTI, it is critical to maintain thorough records of income sources and related expenses to accurately calculate taxable income. Even if UBTI funds support exempt activities, the income remains taxable and must be reported properly.
Tax-exempt organizations should also be aware of the distinctions between unrelated business income and exempt function income to avoid unexpected tax liabilities. Monitoring investments in companies like EQT and understanding the impact on retirement accounts helps mitigate UBTI exposure.
Final Words
Unrelated Business Taxable Income can trigger unexpected tax liabilities for tax-exempt entities engaging in unrelated business activities. Review your revenue sources carefully and consult a tax professional to ensure proper reporting and minimize tax exposure.
Frequently Asked Questions
UBTI is the gross income a tax-exempt organization earns from a trade or business that is not related to its exempt purpose, minus allowable deductions, and it is subject to federal income tax at corporate rates.
An activity generates UBTI if it is a trade or business that is regularly carried on and is not substantially related to the organization's exempt purpose, meaning it doesn't contribute importantly to that purpose.
No, certain types of income like dividends, interest, royalties, most rents, and capital gains are excluded from UBTI. Only income from unrelated trades or businesses after allowable deductions is subject to tax.
Organizations with $1,000 or more in gross unrelated business income must file Form 990-T, which is the Exempt Organization Business Income Tax Return, separate from other IRS exempt organization forms.
Yes, retirement accounts such as IRAs and HSAs can generate UBTI if they invest in certain partnerships or businesses that produce unrelated business income, which may then be subject to tax.
The IRS taxes UBTI to prevent tax-exempt organizations from having an unfair advantage over for-profit businesses by taxing income earned from unrelated commercial activities.
UBTI must be calculated separately for each unrelated trade or business without netting losses against gains from others; then the positive amounts are summed to determine total UBTI.
Yes, if a church operates a miniature golf course commercially and it is not related to its religious purpose, the income from that activity is considered UBTI and subject to tax.
