What Is Unrela♉ted Busine𒆙ss Taxable Income (UBTI)?

Unrelated Business Taxable Income (UBTI) is the income earned by a tax-exempt entity from activities that are not related to its exempt purpose. The Internal Revenue Service (IRS) defines UBTI as “income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption.”

Understanding Unrelated Busꦇiness Taxable Income (UBTI)

The Internal Revenue Code (IRC) 澳洲幸运5官方开奖结果体彩网:Section 501 grants tax-exempt status to a variety of tax-exempt and mutually beneficial organizations. However, a 澳洲幸运5官方开奖结果体彩网:tax-exempt entity, such as a nonprofit or educational organization, may be liable for tax if it engages in, and derives income from, unrelated business activities.

Introduced in 1950, UBTI was introduced to ensure tax-exempt businesses compete fairly with taxable companies in profit-generating activities. UBTI also prevents or limits tax-exempt entities from engaging in businesses that are unrelated to their primary purposes.

Most forms of 澳洲幸运5官方开奖结果体彩网:passive income, such as dividends, interest income, and capital gains from the sale or exchange of capital assets, are not treated as UBTI. For example, if an investor holds an 澳洲幸运5官方开奖结果体彩网:individual retirement ༒account (IRA) that invests in traditional equities, mutual fun🔯ds, and exchange-traded funds (ETFs), the UBTI rules will most likely not apply.

However, if an investment—for example, a 澳洲幸运5官方开奖结果体彩网:mutual fund—generates income that qualifies as UBTI, the fund may be subject to taxation. For example, income fr🌱om a restaura🅷nt business that flows into an IRA is considered taxable. That’s because the business activity doesn’t relate to the tax-exempt purpose of providing a pension to the IRA holder.

Activities That Generate UBTI

To be classified as UBTI, an activity must meet certain criteria, as defined by the IRS:

• Trade or business: The activity must produce income from selling goods or performing services.
• Regularly carried on: The activity must be conducted on a regular basis, similar to nonexempt organizations.
• Not substantially related: The activity must not be related to advancing the organization’s exempt purpose. Activities are considered unrelated if they don’t play a major role in achieving the entity’s mission.

IRS Publication 598 provides more information about unrelated business activities and these three categories.

Examples of activities that could gen♔erate UBTI include:

• Buying and selling a significant number of 澳洲幸运5官方开奖结果体彩网:real estate properties in a year.
• Conducting operations in businesses—such as restaurants, convenience stores, lodging inns, or gas stations—that generate active income and are operated through a 澳洲幸运5官方开奖结果体彩网:pass-through entity such as a limited liability company (LLC) or 澳洲幸运5官方开奖结果体彩网:master limited partnership (MLP).
• Using margin for a stock purchase.
• Making multiple private loans in a year.

Excluded Activities

The IRS excludes these activities from the definition of unrelated trade or business:

• Volunteer Labor: When substantially all the work is performed for the exempt organization for no payment. For example, volunteer-run bake sales would be excluded.
   
• Business for Convenience of Members: When a 501(c)(3) organization or a state college or institution conducts business primarily for the convenience of its members, students, patients, officers, or employees. A school cafeteria would be excluded in this circumstance.
   
• Selling Donated Merchandise: When a business sells merchandise that the exempt organization receives as gifts or contributions. For example, thrift shop operations of exempt organizations would normally be excluded.
   
• Bingo: Certain bingo games are not considered to be unrelated to trade or business.
  

Taxes on UBTI

If a tax-exempt organization has UBTI greater than $1,000, it must pay tax on the gross income. The tax is assessed at corporate rates (21% federal tax rate) for organizations, or at trust rates (ranging from 10% to 37%) for exempt trusts.

According to the IRS, the tax computed on the total UBTI can be reduced by any applicable tax credits, including general business credits (such as the investment credit) and foreign tax credits. However, an exempt trust may not claim the deduction for a personal exemption that a trust normally can claim.

To pay the tax, exempt organizations must file IRS Form 990-T.

Excluded Income

Certain income is excluded from the unrelated business taxable income that an exempt organization may have to pay taxes on:

• 澳洲幸运5官方开奖结果体彩网:Dividends
• Interest
• Certain other investment income
• Royalties
• Certain rental income
• Certain income from research activities
• Gains or losses from the disposition of property

For more details, refer to IRS Publication 598.

The Bottom Line

Unrelated Business Taxable Income (UBTI) is income earned by tax-exempt organizations that isn’t related to their primary exempt purpose. If an organization generates income through activities unrelated to its mission, it may be liable for UBTI taxes. However, many types of passive income, such as dividends and interest, are generally e🥀xcluded. Tax-exempt entities must ensure they comply with UBTI ꦫtax regulations and file the necessary forms to avoid penalties.