Unrelated Business Income Tax

Certain organizations are exempt from paying income tax under the Internal Revenue Code. These include charitable, religious, and scientific organizations; certain pension, profit sharing, and stock bonus plans; IRAs; colleges and universities; and medical savings and college savings accounts. To the extent that these organizations generate "exempt function income," such as "income from dues, fees, charges, or similar items paid by members for the purposes for which exempt status was granted," such income is not subject to federal income tax.

For exempt organizations, income that meets certain characteristics is not exempt function income and is instead unrelated business taxable income on which tax must be paid. Activities that (1) constitute a trade or business, (2) are regularly carried on, and (3) are not substantially related to furthering the exempt purpose of the organization generate unrelated business taxable income.

A "trade or business" is defined as "any activity carried on for the production of income from selling goods or performing services." To be "regularly carried on," the activities would "show a frequency and continuity, and [be] pursued in a manner similar to, comparable commercial activities of nonexempt organizations." Finally, for an activity to be "not substantially related" to the exempt purpose, the activity would lack a "[substantial] causal relationship to achieving exempt purposes (other than through the production of income)."

The specific rules regarding UBIT are numerous, with certain types of income being subject to UBIT depending on the type of exempt organization that generates the income or the intended purpose of the income. Deductions directly connected with producing the unrelated income are generally deductible in a similar manner as regular business deductions, although certain types of deductions are disallowed. Conceptually, the purpose behind the UBIT rules is to prevent normal for-profit businesses from experiencing unfair competition from an exempt organization engaging in the exact same activity without having to pay the tax that the for-profit business pays.

Posted in: Income Tax,IRS,Non Profit