The IRS allows many types of companies to claim a tax-exempt status that allows them to roll their profits back into the operations. Charities, nonprofits, and educational institutions usually fall into this category of tax-exempt organizations, ensuring they have the income to keep their doors open and benefiting those who use their services.
Unrelated business taxable income (UBTI) can still impact those businesses, however, and many companies may not even know how best to claim it — or if they have it at all. This quick guide will walk you through the basics of unrelated business taxable income to help you decide if your company may need to pay taxes on it with tax Form 990-T.
What Is Unrelated Business Taxable Income?
Unrelated business taxable income is generated when your company accrues regular income through a strategy that does not relate to the core purpose of the business. Collecting donations for a nonprofit does not fall into UBTI, for example, but if your charity or nonprofit makes several real estate purchases over the course of the year, then sells those properties for a profit, the funds may count as UBTI according to Internal Revenue Service (IRS) code and tax law.
Activities That Count Toward Unrelated Business Taxable Income
UBTI includes activities that generate income but do not fit into your nonprofit’s normal operations. A social club might be an exempt organization but conduct some activities that do not fall under its usual tasks — like selling food and drink to nonmembers, selling timber cut from club land, accepting advertisers in newsletters and publications, or partially liquidating of club assets — that are not reintegrated into its holdings within the time period set out by law, for example.
In order to determine whether your activity or income counts as UBTI, evaluate whether the activity helps to fulfill the primary mission of your organization. For example:
Churches and Religious Organizations
If your church or religious organization generates profits through something that does not count as a faith-based activity or mission, you may need to count any proceeds from that event as taxable income. This might include:
- Selling parking spaces for local events
- Setting up a food and beverage stand at a local festival
- Selling t-shirts and other apparel items
To determine what counts in your unrelated business income tax for your nonprofit, consider the purpose of your nonprofit and its primary tasks. For example, if you sell food to the community at a low cost in order to address hunger in the community, any proceeds from those sales will not count as taxable income. Other activities might, like:
- Renting out space in your building to a third party
- Selling t-shirts with your logo
- Selling books or educational materials unrelated to your primary purpose
- Receiving profit from timber, a garden, or other items on your land
- Selling toys or other promotional items
- Selling off equipment that your nonprofit no longer uses or needs, without using those proceeds to replace the equipment
You may also find that your nonprofit may have UBTI if it expands what it has to offer outside the target group it intends to reach. Imagine that you have a nonprofit set up to provide housing for charitable contributions to low-income individuals, but acquires a property that it chooses to rent to middle- or upper-class individuals for a much higher rate. That property generates considerable income for your nonprofit, but since it does not fit your primary mission, it is taxable income.
If you have questions about whether specific types of income count as UBTI for your nonprofit, an experienced tax advisor can provide valuable advice that can help you better determine what category that income falls into for a tax return.
What Happens If You Fail to Properly Address UBTI?
Many nonprofits assume that any income they generate cannot be taxed due to their nonprofit status. Unfortunately, failing to properly report unrelated business taxable income and pay taxes on it can leave your group facing significant consequences. This includes:
- Facing substantial tax penalties if it doesn’t file Form 990-T for the coming year due to its failure to properly pay your taxes this year.
- In some cases, losing its nonprofit status or needing to reapply, which could delay its ability to provide aid to the community and make managing its operational budget difficult.
- The IRS might also choose to place a levy on your nonprofit’s accounts receivable, which could make operations difficult until there is tax payment. This unrelated business taxable income may affect your IRA.
Determining Unrelated Business Taxable Income
If you believe you may have unrelated business taxable income through your nonprofit, addressing it properly is critical. When in doubt as a tax-exempt entity, follow these steps:
1. Consider Whether the Income Falls Into the Usual Mission of Your Organization.
An art museum selling prints of artwork in its gift shop may count as normal income for a nonprofit and would not be taxed, for example, but income from selling clothing and memorabilia may count as UBTI and may be taxed accordingly. Carefully consider how your nonprofit’s income fits into its overall mission as well as its unrelated debt.
2. Consult an Experienced Tax Attorney
Classifying income can prove tricky for many nonprofits during the tax year. Avoid potential penalties by working closely with a tax attorney who can offer advice about how to classify any income from your business activities.
That attorney will be able to look through your income, determine what counts as taxable income, and help you better understand how to put together your taxes to address those issues. This will give your organization peace of mind related to its taxes, income, and exempt purpose.
3. Take Care of any Penalties Promptly
Many nonprofits fail to realize that they have accumulated UBTI — especially if they assumed a particular type fit the mission of their business only to discover later that it fell outside their usual parameters. To help avoid further challenges, take care of any penalties immediately. If you discover you had taxable income you didn’t know about, you can usually make arrangements with the IRS to take care of that debt and prevent steeper IRA penalties down the road.
Learn More About UBIT
Unrelated business taxable income can pose a number of challenges for many organizations with nonprofit status in the United States. Fortunately, you do not have to handle those challenges on your own. Contact Silver Tax Group today to discuss your UBTI questions, or to speak with an expert about other tax-related questions you might have for additional information.