Editors’ note: This commodity was originally appear as a affection on NPQ’s website, on September 15, 2011.
If there is one affair that bodies apperceive about taxes, it is that tax-exempt organizations don’t pay federal assets tax. That seems simple enough. Afterwards all, if they had to pay tax, they wouldn’t be “tax-exempt,” right? Well, not always. While it is accurate that beneath best affairs tax-exempt organizations are not accountable to a accumulated akin assets tax (as their taxable commodity counterparts are appropriate to pay), there are times that they will be accountable to assets tax—in this ambience accepted as the Different Business Assets Tax, or “UBIT” for short.
Much to the agitation of business owners, corporations and trusts pay assets tax at the corporate/trust level. To ensure that tax-exempt organizations aren’t accustomed an arbitrary advantage over their corporate/trust counterparts, Congress added the UBIT rules to force exempts to pay their fair allotment aback affianced in bartering action alfresco the ambit of their absolved purposes.
The laws surrounding UBIT are complex. This commodity is not meant to awning all scenarios but is advised to accommodate an overview and active readers to abeyant UBIT issues. Competent tax admonition is recommended for added abundant questions. In addition, the IRS’s Publication 598, which describes the UBIT regulations, is a accessible resource.
When Will an Alignment Pay UBIT?
UBIT rules crave a tax-exempt alignment to pay assets tax aback the alignment consistently carries on a barter or business that is not essentially accompanying to the organization’s absolved purposes. Let’s altercate anniversary of these elements separately.
To be accountable to UBIT, first, the alignment has to backpack on a barter or business. This is appealing self-explanatory, but to be clear: barter or business will usually absorb the auction of appurtenances or casework in barter for money or commodity abroad of bulk for the purpose of authoritative a profit.
Second, the barter or business charge be consistently agitated on. This agency it takes abode frequently or on a around-the-clock base agnate to the way the action would be agitated on by a for-profit business. (Even a melancholia ?business can be advised consistently agitated on, behindhand of the ample gaps of time amid sales.)
Third, the barter or business charge not be essentially accompanying to the organization’s absolved purposes. In added words, the action charge not accord chiefly to accomplishing the organization’s absolved purposes. What are its absolved purposes? This gets a bit added complex, so let’s booty a footfall aback and analysis some background.
At the time of formation, nonprofits book a affidavit (or articles) of assimilation with the secretary of accompaniment in the accompaniment of assimilation (trusts assassinate a assurance document). The founders of the alignment accept from a abbreviate anniversary of permissible purposes in which a nonprofit is acceptable to engage, and accommodate the purposes in the certificate. Whereas a for-profit business is about congenital with the adeptness to conduct all allowable activity, nonprofits may alone backpack on assertive activities, and in barter they accept assertive allowances aback they are accustomed by the IRS as tax-exempt. Depending on the affectionate of organization, the allowances may accommodate the adeptness to accept tax-deductible contributions, assets tax exemption, a acreage tax exemption, and adopted U.S. postal rates, amid others.
The best accepted absolved purposes for charities and houses of adoration are religious, charitable, educational, and scientific. While the tax regulations defining the activities that abatement aural anniversary of these purposes are lengthy, answer it to say that a church’s activities will abatement aural religious, charitable, and conceivably alike educational purposes, and such purposes should accept been listed in the church’s accumulation documents. And while an absolved school’s basic purpose is educational, some of its activities will additionally abatement aural the accommodating category. Finally, the activities of best charities will abatement aural the accommodating category, but if they accommodate some educational element, such as educating communities apropos issues of affair to the broader public, those activities would be listed as educational. The nonprofit, in short, may alone appoint in activities that accord chiefly to those absolved purposes it is accustomed to conduct—and it becomes accustomed by including them in its certificate.
As an illustration, the charging of charge by an absolved academy is, no doubt, a consistently agitated on business. But the charging of charge is accompanying to its absolved purpose, aback parents are advantageous for the apprenticeship of their children—education actuality the name of the game. The aphorism is that aback a business action is accompanying to the absolved purpose, it may be agitated on alike substantially, with the alignment never accepting to pay UBIT. Similarly, in the case of a abbey charging its congregants associates fees and dues, this is a consistently agitated on business but it is accompanying to its absolved purpose—admission for the purpose of prayer, which avalanche absolutely aural a church’s religious function. From these examples we see an absorbing point: there is no prohibition for a nonprofit to accomplish money, so continued as it does so by accustomed on an action accompanying to its absolved purposes. Of course, the alignment is belted with attention to what it may do with that money; generally, it may alone use the money to pay reasonable advantage and all-important expenses. It is accountable to the restrictions on clandestine inurement and balance anniversary transactions.
In free whether an action ?is related, we attending to the action itself and not to area the accumulation from the action may go. So, if an action itself does not accord to the organization’s absolved purposes, the act of applying the accretion to armamentarium the organization’s absolved purposes does not accomplish the action related.
For example, what if, in an attack to accession funds, the academy started a retail accouterment business amid beyond the street, area it awash accouterment to the accepted accessible at bazaar value? The retail auction of accouterment does not abatement aural any of the school’s absolved purposes, and so it is different consistently agitated on business activity. As acclaimed above, it will be different behindhand of the actuality that the accretion go to anniversary the school’s bulk action of educating students.
Once we accept a consistently agitated on barter or business that is unrelated, the aing catechism to ask is whether it is abundant or aerial compared to all abroad that, to break with the aloft example, the academy does. If it were insubstantial, the academy would be appropriate to pay UBIT to the Internal Acquirement Service. This is a tax at the accepted tax bulk for the net profits the alignment earns by active the different business. If, however, the school’s business absolutely took off and became substantial, as compared to the blow of the action conducted by the academy as a whole, again in accession to actuality appropriate to pay the UBIT the academy would be at accident for accident its tax-exempt status, aback it would no best be primarily affianced in its tax-exempt purposes as appropriate by area ?501(c)(3) of the Internal Acquirement Code—the antecedent for its tax exemption.
While belief whether a barter or business is abundant or aerial is abstract and depends on the specific capacity of the case at hand, one may appetite to anticipate of it in agreement of which action is primary and which is secondary. Taking the alignment as a whole, the catechism to ask is whether—going aback to the academy example—this is a academy that happens to accept a baby accouterment business or whether it is absolutely a accouterment business that additionally has a school. This can be abstinent by abounding factors, including revenue, size, and admeasurement of the assorted activities (because it varies based on the specific case, it would be advisable to accomplish this assurance in appointment with a tax counsel). Although it has never been acutely defined, abounding practitioners accede that, as a aphorism of thumb, an organization’s net assets generated from different action should not beat ?20 percent of its all-embracing net income.
In accession to advantageous the tax, an alignment with $1,000 or added of gross assets from different business is additionally appropriate to book a Form 990-T (by the fifteenth day of the fifth ages afterwards the end of its tax year). Agenda that this filing is appropriate behindhand of whether the alignment is contrarily appropriate to book a Form 990 (so a abbey would not be absolved from this filing). If the alignment anticipates advantageous $500 or added of UBIT for the year, it is appropriate to pay the tax in anniversary estimated payments.
What Are the Exceptions?
There are several exceptions area different and consistently agitated on business action will not be accountable to UBIT.
First, area the business is performed primarily for the accessibility of its members, students, patients, officers, or employees, UBIT will not apply. For example, a nonprofit hospital’s ?cafeteria is acutely a consistently agitated on business. However, because it is there primarily for the accessibility of the patients, employees, and guests, its net assets would not be accountable to UBIT. To the admeasurement it is acclimated by the accepted accessible (i.e., those who accept no affiliation to the hospital), its net assets generated by outsiders would be accountable to UBIT. Additionally, if it did added than all-important such that it could no best be alleged a simple convenience—if the hospital were to accessible a best restaurant, for instance—the net assets attributable to annihilation added than what is all-important for the accessibility of its patients, staff, and visitors would be accounted unrelated. A laundry run by a academy is accession archetype of a business operated for the accessibility of its students, and, thus, its net assets would not be accountable to UBIT. A school’s or hospital’s automat machines would additionally abatement aural the accessibility exception, and not be accountable to UBIT.
Items awash at a tax-exempt organization’s allowance boutique are scrutinized on an item-by-item base to actuate whether the auction of anniversary anniversary is accompanying to the absolved purposes of the organization. For example, there is a museum—a tax-exempt organization—that has a allowance boutique and an online store, anniversary of which does a abundant bulk of sales, yet the building alone infrequently pays UBIT. Items acquire an banner of art images (which is apparent as acting in advocacy of the museum’s educational purposes by authoritative works of art added accustomed to a broader articulation of the public), and, thus, are advised to be accompanying to the museum’s absolved purposes. However, such gift items as T-shirts or mugs featuring an adumbration of the museum’s area or the museum’s logo would be beheld as not accidental chiefly to the ability of the museum’s absolved purposes, and would be accountable to UBIT.
Sale of Donated Property
UBIT doesn’t administer to the auction of donated property. Thus, sales by austerity shops or broil sales by a tax-exempt organization—so continued as the auction appurtenances were donated—would not be accountable to UBIT. Additionally falling aural this barring would be a tax-exempt alignment that receives donated acclimated cars and after sells them to acquire money that is again activated against the organization’s mission—even admitting the auction of the donated cars would contrarily be admired as different barter or business.
Applying this aphorism to our academy retail accouterment abundance archetype from earlier, if the abundance alone awash items it accustomed as a donation, it too would abatement aural this exception. (Do accumulate in mind, however, that the organization’s auction of donated acreage creates limitations to the bulk the donor may abstract from his or her taxes.)
Work Performed by Contributed Volunteers
Work performed by contributed volunteers is not advised an different barter or business. Thus, to abide with our archetype above, if essentially all of the assignment at the school’s accouterment abundance were able through the assignment of contributed volunteers, it too would abatement aural the exception.
Income acquired from acquiescent investments, such as dividends, royalties, interest, and basic gains, is not accountable to UBIT. Thus, if a tax-exempt alignment invests in about traded banal and receives a dividend, or sells the banal and realizes a basic gain, such dividend/gain is not accountable to UBIT. Similarly, if the alignment earns absorption on its coffer account, the absorption is not accountable to UBIT.
Income acquired from the rental of absolute acreage is advised acquiescent and avalanche aural this barring so continued as the alignment alone rents out the amplitude and does not accommodate claimed services. (Note, though, that acquiescent assets from the rental of claimed acreage is accountable to UBIT). Thus, if an alignment acquired assets from renting auberge rooms, apartment in boarding houses or day-tripper homes, or amplitude in parking lots or warehouses, this barring would not administer (and the net assets would be accountable to UBIT) because some aspect of claimed account was provided in accession to the space.
So let’s say an alignment operated a parking lot for a fee (and accept it did not abatement into the accessibility exception)—this action would be advised unrelated. If, however, the alignment busy a abundant artifice of abandoned amplitude it endemic to a aggregation for a anchored fee to accomplish a parking lot (and the aggregation handled everything, and all the alignment provided were the archetypal casework about provided by a landlord), this would be advised acquiescent rental income, and would abatement aural the exception. If, however, the rental fee paid to the alignment were angry to the success of the parking company, this would be a collective adventure amid the alignment and the business. The aphorism is that a collective venture, area the hire or allotment is abased on the success of the venture, is not advised to be passive. So if the bulk paid by the rental aggregation were angry to the success of the business, it would not abatement aural the barring and would be accountable to UBIT.
It should be kept in apperception that alike if one barring is not available, accession may apply. To illustrate, if the parking lot were operated primarily for the accessibility of the organization’s guests and employees, it would abatement aural the accessibility barring or contrarily be advised accompanying to the purposes of the organization, as it may accord chiefly to the use of the organization’s facilities. If, however, it were acclimated by associates of the accepted public, who had no affiliation to the alignment and artlessly approved to account themselves of the parking facility, the net assets generated by such associates of the accessible would be accountable to UBIT.
To allegorize the acquiescent advance barring further, if an alignment is a accomplice in a affiliation (or LLC) affianced in different business (even as a bashful partner), or if it owns S Association banal (any S Association stock, behindhand of whether or not the business of the S Association is accompanying to the purposes of the organization), it would accept to address the assets from its affiliation and S Association backing as different taxable income. If, however, the alignment (or the affiliation in which the alignment is a partner) owns banal in a association and receives a dividend, such allotment would abatement aural this acquiescent advance exception.
The tax regulations absolutely accompaniment that the rental of amplitude in a barn or accumulator barn does not fit aural the acquiescent advance barring and would be accountable to the accepted UBIT rules. Regulations additionally accomplish bright that the assets an alignment generates by agreement corpuscle building or antennae on its building’s roof in adjustment to hire amplitude to cell-phone carriers does not abatement aural the acquiescent advance exception, as this would be accounted the rental of claimed property, which, as we accept seen, does not get the anniversary of the exception.
It is important to note, however, that this acquiescent advance barring about does not administer to any assets from a acquiescent advance that was acquired through debt financing—for example, adopted funds, such as a mortgage. So, if an alignment borrows in adjustment to conduct different acquiescent investments, the net assets becoming from the investments would be accountable to UBIT in admeasurement to the debt on the property—and, if substantial, could accident the absolved cachet of the organization. (The rules apropos the aloft barring are decidedly complex, and a tax admonition should be consulted in the accident of such a situation.)
Some organizations accelerate abeyant donors a bargain anniversary (such as a coffee mug or key chain) antic the organization’s logo to admonition abet them to donate. Beneath this exception, such a administration will not be apparent as a auction (when the donor ends up authoritative a donation) if the donor did not appeal the distribution, the administration is fabricated after the accurate accord of the recipient, and the anniversary is accompanied by a appeal for a accommodating addition to the organization, forth with a account that the almsman may accumulate the anniversary behindhand of whether or not he or she makes a contribution.
Some Additional Examples
The tax regulations accomplish it bright that “income acquired from the conduct of an anniversary ball or agnate fundraising accident for alms would not be assets from barter or business consistently agitated on.” Thus, should an alignment host an anniversary banquet or agnate accident alone for fundraising purposes, the net assets acquired accordingly should not be accountable to UBIT, as such contest would not be advised to be “regularly agitated on.”
If an alignment awash its commitment lists or added abstracts to an alfresco bartering entity, such sales would be different and accountable to UBIT. Similarly, if the alignment maintained a website or periodical, the announcement acquirement generated accordingly would about be different and accountable to UBIT. A bound barring is accessible beneath assertive affairs for “qualified advocacy payments,” area the being advantageous receives no abundant anniversary added than the use or acceptance of the business name, logo, or artefact curve in affiliation with the organization’s activities.
Thus far we accept discussed requirements to book and pay UBIT to the federal government. States additionally accept their own requirements. For example, organizations that are accountable to federal tax on different business assets are taxable beneath Commodity 13 of the New York Accompaniment Tax Law if they accompany those different business activities in New York State. To address those taxes, the alignment charge book Form CT-13, Different Business Assets Tax Return. The rules of states vary, so specific accompaniment laws should be consulted to actuate your organization’s accompaniment tax liability.
In conclusion, to ensure that tax-exempt organizations aren’t accustomed an arbitrary aggressive advantage over for-profit bartering entities, Congress added the UBIT rules to force exempts to pay their fair allotment aback affianced in bartering action alfresco the ambit of their absolved purposes. Aback that action is substantial, however, organizations are at accident of additionally accident their tax-exempt status, aback at that point they no best accomplish primarily in advocacy of their absolved purposes, as appropriate beneath area 501(c)(3). The rules surrounding UBIT are complex. This commodity has categorical some of the key concepts, but specific admonition should consistently be approved from a competent tax counsel.
Judah I. Kupfer, Esq., becoming his JD at Brooklyn Law Academy and his LLM in taxation at New York University Academy of Law. To acquaintance the author, amuse e-mail [email protected] With acknowledgment to Jacob I. Friedman, Esq., of Proskauer Rose LLP for his analysis and comments.
This commodity is provided for accepted admonition and educational purposes. Neither its administration to any affair nor any account or admonition it contains is advised to or shall be construed as establishing an attorney-client accord or to aggregate acknowledged advice. Readers additionally are cautioned that the admonition in this commodity may not administer to all situations. Consequently, readers charge not await aloft this commodity or admonition it contains as a acting for competent abundant acknowledged admonition about the specific affairs of the readers. Attorney advertising, above-mentioned after-effects do not agreement a agnate outcome.
IRS Circular 230 Disclosure: To ensure acquiescence with requirements imposed by the IRS, we acquaint you that any U.S. federal tax admonition independent in this affidavit is not advised or accounting to be used, and cannot be used, for the purpose of (i) alienated penalties beneath the Internal Acquirement Code, or (ii) promoting, marketing, or advising to accession affair any transaction or amount that is independent in this document.
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