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How Unrelated Business Income Tax (UBIT) Works for Not-for-Profits

August 31, 2022

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Question:

Our tax-exempt organization has begun a program that we believe will generate income to offset costs of our operations; however, it is not directly related to our mission. Are we subject to tax on these activities?

Answer:

Likely yes. Income from activities not substantially related to your tax-exempt organization’s mission are generally subject to unrelated business income (UBIT) even if you will use the profits to support your mission. This means that you would be subject to 21% tax on net income from these activities exceeding the $1,000 standard deduction. It is also important to note that too much UBIT can, in some circumstances, jeopardize an organization’s tax-exempt status.

You have a couple options to reduce the tax burden as well as protect your tax-exempt status.

  1. Allocate costs against these activities to reduce the net income as long as the costs relate to these activities. These should be well documented, which is where good accounting records come into play. These may include allocations for personnel time, utilities, depreciation, etc. One pitfall to avoid is to be careful not to double allocate costs to any cost reimbursement grants or other activities, often referred to as “double dipping.”
  • Instead of an ongoing program, consider organizing the activities as an annual fundraiser type of activity as fundraising events are typically not subject to UBIT.
  • Have the activities been performed by volunteers? If substantially all the work in carrying on the activity is performed for the organization without compensation, the activities may be excluded from UBIT. The IRS does not define what “substantially” equates to, but that the performance of the volunteer service is a material income-producing factor.

You will want to put a periodic check in place to ensure that any future growth in the activities does not jeopardize your tax-exempt status. The IRS does not want a substantial portion of income to be from UBIT. However, substantial has never been clearly defined.

If you think you may be reaching a substantial portion of income from unrelated business activities, you may want to consult with a professional. It may make sense in some cases to discontinue the activities altogether or to consider establishing a for-profit subsidiary, among other options.

Reach out to us with questions.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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