The tax codes surrounding non-profits can be difficult to understand. As a tax exempt organization, you’re just exempt from paying taxes, right? Well, as with all things tax related, that depends. One such circumstance is whether or not your organization has UBI: Unrelated Business Income (UBI).
Unrelated Business Income Defined
The IRS defines Unrelated Business Income 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.
Now what does that mean? Unrelated Business Income is funds that are regularly received from goods or services not directly related to your non-profit’s mission.
As an example, think of a charity whose purpose is to provide free music lessons to under privileged children. They make most of their money through donations, and through quarterly concerts, performed by the students, with admission fees. Since donations are freely given, not in exchange for goods or services, the donations are not UBI. The concerts are performed by the children receiving the lessons as part of their music education; therefore, the concert admission fees would not be UBI.
If, however, the charity opened up a musical supply store on property it owned as a way to generate more income to buy more instruments, or a bigger concert hall for their students, that would be UBI. That store, even though it has to do with music, does not have anything substantial to do with the charitable purpose of the organization.
Of course, there are exceptions and exclusions.
UBI and Taxes
If not handled correctly, UBI can cost an organization its exempt status. The federal law states that generally no more than 30% of a tax-exempt organization’s income can come from UBI. Even if handled correctly, UBI is still subject to taxation.
You are required to pay corporate tax on the net profits of your UBI, even if those profits are strictly being used to fund your tax-exempt organization.
If you believe that your organization will have made $1000 or more in UBI you are required to fill out form 990-T, this is in addition to the regular information return form, 990, 990-EZ, or 990-PF, that you are required to file. If you believe that your tax liability will be $500 or more, you are required to make quarterly estimated tax payments. Form 990-W can be filled out to help determine what your quarterly payments should be.
The ability to add more revenue streams to your non-profit can be very helpful, but be cognizant of the tax code surrounding UBI. If not well understood, and not accounted for correctly, UBI could cost you your tax-exempt status. However, by understanding your organization, and understanding the tax code, you will be able to utilize UBI and steer clear of any difficulties that may arise from doing so.
Our nonprofit audit services give our clients valuable feedback and guidance. If you have any questions about unrelated business income or about our nonprofit services, one of our CPAs would be happy to speak with you at (925) 933-2626 or, email us at firstname.lastname@example.org.