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Five Things Nonprofits Should Know About: Unrelated Business Taxable Income (“UBTI”)

Please note that, although the term “nonprofit” is generally used, here we are specifically discussing 501(c)(3) entities.

  1. What UBTI Is. UBTI generally means any income that an exempt organization earns through business that is unrelated to its tax-exempt purpose. For example, let’s say a 501(c)(3) organization with the tax-exempt purpose of prevention of cruelty to animals runs an animal shelter to care for and place animals in need of homes. If the organization starts providing pet grooming and boarding services for the general public, the income it earns from doing so will typically be UBTI.
  2. Why UBTI Matters. UBTI matters for two main reasons. First, the UBTI of a 501(c)(3) organization is subject to tax, even though a 501(c)(3) is not generally taxed on its income. Second, if a 501(c)(3) has too much unrelated business activity, it may lose its 501(c)(3) status. There is no clear threshold level of unrelated business that compromises tax-exempt status. (In addition, UBTI may present significant issues for 501(c)(3) organizations with outstanding tax-exempt bonds.)
  3. Why Using UBTI to Support the Organization’s Mission is Not Enough. Wait, what if the animal shelter in #1 above uses the income it earns from grooming animals for the general public to fund the care of additional unwanted animals? Does that mean the income is now related to the exempt purpose? No, generating income to support the tax-exempt purpose of the organization is not enough to show a relationship to its purpose.
  4. That Sponsorship Can Create UBTI Issues. Frequently, 501(c)(3) entities will receive payments from “sponsors.” Although a straightforward sponsorship arrangement does not generally create UBTI issues, the arrangement may move from sponsorship to advertisement, causing a UBTI problem. The difference: Sponsorship is payment by someone engaged in a trade or business without expectation of substantial return. A tax-exempt organization may generally acknowledge a sponsor through the use of logos or distribution of the sponsor’s contact information but may not advertise the sponsor’s goods or services without triggering potential UBTI issues.
  5. That UBTI May Require Your Organization to File an Additional Tax Form. Although a 501(c)(3) is not generally taxed on its income, its UBTI is subject to tax, which is reported on the IRS Form 990-T.