Is IRS Speaking Latin When It says, “UBI”?
Ubi means where in Latin, but when the IRS speaks UBI, it means Unrelated Business Income.
What is UBI, and why might a nonprofit need to know about UBI?
UBI is income from a regularly-carried-on trade or business that is not substantially related to the organization’s exempt purpose.
To generate UBI, the activity must be:
1. A trade or business,
2. Regularly carried on, and
3. Not substantially related to the organization’s exempt purpose.
These three requirements form the three facets of the UBI test. To be considered a source of unrelated business taxable income, an activity must conform to each of the three facets.
Trade or business means selling goods or services to generate income.
Regularly carried on means the activity shows frequency and continuity and that it is conducted in the same way that a nonexempt organization would run a similar business.
Not substantially related means that the activity is not important to furthering the exempt purpose of the organization (other than generating income for it).
A small amount of unrelated trade or business activity in relation to an organization’s exempt purpose activity will have no impact on exempt status. Exempt status is only jeopardized when the activity generating unrelated income makes up a substantial part of the organization’s overall activities.
Exceptions to UBI
The Internal Revenue Code contains a number of exceptions to the usual rules of UBI. That means that some UBI is not subjected to tax. These exceptions include, but are not limited to, activities:
1. Conducted by a volunteer workforce,
2. Conducted for the convenience of organizational members,
3. Involving the sale of donated merchandise,
4. Involving the distribution of low-cost articles,
5. Involving income from convention or trade show participation,
6. Involving income from qualified sponsorship, and
7. Traditional bingo.
Exclusions and Deductions from UBI
In addition to the exceptions discussed, the Code allows certain other exclusions and deductions in calculating UBI tax.
The exclusions include, but are not limited to, income generated from:
1. Interest and dividends,
3 Certain rents from real properties with the exception of income from debt-financed property, and
4 Certain gains and losses.
Allowable deductions include certain expenses, depreciation, and similar items directly connected with carrying on an unrelated trade or business. In addition, other modifications allow for deductions like:
1. The net operating loss deduction, where an unrelated business loss in a previous or current tax year is deductible;
2. Charitable contributions made by the organization regardless of whether they are directly connected with the unrelated trade or business; and
3. The specific deduction that allows for $1,000 to be automatically deducted from the UBI tax calculation.
Charitable Gaming and Applicable Taxes Gaming
Charitable Gaming and Applicable Taxes Gaming is one of the most common and successful types of fundraising. It can range from sponsoring a bingo game to a once-a year raffle or casino night.
Most often, gaming will generate UBI. Federal wagering excise taxes apply to certain types of gaming, but these taxes are typically not applicable to gaming conducted by 501(c)(3) organizations.
Certain wagering transactions also require Form W-2G to be filed. The gaming operator should always complete Form W-2G upon payment of the prize to the winner.
Withholding or backup withholding of income tax from the prize winner is reported on Form W-2G. The rates and requirements of withholding depend on the game played and whether the winner furnishes taxpayer identification at the time the prize is awarded.
Filing Procedures for Form 990-T: Organizations with gross income of $1,000 or more from unrelated business must file Form 990-T annually.
Form 990-T is due the 15th day of the 5th month following the end of the organization’s accounting period. Form 990-T must always be filed in conjunction with Form 990. One cannot replace the other.
Form 8868 can be used to request an automatic six-month extension of time to file Form 990-T.
End of Blog Quiz
1. Tom is president of his nonprofit and tells his board, “There is a great service station that our nonprofit could buy to raise money, since our donations and activities are almost non-existent. It will make a lot of money for us. Why not go for it?” What would you tell the board?
“Your 501c3 status will be seriously jeopardized because the activity generating the unrelated income would make up a substantial part of the organization’s overall activities. ”
2. Angela has an online ministry that sells Bibles, religious books, and religious CDs. She tells her board that everything is “kosher” because these Bibles, books and CDs are all religious and further the nonprofit’s religious purpose of ministering to the people who buy them. She does no other ministry. Is she on firm ground?
No, her 501c3 status is seriously jeopardized because the activity generating unrelated income makes up a substantial part of the organization’s overall activities.
But Angela argues to the IRS that the income is not unrelated because the sales activity ministers to the people buying the materials, and this religious purpose is the foundation of her 501c3 status. Your answer?
I’m sorry, Angela, but the activity of making sales is not in itself a tax-exempt activity. You are making sales, not ministering to people. The religious material may minister to people, but that is not the same thing as your nonprofit ministering to people.
3. Henrietta tells her board, “I’m just going to put our UBI income on our 990. I don’t plan to do anything else.” What would you advise her?
“You must file the 990-T in conjunction with your 990.”
4. Hilton tells his board, “We only made $750 this year from Unrelated Business Income, so we don’t have to file anything.” Is he correct?
Yes, $1,000 is the threshold amount. Anything under that does not have to be reported.