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What is Unrelated Business Taxable Income?

Unrelated Business Taxable Income (UBTI) is a tax on income generated from activities not related to an organization's primary purpose. It ensures that tax-exempt entities, like charities, don't gain an unfair advantage in commercial activities. Understanding UBTI is crucial for maintaining your organization's compliance and tax-exempt status. Wondering how this might affect your nonprofit? Let's examine the implications together.
Jess Rhodes
Jess Rhodes

Unrelated business taxable income is a steep and complicated form of taxation by the U.S. Internal Revenue Code that can affect income of normally tax-exempt organizations, investments, and benefit plans. For tax-exempt organizations, unrelated business taxable income comes from regular business endeavors not substantially related to the organization’s mission statement or purpose. Tax-exempt pension plans, individual retirement accounts, and foundations are also subject to unrelated business taxable income examination.

In order for income to be considered unrelated and therefore taxable, certain requirements must be met. Income must result from a regularly occurring trade or business. Determining whether transactions are regularly occurring depends on the frequency and continuity of the event. The business endeavor must also not be substantially connected to the organization’s mission or tax-exempt offerings.

Man climbing a rope
Man climbing a rope

The concept of unrelated business taxable income was created to mitigate the risk of the small business owner. It prevents tax-exempt organizations from purchasing taxed businesses and producing a product at a lower price. This helps ensure that small businesses won’t suffer due to tax loopholes given to exempt organizations. The tax payment schedule is laddered, much like the federal income tax.

Tax-exempt organizations that engage in business activities that are not directly related to their mission or purpose might incur tax charges from these supplemental activities. Businesses in the U.S. that earn more than $1,000 US Dollars (USD) from unrelated business pursuits, minus corresponding deductions, must file said earnings in the IRS form 990-T. This form helps the IRS determine if the unrelated business income is taxable and at what amount.

Unrelated business pursuits excluded from incurring taxes include the receipt of most passive investment income. Income from asset sale or rental that is not financed by debt is also considered income excluded from taxation. Income accrued as dividends, interest payments, or other routine payments originally approved by the organization or service may therefore avoid taxation.

For those investors who have opted for tax-exempt investment funds, unrelated business taxable income can be incurred if the fund receives income from certain taxable and regular business endeavors. If the investment fund borrows money to fund investments or to acquire more portfolio companies, for example, unrelated business taxable income can be incurred. Income resulting from certain partnerships and affiliates with taxable organizations is often taxable as well.

Unrelated business taxable income examination happens for all retirement plans, including individual retirement accounts. The rules for the examination of taxable income for all exempt organizations are similar. Retirement plans can therefore incur taxes for receiving applicable rental income, operating a taxable trade or business, or gaining income from another taxable business.

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