Unrelated Business Income - Three Important Tests for Charitable Organizations


By Maureen Thomas

As charitable organizations look to diversify their revenue streams, they need to be aware of unrelated business income tax or UBIT. Although tax-exempt organizations do not pay income tax on their exempt activities, certain activities under the Internal Revenue Code (IRC) are deemed “unrelated” and subject to income tax on net unrelated business income. When determining whether an activity is considered “unrelated,” a three-part test must be analyzed.

First, it must be determined if the activity is considered a trade or business and regularly carried on. If the activity meets these two tests, then it must be determined if it is substantially unrelated to the charitable organization’s exempt status. If a particular activity meets these tests, the net income from the activity is subject to unrelated business income tax unless a statutory modification is available.

The Internal Revenue Service (IRS) recently addressed the “unrelated” criteria in private letter ruling PLR 201251019. In this ruling, the IRS evaluated the activities of an IRC Section 501(c)(3) organization whose mission is to promote literacy and an appreciation of reading by children and adults. In determining whether holiday read-alouds for children were considered a trade or business, the IRS ruled that any activity carried on with the purpose of producing income from the sale of goods or performance of services is a trade or business. The organization received ticket revenue from the read-aloud events, therefore it produced income. Regarding whether or not the activity was “regularly carried on,” the IRS examined the number of events held, as well as promotional efforts throughout the year. The IRS ruled that even though the activity was seasonal, it did meet the definition of “regularly carried on.”

Finally, in examining whether the activity was “substantially related,” the IRS ruled that it was substantially related to the organization’s focus on childhood literacy and, therefore, would not be treated as unrelated business income.

Charitable organizations should take a look at their revenue-generating activities to determine whether they may be subject to UBIT. Schneider Downs’ tax professionals have extensive experience in analyzing such activities. Please contact your tax professional at Schneider Downs for more information. 

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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