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  • Writer's pictureMichael Wright

Understanding Unrelated Business Income Tax (UBIT) for Tax-Exempt Organizations

Churches and religious organizations, among other tax-exempt entities, often partake in income-generating activities that are unrelated to their primary tax-exempt purposes. While this is permitted, certain tax implications arise, particularly concerning the Unrelated Business Income Tax (UBIT) .


Before delving into the intricacies of UBIT, it’s vital to note that organizations like churches can engage in revenue-generating ventures that are not directly related to their tax-exempt functions. However, the income they generate from such unrelated activities may be subject to the UBIT if these activities represent a substantial portion of the organization's operations.


The net income derived from these unrelated activities is what ultimately becomes subject to UBIT. Net income, in this context, refers to the profits earned after deducting any allowable expenses related to carrying out these income-producing activities.


While churches and religious entities are primarily focused on carrying out charitable and religious activities, they may also operate facilities, run businesses, or engage in other ventures to support their overarching missions. In such cases, they must carefully assess the extent of these unrelated income-generating activities to determine their UBIT obligations.


When examining the IRS guidelines on UBIT, it becomes apparent that the key factor is the proportion of unrelated business activities concerning the organization's overall operations. Understanding this distinction is essential in managing tax obligations effectively while maximizing the organization's impact and mission fulfillment.



UBIT Concept

Unrelated Business Income Tax (UBIT)

Net Income Subject to the UBIT

Churches and religious organizations, like other tax-exempt organizations, may engage in income-producing activities unrelated to their tax-exempt purposes, as long as the unrelated activities aren’t a substantial part of the organization’s activities. However, the net income from these activities will be subject to the UBIT if the following three conditions are met:

the activity constitutes a trade or business,


the trade or business is regularly carried on, and


the trade or business is not substantially related to the organization’s exempt purpose. (The fact that the organization uses the income to further its charitable or religious purposes does not make the activity substantially related to its exempt purposes.)


Exceptions to UBIT

Even if an activity meets the above criteria, the income may not be subject to tax if it meets one of the following exceptions: (a) substantially all the work in operating the trade or business is performed by volunteers, (b) the activity is conducted by the organization primarily for the convenience of its members or (c) the trade or business involves the selling of merchandise substantially all of which was donated. In general, rents from real property, royalties, capital gains, and interest and dividends aren’t subject to the unrelated business income tax unless financed with borrowed money.


Examples of Unrelated Trade or Business Activities

Unrelated trade or business activities vary depending on types of activities.

Advertising

Many tax-exempt organizations sell advertising in their publications or other forms of public communication. Generally, income from the sale of advertising is unrelated trade or business income. This may include the sale of advertising space in weekly bulletins, magazines or journals, or on church or religious organization websites.


Sale of merchandise and publications

The sale of merchandise and publications (including the actual publication of materials) can be considered the conduct of an unrelated trade or business if the items involved do not have a substantial relationship to the exempt purposes of the organization.

Rental income

Generally, income derived from the rental of real property and incidental personal property is excluded from unrelated business income. However, there are certain situations in which rental income may be unrelated business taxable income:

if a church rents out property on which there is debt outstanding (for example, a mortgage note), the rental income may constitute unrelated debt-financed income subject to UBIT. (However, if a church or convention or association of churches acquires debt-financed land and intends to use it for exempt purposes within 15 years of the time of acquisition, then income from the rental of the land may not constitute unrelated business income.)

n if personal services are rendered in connection with the rental, then the income may be unrelated business taxable income.


Parking lots

If a church owns a parking lot that is used by church members and visitors while attending church services, any parking fee paid to the church would not be subject to UBIT. However, if a church operates a parking lot that is used by members of the general public, parking fees would be taxable, as this activity would not be substantially related to the church’s exempt purpose, and parking fees are not treated as rent from real property. If the church enters into a lease with a third party who operates the church’s parking lot and pays rent to the church, these payments would not be subject to tax, as they would constitute rent from real property.


Whether an income-producing activity is an unrelated trade or business activity depends on all the facts and circumstances. For more information, see IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations.


Tax on Income-Producing Activities

If a church, or other exempt organization, has gross income of $1,000 or more for any taxable year from the conduct of any unrelated trade or business, it must file IRS Form 990-T, Exempt Organization Business Income Tax Return, for that or for any taxable year from the conduct of any unrelated trade or business, it must file IRS Form 990-T, Exempt Organization Business Income Tax Return, for that year.


If the church is part of a larger entity (such as a diocese), it must file a separate Form 990-T if it has a separate EIN. Form 990-T is due the l5th day of the 5th month following the end of the church’s tax year. (IRC Section 512(b)(12) provides a special rule for parishes and similar local units of a church. A specific deduction is provided, which is equal to the lower of $1,000 or the gross income derived from any unrelated trade or business regularly carried on by the parish or local unit of a church.)


In conclusion, the Unrelated Business Income Tax is a crucial consideration for tax-exempt organizations, including churches and religious institutions, engaged in revenue-generating activities outside their primary exempt purposes. By comprehensively assessing their unrelated business operations and net income, these organizations can navigate the regulatory landscape and fulfill their financial responsibilities effectively.



This blog post sheds light on the complexities of UBIT and its implications for tax-exempt organizations. Understanding these nuances is essential for ensuring compliance and effective financial management within the nonprofit sector.


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