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Exempt organizations and UBIT.

Many tax-exempt organizations in the United States perform many of the same functions and provide many of the same services that forprofit entities do; the major difference is that a for-profit generally must pay taxes on all its income, while an exempt organization may escape taxation on some.

To keep exempt organizations from having an unfair advantage when they compete with tax-paying entities, the Internal Revenue Code includes an unrelated business income tax (UBIT) that places the unrelated business activities of exempt organizations on the same tax basis as those of for-profits.


Exempt organizations normally must be both organized and operated exclusively for an exempt purpose. However, "exclusively" in this context does not mean 100%; an exempt organization may carry on some level of nonexempt activity for business purposes (although the courts and the IRS often differ on exactly how much this amount may be). An activity is not taxable under UBIT provisions unless it meets three requirements.

Trade or business requirement. Normally, any activity carried on to produce income by selling goods or rendering services is a trade or business; if an activity does not possess the characteristics of a trade or business, UBIT provisions do not apply. This test looks to both an activity's profit motives and the way in which the activity is run.

An activity conducted simply to produce revenue and not to make a profit is not a trade or business. This does not necessarily mean the activity must make a profit; if the activity is an unrelated trade or business, it does not lose that status because the activity loses money.

In addition, if an activity is carried on in a manner similar to a commercial business, it is considered a trade or business. This determination considers the activity's customers, its selling techniques, its place within the organization and similar activities conducted by for-profit enterprises.

Regularly carried on. To be considered an unrelated trade or business subject to tax, an activity also must be carried on regularly. The activity must show a frequency and continuity and be pursued in a manner similar to comparable commercial activities of nonexempt organizations. This does not mean that the activities must be conducted five days a week, 52 weeks a year; an activity conducted one day each week year round is considered regularly conducted. At the same time, discontinuously or periodically conducted activities are not considered regularly carried on if they are conducted without the competitive and promotional efforts typical of commercial endeavors.

Not substantially related. Activities will be subject to UBIT only when they are not substantially related to an organization's exempt purpose. A trade or business is substantially related when the organization's business activities have a causal relationship to the achievement of its exempt purposes and that relationship is a substantial one. The activity from which the income is derived (the production or distribution of goods or the performance of services) must contribute importantly to the accomplishment of the organization's exempt purpose. The size and extent of the activities must be analyzed in relation to the nature and extent of the exempt function the activities are intended to serve to determine whether they contribute importantly to that exempt function.


Although they may be revenue raisers, certain activities are not subject to UBIT, including:

1. Businesses in which "substantially all" work is done by volunteers (for example, church school lotteries).

2. Businesses conducted by charities primarily for the convenience of members, students, patients, officers and employees (for example, hospital pharmacies).

3. Businesses that sell donated merchandise (thrift shops, for instance).

4. Low-cost articles distributed incidentally to the solicitation of charitable contributions.

5. Business involving the exchange or rental of mailing lists between certain charitable and veterans' organizations.

For a discussion of this and other current topics, see the Tax Clinic department, edited by Mitchell Stump, in the September 1994 issue of The Tax Adviser.
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Title Annotation:unrelated business income tax
Author:Fiore, Nicholas
Publication:Journal of Accountancy
Date:Sep 1, 1994
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