How to define Unrelated Business Income Tax
The Internal Revenue Service anticipates that exempt organizations will engage in activities that may be in competition with private business endeavors; but to be non-taxable, the activities must be substantially related to the purpose for which the organization has an exemption status. Therefore, university members derive taxable income from an activity if that activity is not related to its educational, scientific, literary, and charitable purposes. A college or university is generally deemed to have Unrelated Business Taxable Income (UBTI) when it realizes gross income from any regularly conducted trade or business that is not substantially related to its educational and other exempt purposes. (IRS Treasury Regulation 1.513-1(a)). In order to determine whether a particular activity that the university/agency engages in will generate taxable income, the following three criteria must all be present.
Substantially Unrelated to the Exempt Purpose
- The first criteria in determining whether an activity is taxable is to determine whether the activity is "substantially unrelated" to the exempt purpose of the organization. Conversely, to be considered related nontaxable income, there must be a substantial causal relationship between the activity that generates revenue and the exempt purpose of the organization (i.e., the activity must contribute importantly to the accomplishment of the exempt purpose other than the university's need to produce income) (IRS Treasury Regulation 1.513-1(d)(2)).
- The exempt purpose of colleges and universities includes (a) teaching and instruction, (b) research, and (c) public service. The mere fact that an activity generates a source of funds that are then used to carry out a mission-related activity does not mean that the activity is related to the mission.
- Particular emphasis is placed on the size and extent of the activity. If an activity is conducted on a scale larger than reasonably necessary to carry out the exempt purpose, it is more likely to be treated as unrelated. (IRS Treasury Regulation 1.513-1(d)(3)). Use for both exempt and commercial purposes will not necessarily exempt the income derived from commercial use unless the business activity "contributes importantly" to the accomplishment of exempt purposes. (IRS Treasury Regulation 1.513-1(d)(4)(iii)).
Trade or Business
- Activities cannot be considered taxable unless they are deemed to be a "trade or business" as defined in IRC Section 162. Among other things, a trade or business has to exhibit an intent to profit from the activity (real economic profit). If the intent is to merely recover costs and indeed no realized profit exists, the activity lacks a profit motive and is not subject to taxation. In addition there must be a regularity of activities and income production that would be different than the level of activity found in a hobby-like activity (IRS Treasury Regulation 1.513-1(b)).
Regularly Carried On
- The IRS Treasury Regulations consider the frequency and continuity of the activity and the manner in which it is pursued to determine if the activity is regularly carried on. Thus, the unrelated business income tax (UBIT) applies only to a business activity which is regularly carried on as distinguished from commercial transactions which are sporadic or infrequent (IRS Treasury Regulation 1.513-1(c)(1)).
- An activity should not be considered as regularly carried on if it is:
- on a very infrequent basis;
- for a short period of time during the year; or
- without competitive and promotional efforts.
Activities over a period of only a few weeks are not "regular" for an exempt organization if the activities are of a kind normally conducted by a nonexempt business on a year-round basis. Intermittent, casual or sporadic activities are generally not regular. However, year round activities are regular even if they are conducted only one day a week. Further, seasonal activities may be regularly carried on even though they are conducted only for a short period each year. (IRS Treasury Regulation 1.513-1(c)(2)).
The IRS expanded its definition of time period with the court case National Collegiate Athletic Association vs. Commissioner in July 1991 which looked at the duration of the event itself and not the preparation time involved.
Unrelated Business Income
Activities that are determined to produce Unrelated Business Income/Loss (UBI) will be included in the university's consolidated Exempt Organization Business Income Tax Return (Form 990-T), to be prepared each year for submission to the Internal Revenue Service.