The Effect of UBIT on Nonprofit Organizations
Thu, Nov 6, 2008
The trade and business activities of nonprofit organizations, which are generally tax-exempt, will be subject to the Unrelated Business Income Tax (UBIT) for unrelated business income (UBI) that is 1) from a trade or business that 2) is regularly carried on and that is 3) not “substantially related” to the organization’s exempt purpose.
Generally, the income earned by nonprofits is tax-exempt to the extent that it is related to the organization’s purpose, such as promoting public awareness and appreciation of art in the case of an art museum, or promoting public awareness and appreciation of marine life in the case of an aquarium.
However, nonprofit organizations sometimes engage in business activities that seem to fall slightly outside the scope of their main purpose, such as gift shop sales and food sales. Whether the income from gift shop sales, food sales and facility rentals by nonprofit organizations is UBI for the purposes of applying UBIT ultimately depends on the nature of the business activity.
Gift Shop Sales
As long as the gifts sold in a nonprofit organization’s gift shop are “substantially related” to the nonprofit’s exempt purpose, UBIT will not apply to income from gift shop sales. Examples of gift sales that the IRS has deemed “substantially related” include the sale of art books in the case of an art museum, because art books enhance the appreciation of art in general. However, the sale of souvenirs from the city in which an art museum is located is not substantially related to the purpose of an art museum, and therefore is subject to UBIT.
Food Sales
As long as the operation of a restaurant is reserved for use by the nonprofit’s staff and visitors, rather than to the general public, income from food sales are probably not subject to UBIT.
Facility Rentals
If a nonprofit organization rents out its facilities for private parties like benefit dinners and award ceremonies, the income generated from such rentals is subject to UBIT. An exception to this rule is when the facility rental promotes the organization’s exempt purpose, such as when a special event held in a museum facility serves primarily to expose the museum’s artwork to people who would not have seen it otherwise.
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