UBIT stands for unrelated business income tax (UBIT). UBIT is a tax imposed under Internal Revenue Code (IRC) §511(a)(2)(B) on exempt organizations that recognize income from business activities that are not substantially related to the exempt purpose of the organization. As an educational institution, UCCS is an exempt not-for-profit organization under IRC §501(c)(3).
Here are a few terms similar to UBIT:
UBI – Unrelated business income
UBTI – Unrelated business taxable income
Who is responsible for reporting UBIT?
Each UCCS department or unit must identify potential unrelated business activity within the department or unit in consultation with the UCCS Controller’s Office. The department must keep adequate documentation of financial data. When a department or unit identifies a potential unrelated business activity, the department or unit must report the activity to the UCCS Controller’s Office by the 10th day of March, June, October, and December. The UCCS Controller’s Office will determine whether an activity is considered an unrelated business activity and, if so, its taxability. Departments or units should not avoid or terminate an unrelated business activity to avoid paying taxes but should rather consult with the UCCS Controller’s Office. It shall be the responsibility of the UCCS Controller’s Office to coordinate reporting of UBI to the CU Tax Manager.
Who is responsible for paying the Taxes and possible penalties?
Each UCCS department or unit is responsible for any taxes or penalties assessed by the Internal Revenue Service related to the unrelated business activity held by their department.
What is the exempt purpose of UCCS?
The exempt purpose of UCCS is educational which includes instruction, research, and community outreach. Educational as defined by the internal revenue code is 1) the instruction or training of individuals for the purpose of improving or developing their capabilities, or 2) the instruction of the public on subjects useful to individuals and beneficial to the community. As a result, if UCCS regularly carries on a trade or business not substantially related to its exempt purpose, UCCS is generally subject to tax on the income from that unrelated trade or business.
Are there guidelines to assist in determining if an activity is an unrelated trade or business?
Yes, there are guidelines to assist in determining if an activity is an unrelated trade or business. Per Publication 598, Tax on Unrelated Business Income of Exempt Organizations (Pub 598), organizations must apply the three-part test when determining if a business activity is an unrelated trade or business. The three-part test consists of the three questions below. If you answer “yes” to each of the questions, then the activity is an unrelated trade or business and may be subject to UBIT.
Is the activity considered a “trade or business”?
The term “trade or business” generally includes any activity conducted to produce income from selling goods or performing services. Services are intangible products such as catering, security, cleaning, and accounting, no transfer of possession or ownership takes place when services are sold. An activity must be conducted with intent to make a profit to constitute a trade or business.
Is the activity “regularly carried on”?
Business activities of an exempt organization ordinarily are considered “regularly carried on” if they show a frequency and continuity and are pursued in a manner similar to comparable commercial activities of nonexempt organizations. For example, if an activity is conducted during a specific season or time which is normal for the industry then that activity is considered regularly carried on. If the business of the organization is conducted for only a few weeks, while the normal profit-making business is conducted all year, then the activity is not considered regularly carried on. If the activity is intermittent and without competitive or promotional activities that are usually inherent in such commercial businesses, then it is not regularly carried on.
Is the activity “substantially unrelated” to the exempt purpose of the organization?
A business activity isn’t substantially related to an organization’s exempt purpose if it doesn’t contribute importantly to accomplishing that purpose (other than through the production of funds). If the business activity has a substantial causal relationship to the achievement of the exempt purpose, it is related. If the activity serves the exempt function, but is larger than necessary, the excess income could indicate that there is unrelated business income. Ultimately, it is about how the funds are acquired and not about their destination or usage.
Are all unrelated trades or business activities subject to UBIT?
No, according to the IRS, the following activities are specifically excluded from the definition of unrelated trade or business, therefore generally not subject to UBIT:
Bingo games, so long as it is both legal and in compliance with IRS requirements. See IRC § 513-5.
Convenience of members, defined as certain activities carried on primarily for the convenience of its members, students, patients, officers, or employees are not an unrelated trade or business. See IRC § 513.
Selling donated merchandise, defined as the sale of merchandise, substantially all of which has been received as gifts or donations does not constitute an unrelated trade or business. See IRC § 513-1.
Volunteer workforce, defined as any trade or business in which substantially all work is performed for the organization without compensation isn’t an unrelated trade or business. See IRC § 513-1.
Qualified sponsorship payments, defined as any payment made by a person engaged in a trade or business for which the person will receive no substantial benefit other than the use or acknowledgment of the business name or product lines in connection with the organization’s activities. “Use or acknowledgment” doesn’t include advertising the sponsor’s products or services. See IRC § 513-4.
What about advertising? How is advertising different from a qualified sponsorship payment?
Advertising is an exchange transaction in which a commercial enterprise purchases the opportunity to reach a target audience with their message using UCCS media. Advertising is a call to action which is unrelated to the exempt purpose and is not an allowed exception. Advertising revenue may create a UBIT liability.
Do all revenue generating activities require a review for UBI? Or is there some excluded income?
Yes, all revenue generating activates, including passive activities, should be reviewed for UBI and potential UBIT. The following types of income are generally excluded when determining UBI, therefore not subject to UBIT:
Dividends, interest, annuities, and other investment income –All dividends, interest, annuities, payments with respect to securities loans, income from notional principal contracts, and other income form an exempt organization’s ordinary and routine investments that the IRS determines are substantially similar to these types of income are excluded in computing UBIT. See IRC § 512-5.
Royalties – To be considered a royalty, a payment must relate to the use of valuable right. Payments for trademarks, trade names, or copyrights are ordinarily considered royalties. Similarly, payments for the use of a professional athlete’s name, photograph, likeness, or facsimile signature are ordinarily considered royalties. See IRC § 512-5.
Rents – Rents from real property are excluded from figuring UBIT. However, rents from personal property aren’t excluded. Special rules apply to “mixed leases” of both real and personal property. The exception does not apply to unrelated debt-finance income and property. See IRC § 512-5.
Gains and losses from disposition of property – Excluded are gains and losses from the sale, exchange, or other disposition of property other than: 1) stock in trade, 2) property held for sale to customers in the ordinary course of a trade or business, or 3) cutting of timber that an organization has elected to consider as a sale or exchange of timber. See IRC § 512-5.
Are there other concepts to consider when determining if an activity contributes importantly to the accomplishment of an exempt purpose?
Yes, apply the following principles when determining if an activity is an unrelated trade or business.
Size and Extent
An emphasis is placed on the size and extent of the activity. If an activity is conducted on a scale larger than reasonably necessary to accomplish the exempt functions, the activity is likely to be treated as an unrelated trade or business.
Selling the products of an exempt function
Ordinarily, selling products that result from the performance of an exempt function isn’t an unrelated trade or business if the product is sold in substantially the same state it is in when the exempt function is completed. For example, if an exempt organization maintains an experimental dairy herd for scientific purposes, the sale of milk and cream produced in the ordinary course of operation of the project isn’t an unrelated trade or business. However, if a completed product resulting from an exempt function is used or exploited in further business activity beyond what is reasonably appropriate or necessary to dispose of it as is, the activity is an unrelated trade or business. For example, an exempt organization maintains an experimental dairy herd for scientific purposes, but now the organization uses the milk and cream in the further manufacture of food items such as ice cream, pastries, etc., the sale of these products is an unrelated trade or business unless the manufacturing activities themselves contribute importantly to the accomplishment of the exempt purpose of the organization.
Dual use of assets or facilities
If an asset or facility is necessary to the conduct of an exempt function, is also used in commercial activities, its use for exempt functions doesn’t, by itself, make the commercial activities a related trade or business. For example, a museum has a theater auditorium designed for showing educational films in connection with its program of public education in the arts and sciences. The theater is a principal feature of the museum and operates continuously while the museum is open to the public. If the organization also operates the theater as a motion picture theater for the public when the museum is closed, the activity is an unrelated trade or business.
Public Service versus Business-like Sales
Goods and services offered to the public may create taxable UBI, if most of the total sales are to the public and the goods or services are commercially available. By contrast, if the goods or services to the public are due to the University’s expertise or specialized equipment which is generally not commercially available, the sales may be sufficiently related to the University’s exempt purpose.
Rental of University Facilities
Use of University facilities by external entities for purposes not related to the exempt purpose may create taxable UBI, due to comparable facilities being commercially available. Rent from real property becomes taxable if:
The rent also covers the cost of services and personal property, or
The amount of the payment is based on a percentage of the payer's profits or income, or
The underlying real property generating the income is debt-financed and the transaction falls outside one of the debt-financed income exceptions.
What is an Unrelated Business Activity?
A general term that describes an economic activity carried out by an organization that creates revenues and is not related to the University’s exempt purpose.
How is the tax on an unrelated business activity (UBIT) calculated?
The tax on an unrelated business activity (UBIT) is calculated on the net income (revenues minus directly connected expenses) for each unrelated business activity. Each unrelated business activity is subject to Federal and possibly, State income tax. In some cases, net operating losses (NOL) may be used to offset at least 80% of current year UBI, resulting in a decreased tax liability. NOTE: Activities should not be terminated solely to avoid paying taxes.