Unrelated Business Income — A Taxing Issue for Charities

In a webcast earlier this year, the IRS cautioned new 501(c)(3) charitable organizations that generating "substantial" unrelated business income (UBI) could jeopardize their tax-exempt status. But figuring out how much is too much isn't clear cut.

The Income Picture

UBI is income generated by regularly conducted trade or business activities that are not substantially related to an organization's exempt purpose. For example, if a tax-exempt museum sells tickets to a special exhibit, the activity is related to the museum's purpose. The money from the ticket sales is not unrelated business income, so it is not taxable.

It may be a different story if the museum operates a restaurant on site that is open to members of the general public who don't view the exhibits. Even if all the income is used to support the museum and its programs, the activity of selling food to the general public is not related to the museum's exempt purpose. Therefore, receipts the restaurant generates from these sales is UBI and may be taxable.

There are a few exceptions. For example, income from the following is not considered UBI:

• Activities run by volunteers
• Activities that primarily benefit the organization's members, students, patients, officers, or employees
• The sale of donated merchandise

How Much Is Too Much?

There is no set test to determine how much UBI is too much. The IRS will consider all the facts and circumstances in determining whether a nonexempt activity is substantial in relation to all of an organization's activities. If gross UBI for the year is $1,000 or more, it must be reported on IRS Form 990-T, Exempt Organization Business Income Tax Return.