Unrelated Business Income: What Every Not‑for‑Profit Needs to Know

Not‑for‑profit organizations (NFPs) generally do not pay tax on income from activities that directly further the exempt purposes for which they were created. But they may have to pay tax on income from activities that are operated like a regular business and are not closely tied to those exempt purposes. This is called unrelated business income (UBI).

UBI is income from a trade or business that 1) is carried on regularly, like a normal commercial activity, and 2) does not have a substantial connection to the organization’s mission, other than simply bringing in money to fund programs.

Common Exclusions

The tax law excludes several types of income from UBI, even if they might otherwise appear to be UBI:

• Interest, Dividends, and Capital Gains: Most typical investment income, such as bank interest and stock dividends, is excluded from UBI. Gains and losses from selling investments or other property are usually excluded as well. However, this exclusion may not apply if the property is debt financed (explained below).
• Rental Income: Income from renting out real property (such as land or buildings) is generally excluded from UBI. But the exclusion may not apply if the organization provides substantial services to tenants (beyond basic services like utilities and routine maintenance), if a significant amount of personal property (for example, equipment) is rented along with the real estate, or if the property is debt‑financed.
• Convenience of Members: Income from a trade or business operated primarily for the convenience of members, students, patients, officers, or employees is excluded. Examples include a cafeteria operated for students and staff at a school, or laundry services provided to residents of a shelter.
• Volunteer Labor: If substantially all of the work (generally at least 85%) in an activity is performed by volunteers, the income from that activity is excluded. This often applies to thrift stores or fundraising events staffed almost entirely by unpaid volunteers.

Common Types of Unrelated Business Income

1. Income from Debt Financed Property

Income from debt‑financed property may be treated as UBI, even if it would normally be excluded as investment or rental income. Debt‑financed property is income‑producing property (including property that may later be sold at a gain) that has “acquisition indebtedness” at any time during the year (i.e., a building purchased with a mortgage or securities bought on margin).

2. Partnership and S Corporation Investments

Investments in partnerships and S corporations are frequent sources of UBI for NFPs.

• S Corporations: A tax-exempt organization’s share of an S corporation’s income or loss is treated as UBI, no matter what type of income it is at the S corporation level. That means items that would usually be excluded, such as interest, dividends, or capital gains, are treated as unrelated when earned through an S corporation.
• Partnerships: As an investor in a partnership, the NFP is treated as if it directly carried on its share of the partnership’s activities. If the partnership conducts a trade or business that is regularly carried on and not substantially related to the NFP’s exempt purpose, the NFP’s share of that income (and related deductions) is treated as UBI. By contrast, the NFP’s share of the partnership’s qualifying investment income and rental income generally falls under the exclusion rules and is not UBI, unless it comes from debt financed property. For example, if a partnership owns rental real estate that is subject to acquisition indebtedness, a portion of the rental income may be treated as UBI under the debt financed property rules.

3. Compliance Implications

• Form 990 T Filing Requirement: An NFP must file Form 990 T if it has $1,000 or more of gross income from unrelated business activities during the year. Form 990 T reports the unrelated revenue and expenses and calculates the tax due. It is generally due on the 15th day of the fifth month after year end, with a six-month automatic extension available. Any tax due must still be paid by the original due date. Most states also tax UBI so there may be additional state filings to consider.
• Estimated Tax Payments: If the organization expects its unrelated business income tax for the year (after credits) to be $500 or more, it must make quarterly estimated tax payments. These estimates are generally due on the 15th day of the 4th, 6th, 9th, and 12th months of the tax year, similar to the rules that apply to taxable entities.

Gain Greater Clarity with Citrin Cooperman

The examples above highlight several common areas that may generate UBI, but they do not cover all possible situations. If your organization is considering new revenue streams or wants to confirm that existing activities are properly reported, Citrin Cooperman's dedicated Not-for-Profit Industry Practice professionals can help you evaluate the potential tax implications and compliance requirements. For assistance, please contact your Citrin Cooperman advisor.