Many people think that tax-exempt organizations don’t pay federal income tax. While this assumption is true under most circumstances, there are times that they are indeed subject to income tax. When tax exempt organizations engage in commerce unrelated to their exempt status, Congress legislated that they are in fact required to pay their fair share in taxes. This is known as “Unrelated Business Income Tax” or UBIT for short.
To be subject to the UBIT rules, a tax exempt organization must:
- Carry on a trade or business usually involving the sale of goods or services in exchange for money or something of value for the purpose of making a profit
- Regularly carry on the trade or business; it must take place frequently or on a continual basis similar to the way a for-profit business would be carried on
- Carry on a trade or business that is not substantially related to the organization’s tax-exempt purpose
There are several exceptions where unrelated and regularly carried on business activity will not be subject to UBIT including:
- The business is performed for the convenience of its members. For example, a non-profit hospital’s cafeteria
- Work performed by unpaid volunteers
- The sale of donated property
- Passive investments such as dividends, royalties, interest, and capital gains
While the above information outlines the basic rules of UBIT, the surrounding laws are very complex and specific advice should be sought from competent tax counsel.