We recently discussed Unrelated Business Income (UBI) that a nonprofit may find itself earning. Although a nonprofit is exempt from federal and state taxes, that doesn’t mean it is entirely free from paying taxes. In the case of Unrelated Business Income, a nonprofit will generally have to pay taxes.
What Is UBI?
As a rule, any profit that a nonprofit generates is used by the organization to further its stated mission. This can come from sales of products, such as a library selling used books and branded goods, or a service that the nonprofit provides to the community.
Many nonprofits have other activities to raise additional funds for their work, such as bake and yard sales. But generating additional income that is “regularly carried on,” such as a bookstore, coffee shop or other small business that isn’t significantly related to the organization’s mission may be taxed as regular income.
If a nonprofit’s unrelated business income exceeds $1,000 of gross unrelated income from these UBIT income sources, it will pay taxes on it using IRS Form 990-T and state form IL-99-T. However, if the nonprofit’s UBI exceeds the monies it takes in through regular fundraising and could compete with a for-profit business, the IRS could view it as a for-profit business. The nonprofit would then lose its tax-free status.
New Rules For UBI Taxation
The Tax Cuts and Jobs Act, which took effect on December 22, 2017, changed the way a nonprofit reports its income.
Previously, an organization could offset one stream unrelated of income with net operating losses from another, reducing their tax liability. After 2017, section 512(a)(6) of the Internal Revenue Code now requires that the UBI of each unrelated business be calculated separately. Called “siloing,” the nonprofit is now required to calculate each UBI individually instead of using a single figure.
Additionally, some activities, such as employee fringe benefits, must also be treated as UBI, even though they don’t generate any income for the nonprofit.
The full statute reads:
- 6) Special rule for organization with more than 1 unrelated trade or business In the case of any organization with more than 1 unrelated trade or business—
- unrelated business taxable income, including for purposes of determining any net operating loss deduction, shall be computed separately with respect to each such trade or business and without regard to subsection (b)(12),
- the unrelated business taxable income of such organization shall be the sum of the unrelated business taxable income so computed with respect to each such trade or business, less a specific deduction under subsection (b)(12), and
- for purposes of subparagraph (B), unrelated business taxable income with respect to any such trade or business shall not be less than zero.
It’s The Law, But Not Yet Clear
There are a number of questions about the way nonprofits will be required to report UBI. The Treasury Department has yet to provide clear guidance on what “one unrelated trade or business” actually means. The IRS has information available on its website.
Nonprofits may not need to wait for the Treasury Department. The Nonprofits Support Act was introduced into the House of Representatives on June 7, 2018, which would undo the UBI requirements for nonprofits. The Protect Charities and Houses of Worship Act was also introduced into the Senate on August 1, 2018. Both of these bills would undo the UBI requirements laid out in the Tax Cuts and Jobs Act.
Get Help In Chicago For Your Nonprofit’s UBIT
Unrelated Business Income Tax is both straightforward and significantly broad. With the many exceptions and modifications designed for specific charitable and for-profit activities, it is important to be well-versed in these tax laws.
With decades of experience helping many nonprofits throughout Chicago, James C. Provenza & Associates, PC can help your tax-exempt nonprofit operate within IRS tax laws and properly differentiate tax-exempt income and unrelated business income. When preparing your annual reports to the IRS, contact our Chicago law office to speak with James Provenza. Call us today at (847) 729-3939 or use our online contact form.
