Chicago Nonprofit Attorney – Unrelated Business Income Tax (UBIT)
For a 501(c)(3) nonprofit in Illinois to continue operating with tax-exempt status, it must primarily operate and conduct activities for a tax-exempt purpose. Because of this regulation, nonprofits are limited in the amount of business activity it can conduct that is unrelated to their exempt purposes. Income acquired outside of tax-exempt purposes is taxed as if the income was earned by a for-profit entity.
Additionally, the IRS needs to know the extent of your unrelated business income. If this unrelated income comprises a significant portion of an organization’s income, that organization can lose its tax-exempt status. Therefore, when an organization declares its income, it also needs to submit unrelated income and pay an unrelated business income tax (UBIT).
What is Unrelated Business Income Tax
If you are operating a tax-exempt nonprofit, your activities are legally defined as unrelated business as long as the activity meets three requirements, including:
- The activity generating income is a trade or business
- Regularly carried on
- Not substantially related to the organization’s tax-exempt purposes
As a deeper definition, a trade or business is an activity conducted with the goal of obtaining a profit. For instance, a 501(c)(3) tax-exempt museum selling posters in its gift shop may have to declare the posters as Unrelated Business Income. This may be true even if the posters feature paintings and the posters have an educational purpose (such as further study or enjoyment of art).
The question of unrelated business income is whether the museum is selling posters to advance its educational purposes. As you can see, there’s a fine line here, and through the IRS’s “fragmentation rule,” the IRS can examine the sale of each item and determine if the sale is related or unrelated.
Taxes Will You Need to Pay
If an activity is deemed as Unrelated Business Income, the 501(c)(3) nonprofit may need to declare this income to the IRS and pay federal taxes that are similar to that of a for-profit organization. To declare this income, a non-profit generating more than $1,000 of gross unrelated income must file Form 990-T, and the nonprofit must pay an estimated tax if the nonprofit expects its taxes to be more than $500.
Like most IRS tax laws, there are several modifications, other rules, and exceptions. For example, if the business is conducted by volunteers, such as a church operating a commercial parking lot with volunteers, then the nonprofit may not have to pay tax on the income generated from that activity. Donated merchandise is also exempt from UBIT.
Contact James C. Provenza & Associates, PC Today
Unrelated Business Income Tax is both straightforward and significantly broad, and 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. When preparing your annual reports to the IRS, contact our Chicago law office to consult with James Provenza. Call us today at (847) 729-3939.