Unrelated Business Income: What Nonprofits Need to Know

Nonprofit organizations enjoy tax-exempt status because their activities align with a charitable, educational, religious, or other exempt purpose. However, income generated from activities not related to a nonprofit’s core mission is considered unrelated business income (UBI) and is subject to federal income tax.

To ensure compliance and avoid potential penalties, nonprofit leaders need to understand what UBI is, how to report it, and management best practices.

What is Unrelated Business Income (UBI)?

UBI is income generated from a trade or business activity that meets the following three criteria defined by the IRS:

Regularly Carried On

The activity is conducted frequently and continuously, similar to for-profit businesses. For example, running a gift shop that operates daily would likely be considered regularly carried on. However, a one-time fundraising event, like an annual gala or charity auction, is typically not considered UBI because it is not conducted regularly.

Trade or Business

The activity involves selling goods or services with the intent of generating revenue. Examples include leasing out unused office space, selling advertising in newsletters, or operating a café. These activities generate income and function in ways that are comparable to a commercial business.

Not Substantially Related to the Exempt Purpose

The activity does not contribute directly to the nonprofit’s core mission or exempt purpose. For example:

• If an educational nonprofit organization opens a coffee shop that has no educational component, the income from the coffee shop is UBI.
• If a hospital rents out parking spaces to the general public, the parking income may also qualify as UBI.

Common Examples of UBI Activities

• Operating a gift shop that sells items unrelated to the nonprofit organization’s mission
• Renting out facilities to non-members for events
• Sponsorship deals that involve advertising or endorsement rather than charitable recognition
• Offering consulting services for a fee unrelated to the organization's core purpose

How Should UBI Be Reported?

Filing Requirements: Form 990-T

Nonprofit organizations that generate $1,000 or more in gross income from unrelated business activities during the tax year must file Form 990-T, Exempt Organization Business Income Tax Return. This ensures proper tax reporting and compliance with federal regulations.

Gross Income Reporting

All revenue from unrelated business activities must be reported in Part I of Form 990-T. The gross receipts include the total income generated before deducting any expenses.

Deducting Expenses

Nonprofit organizations can deduct expenses directly associated with generating UBI. Common deductible expenses include:

• Salaries or wages for employees involved in the activity
• Rent or utilities for facilities used for the unrelated business
• Cost of goods sold (COGS), such as inventory expenses

For example, if a nonprofit earns $50,000 in gross income from leasing event space but spends $20,000 on maintenance, cleaning, and staffing, the taxable UBI would be $30,000.

Net Taxable Income

After deducting allowable expenses, the remaining amount is the taxable income, which is subject to corporate income tax rates.

Special Schedules

Supporting schedules and documentation must be attached to the Form 990-T, including a breakdown of income sources, itemized expenses, and detailed calculations. This level of transparency reduces the risk of errors or audits.

Additional Reporting Considerations

State and Local Taxes

Many states impose their own taxes on UBI, and some require a separate state tax return. Nonprofit organizations should check state-specific regulations to ensure compliance.

Quarterly Estimated Payments

If the nonprofit organization expects to owe $500 or more in taxes on UBI, it must make quarterly estimated tax payments to avoid underpayment penalties.

Best Practices for Managing Taxable Income from UBI

Managing UBI effectively requires a proactive and strategic approach to avoid potential risks and ensure accurate reporting. Here are several best practices nonprofit leaders should adopt:

Maintain Separate Accounts for UBI Activities

Use separate bank accounts or financial records for unrelated business activities and track income and expenses for UBI activities independently of mission-related operations. This approach simplifies reporting and ensures accurate allocation of costs.

Conduct Regular UBI Audits

Revenue-generating activities should be reviewed annually (or more) to identify potential UBI sources. Document the rationale for classifying activities as mission-related or unrelated. An audit can uncover risks, ensure compliance, and help nonprofit organizations adjust their strategies accordingly.

Understand UBI Exceptions

Certain types of income are not subject to UBI tax, including:

• Passive Income: Dividends, interest, certain royalties, and rents from real property are generally excluded from UBI.
• Volunteer-Operated Activities: Income from activities where substantially all work is performed by unpaid volunteers (e.g., bake sales run by volunteers).
• Convenience Income: Revenue from services provided for the convenience of members, students, or employees (e.g., an on-campus cafeteria at a university).

Limit the Scope of UBI Activities

If UBI activities become too large or significant relative to the nonprofit’s mission-related activities, it could trigger IRS scrutiny. In extreme cases, excessive UBI could jeopardize the organization’s tax-exempt status.

Nonprofit organizations should keep UBI activities secondary to mission-driven operations and invest resources primarily in activities directly advancing the nonprofit organization’s mission.

Leverage Professional Expertise

Professional assistance ensures compliance with IRS rules and reduces the likelihood of errors or penalties. To that end, it is helpful to engage tax advisors or accountants with nonprofit expertise to guide UBI compliance. Accounting software tailored to nonprofit organizations can help streamline financial management.

Why Proper UBI Management Matters

Failing to properly manage and report UBI can lead to several consequences:

• Financial Penalties: The IRS can impose fines and interest for failing to report UBI accurately or failing to file Form 990-T.
• Reputation Risk: Nonprofit organizations that mismanage UBI may face reputational damage if errors come to light during an audit.
• Tax-Exempt Status Risks: If a nonprofit organization generates too much UBI or improperly reports it, the IRS could revoke its tax-exempt status.

Understanding the requirements, maintaining proper records, and adopting best practices is necessary for nonprofit organizations to ensure compliance, mitigate risks, and maintain focus on their mission.

Keep the Mission, Minimize the Tax Headaches

Nonprofit leaders who proactively manage UBI can protect their organization’s tax-exempt status while strategically leveraging additional revenue sources to support their mission.

For more guidance, consult a nonprofit tax professional to tailor UBI strategies to your organization’s specific needs.