Unrelated Business Income Tax (UBIT)

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by the Nonprofit Risk Management Center.

In 1950, the Internal Revenue Code (IRC) was amended to include a provision concerning unrelated business income tax or UBIT. The change in the code was intended to remove unfair competition between nonprofits and for-profits. Thus, it made net profits from activities that don’t further a tax-exempt organization’s exempt purposes subject to normal corporate-tax rates. Although this sounds straightforward enough, the regulations offer a sumptuous feast of complicated options each of which need to be sampled and digested before moving on to the next course.

Under Section 512(a) of the IRC, tax-exempt nonprofits are subject to tax on gross income, minus directly connected expenses, for activities that constitute an “unrelated trade or business.” The Code offers a three-prong test for determining whether a particular activity is an “unrelated trade or business.” The activity must be (1) a trade or business that is (2) regularly carried on, and (3) isn’t substantially related to the organization’s exempt purpose. Remember:

  • Incurring UBIT liability isn’t inherently bad. If you generate “unrelated business income” per the IRS rules, you should report this income and directly connected expenses on IRS Form 990-T. Subsequently, you may owe some taxes on that income. However, since you only pay taxes on the activity’s net income after you subtract allowed expenses (“directly connected expenses”) from the gross reported income, in many cases, generating unrelated business income results in no tax liability. Many nonprofits that have been at this for a long time simply consider the tax liability on their UBI as a cost of doing business.If your nonprofit incurs unrelated business income, you’re in good company. In 1995, more than 36,000 exempt organizations reported gross unrelated business income. This number has no doubt risen in the past five years.
  • The IRS can help. Obtain a copy of Publication 598, which offers a thorough explanation of UBIT. It’s available as a PDF document at http://www.irs.gov/pub/irs-pdf/p598.pdf. Or start at www.irs.gov and look for Publication 598 under the “Publications and Forms” section of the IRS Web site.
  • A nonprofit that expects to incur $500 or more in UBIT liability must make estimated tax payments on a quarterly basis. Large nonprofits that generate substantial unrelated business income may be subject to the Electronic Federal Tax Payment System (EFTPS).
  • Seek advice and counsel. If you are uncertain whether or not your nonprofit is generating unrelated business income, seek the advice and counsel of an attorney or a CPA with experience in this area.


A number of activities are specifically excluded from the IRC’s definition of “trade or business.” Here’s a partial list:

  • Volunteer services – an activity where substantially all of the work performed is done by uncompensated personnel.
  • Provided for the convenience of members – an activity offered for the convenience of an organization’s members.
  • Qualified sponsorship activities – recognizing the financial support of a corporate sponsor by listing the sponsor’s name. An acknowledgement of sponsorship isn’t “advertising” as long as it doesn’t include qualitative or comparative language, price information or other indications of savings or value, or the nonprofit’s endorsement.
  • Bingo games – in states where bingo is legal and isn’t regularly sponsored by for-profit businesses.
  • Mailing list exchanges – the exchange of mailing lists between exempt organizations.
  • Convention or tradeshow activity – a convention offered for educational purposes, including the sale of exhibit or display space at the convention.

The Usual Suspects

While there various activities that may result in unrelated business income (UBI), we focus below on two areas that generate concern and confusion among nonprofits. For a thorough treatment of this subject, see IRS Publication 598.

Licensing Arrangements – During the past two decades there has been phenomenal growth in the number of nonprofits that enter into licensing arrangements with for-profit businesses and earn a royalty for these arrangements. As long as the tax-exempt organization’s participation is passive, it’s unlikely to face the prospect of UBIT. When the nonprofit actively participates in the arrangement, such as by aggressively promoting the sale of a mailing list or assigning a staff to undertake specific tasks that promote the licensor’s products, the IRS may find that the activity falls outside the exception for licensing arrangements. To avoid converting your licensing arrangement to one that generates unrelated business income:

  • Make your mailing list (or other items licensed by your nonprofit) available on a selective basis only, devoting only minimal staff time and expenses to the maintenance and marketing of the list;
  • Avoid providing any specific services to the licensee that assist them – beyond something as simple as informing members of the availability of the product through an annual notice – in promoting their products or services;
  • If you do provide services, delineate these services in an agreement that is separate from your mailing list rental or other licensing agreement;
  • Refer to the agreement as a “Licensing Agreement,” and make certain that the agreement specifies that the nonprofit isn’t providing specific services in exchange for the royalty payment;
  • Make certain that fees charged for mailing list rental or other licenses aren’t based on the actual net income generated by the renter – doing so could result in the classification of the arrangement as a joint venture, rather than a true licensing agreement;
  • Report the income generated through licensing arrangements as royalty income on your Form 990.

Advertising – Paid advertisements are one of the most common sources of UBI in the nonprofit sector, as numerous nonprofits feature paid advertising in their periodicals to offset the expense of publishing educational material. In many cases, however, the expenses specifically related to the advertising may offset the revenue resulting in no net tax liability to the nonprofit. 

The IRS recognizes that nonprofits often publish for educational purposes. It’s important to make certain that your nonprofit properly accounts for its advertising revenues and expenses and keeps within the requirements established by the IRS. Unless, of course, it’s your intention that your publishing activities fall outside the safe harbor, you should pay close attention to the four-prong test used by the IRS to determine if publishing activities are educational and thus consistent with a nonprofit’s exempt purposes. This test consists of the following criteria:

  1. The content of the publication must be educational – such as information to help individuals improve their capabilities.
  2. The preparation of materials must follow “educational” methods. Reasoned and factually supported material is likely to be considered educational; unsupported opinion is not.
  3. The distribution of materials must be necessary or valuable to achieving the nonprofit’s exempt purposes; and
  4. The manner in which the distribution is accomplished must be distinguishable from ordinary commercial publishing practices – the lack of a profit motive is often cited as the most important factor distinguishing a nonprofit’s publishing activities from regular commercial publishing. Substantial net profit from publishing may result in an unfavorable ruling from the IRS. 

Understanding the unrelated business income provision of the Internal Revenue Code is no easy task. However, like consuming a Thanksgiving feast, the safest approach is to take small bites, chew carefully and pace yourself. And never forget the critical importance of reaching out to the professional advisors that serve your nonprofit – your attorney and your CPA – for help understanding and applying the regulations and the judicial interpretations of the regulations to the circumstances facing your organization.