Unrelated Business Taxable Income (UBTI)

Unrelated Business Taxable Income (UBTI)

Unrelated Business Taxable Income (UBTI) is income a tax-exempt organization earns from a trade or business activity that is regularly carried on and not substantially related to the organization’s exempt purpose. The UBTI rules prevent tax-exempt entities from competing unfairly with taxable businesses when they engage in profit-making activities unrelated to their mission.

How UBTI is determined

An activity generates UBTI only if it meets all three tests:
* Trade or business — produces income from selling goods or performing services.
* Regularly carried on — conducted in a manner similar to comparable commercial enterprises.
* Not substantially related — does not materially contribute to the organization’s exempt purposes, aside from generating income.

Most passive investment income (dividends, interest, capital gains) generally does not qualify as UBTI, but specific situations (for example, using margin debt or certain operating income inside an IRA or tax-exempt entity) can create UBTI.

Common examples that can produce UBTI

• Operating a restaurant, convenience store, motel, gas station, or similar active business.
• Buying and selling large numbers of real estate properties as an ongoing business.
• Making multiple private loans or otherwise regularly lending money.
• Using margin or leverage in an account that produces business-type income for a tax-exempt entity.
• Income from businesses owned through pass-through entities (LLCs, MLPs) that operate unrelated activities.

Example: Income from a restaurant that flows into an IRA or other tax-exempt account is typically taxable as UBTI because the activity is unrelated to the account’s exempt purpose.

Activities and income excluded from UBTI

Certain activities and types of income are excluded:
* Volunteer-run activities where substantially all work is unpaid.
* Businesses operated primarily for the convenience of members, students, patients, or employees (e.g., a school cafeteria serving students).
* Sales of donated merchandise (typical thrift-shop operations).
* Certain bingo games.
Excluded types of income commonly include:
* Dividends, interest, and most other investment income.
* Capital gains and losses on disposition of property (when not produced by an unrelated business).
* Royalties and certain rental income.
* Certain research-related income.

Taxation and filing

• Filing requirement: If an exempt organization has gross unrelated business income of $1,000 or more in a year, it must file IRS Form 990-T to report UBTI and compute tax.
• Tax rates: UBTI for organizations is taxed at corporate rates (currently 21% federal) or at trust rates (roughly 10%–37%) for exempt trusts.
• Credits and reductions: The computed tax may be reduced by allowable business tax credits (for example, foreign tax credits and certain general business credits), subject to limitations.
• Estimated payments: Organizations that expect to owe $500 or more in unrelated business income tax for the year generally must make estimated tax payments. These payments are typically due on the 15th day of the 4th, 6th, 9th, and 12th months of the tax year.

Penalties for noncompliance

Failure to file Form 990-T, underpayment of tax, or late payment can result in interest and penalty charges. Exempt organizations should track unrelated activities and income to avoid surprises and ensure timely filing and payments.

Practical steps for tax-exempt organizations

• Identify and document each activity that generates income; apply the three-part UBTI test.
• Distinguish passive investment income from business income.
• Track gross unrelated business income to determine filing thresholds.
• Prepare Form 990-T when gross UBTI is $1,000 or more; make estimated payments when required.
• Consult a tax advisor for complex situations (e.g., investments that use leverage, passthrough entities, or activities that may be partly related to the exempt purpose).

Key takeaways

• UBTI applies to income from trade or business activities that are regularly carried on and not substantially related to an organization’s exempt purpose.
• Passive investment income is generally excluded, but active business income usually triggers UBTI rules.
• Organizations with $1,000 or more in gross unrelated business income must file Form 990-T and may owe tax; estimated tax payments may be required if the expected tax is $500 or more.
• Proper tracking and timely filing reduce the risk of penalties.

Sources: Internal Revenue Service Publication 598; Internal Revenue Code §501; IRS guidance on Unrelated Business Income Tax (UBIT).