Under section 512, income that a tax-exempt organization generates by conducting a regularly carried on trade or business that is not substantially related to the organization’s exempt purpose is unrelated business income (UBI). If an exempt organization’s UBI is $1,000 or more, the organization could be subject to the unrelated business income tax under section 511 and must file Form 990-T, “Exempt Organization Business Income Tax Return (and proxy tax under section 6033(e)).” If an exempt organization’s unrelated trade or business makes up more than an insubstantial portion of its activities, it could be in danger of having its tax-exempt status revoked by the IRS.
Advertising is a common generator of UBI. Other sources of UBI include royalties (if the royalty arrangement is not done properly), alternative investments, and debt-financed rental property.
There are exceptions to UBI. For example, under the “convenience exception,” income would not be considered UBI if the activity, such as the operation of a small shop selling necessities, was carried out for the convenience of the organization’s members. There is also the “thrift shop” exception, in which most of a shop’s merchandise has been donated, and the “volunteer” exception, in which almost all of the organization’s work is conducted by unpaid volunteers.
Under section 512, income excluded from UBI includes interest and dividends, rental income, royalties (unless the royalty arrangement is not done properly), mailing list rentals between charities, and gains and losses from disposing assets. Common exclusions under section 513 include trade shows, some qualified sponsorship payments, distributions of low-cost items, and some bingo games.
Tax Analysts covers news, proposed legislation, and IRS guidance addressing unrelated trade or business income.