For most tax-exempt organizations, unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption. An exempt organization is required to file Form 990-T when it has $1,000 or more gross income from unrelated business. An organization must pay estimated tax if it expects its tax for the year to be $500 or more.
The obligation to file Form 990-T is in addition to the obligation to file the annual return, Form 990, 990-EZ or 990-PF. In addition to filing Form 990-T, North Carolina organizations are required to file a North Carolina corporate return, Form CD-405, to report and pay tax on their unrelated business income. This is taxed at the corporate rate of 2.5% of the net income attributed to North Carolina.
The Internal Revenue Code contains a number of modifications, exclusions and exceptions to unrelated business income. Some of the activities not subject to unrelated business income are:
- Bingo games
- Passive rental of the organization’s facilities
- Passive income (dividends, interest & royalties)
- Selling of donated merchandise or in-kind gifts
- Realized gains/losses from disposition of property
- Revenue from hosting events for educational purposes
- Volunteer labor – Any trade or business is excluded in which substantially all the work is performed for the organization without compensation. Some fundraising activities, such as volunteer operated bake sales, may meet this exception.
- Convenience of members – Any trade or business is excluded that is carried on by an organization for the convenience of its members, visitors, students, patients, officers, or employees. A typical example of this is museum dining & parking.
What Is Considered Excessive Unrelated Business Income?
Although nonprofits can earn profits from unrelated business activities, these profits can only make up a certain percentage of the organization’s overall income.
This limit is not clearly defined, however. Instead, it is up to the IRS to determine if your percentage of total income coming from UBI is too high. In cases where the IRS is evaluating unrelated business income to determine adequacy, it considers various factors specific to the situation at hand.
How will Unrelated Business Income Impact my Organization?
While it is not uncommon for a nonprofit organization to have unrelated business income, there is a common misconception that unrelated business income will give the public a negative perception of the nonprofit. Unless substantial, unrelated business income does not have an adverse connotation in the eyes of the Internal Revenue Service, donors, and grantors because many organizations wisely use the resources, they have available to produce additional income to be used to further its organization’s purpose.
Please contact the Not-for-Profit Niche team at Gilliam Bell Moser LLP for further guidance.