Unrelated Business Income is the income from a trade or business that an organization regularly carries on and that is not substantially related to the performance of the organization's exempt purpose, except that the organization uses the profits derived from this activity.
To determine whether a particular activity that the university engages in will generate taxable income, the following three elements must all be present:
- The activity must be "a trade or business";
- The trade or business must be regularly carried on, AND
- The conduct or the trade or business is substantially unrelated to the exempt purpose
1. Trade or Business
The term "trade or business" generally includes any activity carried on to produce income from selling goods or performing services. An activity does not lose its identity as a trade or business merely because it is carried on within a larger group of similar activities that may, or may not, be related to the organization's exempt purpose.
- A trade or business must exhibit intent to profit from the activity.
- An activity carried on for profit is an unrelated trade or business.
- However, sustained, significant, and repeated losses generated by unrelated activities may not be considered "trade or business" for lacking a profit motive.
Suppose the university charges substantially below the cost of its goods or services. In that case, the activity is not a "trade or business," and the losses are not allowed to offset against the income derived from an unrelated for-profit business. On the other hand, if the business is conducted competitively, it is considered strong evidence of a profit motive (Reg. 1.513-(b)).
2. Regularly Carried On
Business activities are considered regularly carried on if they show frequency and continuity and are pursued like comparable commercial activities of nonexempt organizations.
An activity should not be considered as regularly carried on if it is (a) on a very infrequent basis; (b) for a short period of time during the year; or (c) without competitive and promotional efforts.
Activities over a period of only a few weeks are not "regular" for an exempt organization if a nonexempt business typically conducts the same kind of activities on a year-round basis. Intermittent, casual, or sporadic activities are generally not regular. However, year-round activities are regular, even if they are conducted only one day a week. Furthermore, seasonal activities may be considered regularly carried on, even though they are conducted only for a short period each year (Reg. 1.513-1 (c)(2)).
3. Substantially Unrelated
Business activity is not substantially related to an organization's exempt purpose if it does not contribute to accomplishing that purpose (other than through the production of funds). Whether an activity contributes significantly depends in each case on the facts involved (Reg. 1.513-1(d)(2)).
New Program or Activity Review
In determining whether activities contribute importantly to the accomplishment of an exempt purpose, the size and extent of the activity involved must be considered. If an activity is conducted on a scale larger than reasonably necessary to carry out the exempt purpose, the part of the activity that is more than needed to accomplish the exempt purpose is considered unrelated (Reg. 1.513-1(d)(3)).
If the activity is determined to likely generate unrelated business taxable income (i.e., be subject to UBIT), a Unrelated Business Income (UBIT) Questionnaire (pdf)will need to be completed by the department. The UBIT team will instruct the department if their activity is subject to UBIT and provide further information on what they will need to provide in an annual basis.
Identification of UBIT Activities
Financial Operations performs yearly reviews of new University revenue activities to identify potential UBIT and contacts business units and departments to determine if they may be engaged in a UBIT-generating activity. However, business officers are strongly encouraged to contact this office if they are contemplating a potential UBIT-generating activity or complete the Unrelated Business Income (UBIT) Questionnaire (pdf) to initiate a review by our team.
Common Types of Activities That Generate UBIT
While not all-inclusive, following is a list of the type of activities that commonly generate UI in a university environment:
Rental Payments: Rents from real property are generally excluded from UBIT, while rents from personal property are taxable. In the event of a mix of personal and real property, the entire rental payment is exempt if the portion due to personal property is less than 10%. If the portion is between 10% and 50% personal property, then only the portion attributable to the real property is exempt. If the portion of personal property exceeds 50%, the entire rental payment is subject to tax. The rental exclusion does not apply to leases based upon a percentage of the profit earned by the tenant.
Research-Related Activities: Income from sponsored research is exempt from UBIT regardless of whether it qualifies as fundamental research or applied research. However, the term “research” does not include activities normally carried on primarily for commercial benefit, such as testing or inspecting products or assays, or designing or constructing equipment to be used in commerce.
Commercial Consulting: Income from consulting performed through the University (i.e., not contracted by the faculty member personally) which is unrelated to its nonprofit missions is subject to UBIT.
Bookstore Sales of “Convenience Items”: Sales of certain otherwise taxable items are exempt from UBIT under the "convenience" exception if sold to University students, faculty and staff. The convenience exception applies to the operation of on-campus vending machines, the sale of sundry personal items by the University bookstore, and the laundering of dormitory linens and student clothing. The convenience exception does not apply to items with useful lives of more than one year (e.g., video games and gaming systems, televisions, etc.).
Sponsorship Payments: Qualified sponsorship payments are exempt from UBIT. A “qualified sponsorship payment” is defined as a payment made by a corporate sponsor for which it receives no substantial return benefit other than the use or acknowledgement of its business name, logo, or product lines. "Use or acknowledgement" does not include advertising (defined as qualitative or comparative descriptions of the sponsor’s products or an inducement to buy) or other services provided to the sponsor in exchange for the payment. Any income from the provision of advertising or other services, including the right to use University trademarks or logos, is subject to UBIT.
Advertising: The sale of advertising generally is taxable if it appears in a University newsletter, magazine, scholarly journal, phonebook, or sports programs. However, sales of advertising does not generate UBIT if the activity contributes to the University's educational mission through the training of students.
Travel Tours: Travel tours hosted by the University are subject to UBIT if the tours are intended primarily for the purpose of leisure or entertainment rather than for educational purposes. However, tours accompanied by faculty members who provide educational lectures with a written syllabus are generally considered related to the University’s educational mission and thus not taxable, even if the tour enrollees are not exclusively students.
Professional Performances: Professional performances by paid entertainers that do not promote the University’s nonprofit missions are subject to UBIT.
Investments: Dividends, interest, annuities, payments with respect to securities, and loans are generally considered “passive income” and excluded from UBIT. However, income derived from debt-financed assets (other than debt-financed real estate owned by colleges and universities) is taxable.
Joint Ventures: The University’s ownership interest in a partnership, LLC or other joint venture may generate UBIT if the entity is operated for taxable purposes. Income from an interest in "S" corporation is taxable regardless of the nature of the income.
Royalties: Royalties derived from the licensing of trademarks, patents or copyrights are considered passive income and excluded from UBIT.
Exclusion from Unrelated Business Activities
The following activities are specifically excluded from the definition of unrelated trade or business.
Any trade or business in which substantially all of the work (probably 85%) is performed without compensation is not unrelated trade or business. In assessing the contribution made by volunteers, the IRS considers factors such as the monetary value of the respective service rendered, the number hours worked, the intrinsic importance of the volunteer work performed, and the degree of reliance placed upon volunteers (Reg. 1.513-(e)(1)).
Convenience of Members
Any activity carried on primarily for the convenience of university members such as students, officers, or employees, is not unrelated trade or business. Any sales to nonmembers, e.g. the general public, are unrelated and taxable, unless the sales are not regularly carried on (Reg. 1.513-1(e)(2)). The IRS has ruled that alumni should be treated the same as members of the general public (PLR 8020010).
Selling Donated Merchandise
A trade or business that consists of selling merchandises, substantially all (probably 85%) of which the University received as gifts or contributions, is not an unrelated trade or business (Reg. 1.513-1(e)(3)).
Additional Information on Unrelated Business Income
In addition to the information above, please also refer to IRS Publication 598: Tax on Unrelated Business Income of Exempt Organization.