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More Nonprofits to Face Unrelated Business Tax

December 2019 Update: The recently passed Consolidated Appropriations Act of 2020 repeals the provision included in the TCJA of 2017 that required tax-exempt employers to pay UBIT if they provide qualified transportation fringe benefits or parking to employees.

By Steven Brettholtz, CPA, CFF

In the hunt for new and reliable sources of revenue, most nonprofit leaders at some point will consider money-makers other than donations and fundraising events. Selling goods or services, or renting property, usually top the list of ideas until someone raises concerns about how the revenue from such activities might affect the organization’s tax-exempt status. This is quickly followed by the specter of Unrelated Business Income Tax or UBIT. In this article, we will explain the basics of UBIT, changes that went into effect for tax years starting after January 1, 2018, and why more nonprofits will need to deal with UBIT.

Why a Business Tax for Nonprofits?

The UBIT allows nonprofits to engage in income-generating activities that don’t directly connect to their nonprofit purpose while keeping their status as a tax-exempt organization. It applies federal income tax to income generated by a charity’s unrelated business activities.  It doesn’t matter if the money will support the nonprofit mission, only that the way in which it was made doesn’t directly relate to the purpose of the nonprofit. This is meant to help keep a level playing field with income-tax-paying businesses providing the same goods and services. The UBIT rate matches the corporate tax rate. Fortunately, the IRS has given nonprofits maneuverability to raise funds without being subject to the UBIT.

What Is and Isn’t UBIT

 Activities that can trigger UBIT must:

  • result in an exchange of money for goods or services
  • be ongoing or regularly occurring and pursued like comparable commercial activities, and
  • not substantially related to the tax-exempt purpose of organizations.

This last element is subjective and can spark a need for professional advice. Nonprofits need to take a close look at their stated exempt purpose and activities on their exemption applications to decide if a business venture is related or not.

There are exceptions for certain activities, allowing many nonprofit activities to avoid UBIT.

  • Volunteer labor: Any business activity is excluded in which substantially all the work is done by volunteers without compensation. Think volunteer-run bake sales.
  • The convenience of members: Any activity that is primarily for the convenience of its members, patients, employees, etc. is excluded.  A typical example is money made in a cafeteria or from vending machines.
  • Selling donated merchandise: Generating funds by selling merchandise, substantially all of which the organization received as gifts or contributions, is excluded.  This is often called the “thrift shop” exception.
  • Bingo: If the game is legal in the jurisdiction where it is played and similar games are not regularly run by for-profit organizations, income from these types of games is excluded.
  • Conventions & trade show revenue is excluded.
  • Dividends, interest, and royalties are excluded.
  • Real property rental income: This exception can get tricky. First, the property must be owned with no outstanding debt, like a mortgage. Second, no services can be provided in addition to the lease. For example, a nonprofit can lease owned space for a special event and income is excluded from UBIT if the nonprofit doesn’t provide any additional services like catering or bartending.
  • Neighborhood land rule exception: If land is purchased for future expansion and is rented in the interim, rental income may be excluded from UBIT. However, there are time limits and restrictions to the lease that must be met.

New Tax Law & UBIT

Some significant changes to UBIT came out of the 2017 Tax Cuts and Jobs Act. Notably, organizations with multiple unrelated business activities can no longer offset income from one line of activity with losses from another line of activity. Prior to the TCJA, organizations could aggregate the income and deductions from all their unrelated businesses.

Probably the most challenging change, tax-exempt organizations will now need to pay UBIT on qualified transportation fringe benefits for their employees. Qualified transportation fringe benefits (QTFB) include:  providing parking on land owned or leased by the nonprofit, paying an employee’s parking fees, or reimbursing the employee for parking. The current rate is 21 percent and any nonprofit providing QTFB to employees—even those who have no other unrelated business income—will need to calculate the UBIT.  

In December 2018 the IRS released clarifications with a four-step process to help nonprofits determine what portion of their parking is subject to UBIT. The agency also clarified that the UBIT on the transportation benefit need not be reported as a separate business activity from existing unrelated business activity. This allows losses on an existing business subject to UBIT to help offset the tax created by UBIT being applied to transportation benefits to employees.

When a nonprofit’s unrelated business income reaches the threshold of $1,000, including the UBIT applied to transportation benefits, the organization is required to file a 990-T.  The 990-T must be paper filed, not electronically submitted.

If your organization needs help navigating the Unrelated Business Income Tax and the recent changes, give our office a call.

Steven Brettholtz is president of Myers, Brettholtz & Company, PAHis decades of accounting experience include numerous assignments in all phases of taxation for individuals, businesses entities and non-profit organizations. He is a member of the Florida, California, Hawaii, Nevada, New York Accountancy Societies, and the American Institute of Certified Public Accountants (AICPA).   

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