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  Tax Exemption Home: Non Profit / Exemption Information: Exemption Workshop - Chapter 4 - UBI - Part 1
 

Exemption Workshop - Chapter 4 - Unrelated Business Income - Part 1

The Rules for Unrelated Business Income (UBI)

Unrelated Business Income, also known as UBI, consists of rules according to the Section 501(c) (3). It says that an organization of non-profit nature under the section 501(c) (3) is allowed to conduct activities that generate income that is not related to their purpose of tax-exemption. However, this is only possible if the nature of the activities is in any way not related to the main activities of the corporation’s activities. Yet whatever the non-profit organization profits from the said activity will be subject to this unrelated business income (UBI). However there should be three conditions that have to arise. The first one is that the activity is composed of a trade. The second one is that the activity is always carried on, and the last one is that the activity must be somewhat in relation to the company’s nature of business.

The section also explains the word “trade” and “business” to make sure that all the company owners know the real meaning. This is referred to as an action that profits the corporation from the sale of products or services. In relation to this, the name and identity of a corporation is not lost if they engage in activities that is done in a bigger group that is composed of related programs and activities. To make things clearer, let me give you an example. When a pharmacy sells medications to the public and also sells medical supplies to the hospital and to any patient, then these are all called “trades” or “businesses”.

Businesses That Are Regularly Carried On

The term “regularly carried on” refers to the frequency of the event of the activities that the corporation holds. These are of unrelated business if it is carried on in similar times as those of commercial businesses and organizations of tax exempt status.

Let me give you a clear example. If hospitals puts a sandwich stand in the hospital cafeteria and operates it daily or as long as the hospital is open, then it is considered as a regular business. However, if the hospital brings a sandwich stand to a tradeshow and profits from that, it is no longer a regular part of the hospital’s business.

Business That Is Not Related by Substantial Means

A business that is not related by substantial means is one that has activities that do not contribute to the purpose of being a tax-exempt corporation, except through the means of profit. Even if the activity is of charitable purposes, it still does not make it a part of their tax exempt purpose. It is a case-to-case situation on whether or not a certain activity is considered as substantial to the corporation.
There are many considerations when it comes to knowing if an activity is of important purpose to the company. How big the activity is and the range of it is some of the things that have to be considered. These factors must be in relation to the purpose of the corporation. If the activity is conducted on a bigger scale than what is normally needed, then it is not of substantial purpose to the corporation. But as stated earlier, the identity of the corporation is not lost even if they engage in activities that are of larger scale that are in relation to their nature of business.
Allow me to explain it further by example. If a hospital has a sandwich stand inside their premises, the profit garnered from the sale of products to the hospital staff and the patients admitted are related to the corporation’s purpose, however the sale of the products to the general public are of unrelated purpose and this is the profit that is subject to the Unrelated Business Income tax.

Examples of Businesses and Activities That Are Unrelated

In order to make you understand further, allow me to present the examples of activities that are considered unrelated. If the activity is related to management of debt, advertising or marketing, the use of parking areas, gaming, profit from rented property, and income from publications and other merchandise.
When it comes to advertising, there are companies that profit from this area because they offer advertising opportunities to other companies. This may be in the form of posting an advertisement in the company’s publication or ad space in the area or any other kind of advertising space and public communication. Remember that advertising belongs to unrelated business income. Any type of income generated from advertising like profit from selling ad spaces are subject to unrelated business income tax.

Sometimes, a corporation conducts gaming activities like lotteries, raffles, betting, and other games. Others that are included in this category are video games, Beano, bingo, pull-tabs, tip boards, scratch off, punchboards, Calcutta wagering, and pickle jars. However, there is an exemption for bingo because it does not produce unrelated business income for organizations that are of tax-exempt status.

Merchandise and Publications Profit

If a corporation produces merchandise and publication and sells these items, these are considered as unrelated business income. This holds especially true if the purpose of these items are not that important to the organization.
Profit from Property Rented

If the corporation rents out any of their property, this is considered as unrelated business income. But some situations may arise that will make this income a part of unrelated business income that is taxable. If a property is rented that still has an outstanding loan balance, like in the case of a mortgaged property, then it is a debt-financed income of unrelated nature and is under unrelated business tax income. If the corporation also provides services from staff and other personnel for the property then it is also considered as unrelated business of taxable income.

Income from Parking Lots

If a corporation owns a parking lot and this parking lot is used by the members and officers of the corporation, then it is not considered as part of the unrelated business tax income. However, if this same parking lot would be rented to the general public and the corporation would earn from this rent, the fees gathered from this service are considered to be taxable. This is because the service is not importantly related to the corporation’s purpose. If a third party company makes an offer of lease to the corporation and the third party is the one that controls and manages the parking lot, the corporation receives fees for the lease. But this is not considered as part of unrelated taxable income because it is rented from the property of the corporation.

Services for Management of Debt

If a corporation needs services for management of debt, it is of unrelated business only if the company that handles it is not the usual organization for credit counsel. This credit counsel company must also follow the guidelines of Section 501q. This organization that provides counselling is the one that manages repayment of the debt of the consumers. This may also include any process related to marketing as well as talking to certain creditors about lowering the interest rates.

The Exceptions to UBI

There are some exceptions to the rule when it comes to unrelated business income. There may be activities that are considered as unrelated in nature but would not be subject to unrelated business income tax.

The major exceptions are those activities or programs that are managed and done by volunteers to the corporation, activities and programs that are only for the benefit of the members of the organization, students of a private school, patients of a hospital, board officers, and the employees of the corporation. It also includes the profit gained from selling donated items, giving out items that are related to the solicited items from non-profit institutions, profit gained from bingo games, programs like trade shows and conventions as well as income from sponsorships. There may be other exemptions but as for this topic these are the major ones included.

Unrelated Trade: Defined

Unrelated trade or business is defined according to the purpose to which they serve and who runs these businesses. There are many exemptions however.  
It is not considered a legit business when volunteers who do not receive compensation carry out the trade for an organization. An example of such is a gift store controlled by an orphanage where all of its employees are volunteers from the community near the orphanage. They cannot be considered as business even though the operation of the gift shop does not affect the primary purpose of the orphanage and does not make a significant contribution to its function.
Unrelated trade or business also does not include any business carried out by any organization, public hospitals, state colleges or any university mainly for the ease of its constituent, students, officers, and workers. A bookstore operated by a state university to provide school supplies or a cafeteria operated by public hospitals to offer food for their staff and patients would not be considered an unrelated trade or business.

Also not included in the definition of trade or business of selling of products and goods if to a large extent, all of this merchandise has been given as gifts of donated. An example of such businesses is a discount shop operated by an organization to which all of the goods are donated by the members of that organization to be sold to the general public.

The words “unrelated trade or business” also do not consist of any income generating activity conducted by any organizations that involves the delivery and supplication of low-cost items to the public. In 2009, a piece of item is low cost if its value is less than $9.50. Donations received by an organization that distributes freebies such as balers and pins to which solicitations are asked for as contribution would be able to fall within this exemption  because the balers and pins would usually cost less than the set threshold sum.

More Exemptions for Unrelated trade or Business

Other definitions have recently been added to the definition to unrelated trade or business, and so it goes that there are more exemptions. Another exemption to “unrelated trade or business” are the activities conducted by an organization at conferences, during yearly meetings, or at trade fairs if the primary purposes of supporting the activity is to promote the goods and or services of an industry or to educate attendees of such conventions of new industry developments, products, and services. An example of this is the renting of display spaces during a trade fair done during an annual meeting for businesses.

If the business does not meet the exemptions, meaning they are legal and receive money, the payments given to these businesses also are categorized. If an individual who is in the engaged in trade or business gives payment to an organization, it is not considered income from a business if the individual will not receive any return benefit or service. This meets the exemption if the payment given by the individual is to allow the utilization or acknowledgement of the payee’s company, name or logo in connection with the organization’s activities and actions.

The term utilization and acknowledgment does necessarily mean free advertising for the payee, but it may mean exclusivity.  What the payee may get is exclusive sponsorship arrangements with the organization, a constant display of the payee’s company logo and slogan in the organization’s activities, and even a list of the company locations, phone numbers, constant display and depictions of the payee’s products and services.

A common example of this is sponsorship of a major soft drink brand to a minor league baseball team. The company supplies the uniforms of the athletes and sponsors them for other operational services. However, the uniforms bear the logo of the soft drink brand or the item itself. The use of the company name and logo of the team acknowledges the sponsorship. The funding of these is not considered income from a business.

  Chapter 4 - Unrelated Business Income - Part 2->  


 

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