UBI Tax Refresher: What Your Nonprofit Needs to Know

As nonprofits, one of the biggest benefits and incentives you have is being exempt from paying taxes. However, sometimes your activities don’t quite match up with the mission of your organization. Income from these activities is considered unrelated business income (UBI) — and it could lead to a surprise in your tax obligations.

If your nonprofit has UBI activity, you’ll have to file additional federal (990T) and state tax forms. This means you might ultimately pay taxes on the income earned. But why does that happen?

Imagine your nonprofit’s mission is to assist those in need. To accomplish this, your organization takes out a mortgage loan and purchases a new facility that helps better serve the community.

However, let’s say you only use half of the building for current operations. The board votes to rent out the remaining area to earn some extra income on the side. When under mortgage, rented-out facilities may be considered UBI and be subjected to unrelated business income tax (UBIT). (Rental income that is earned when the building is wholly owned by the organization without any attached debt is not considered UBI.)

In this situation, renting out the facility could be considered as part of your mission of assisting those in need. Perhaps another nonprofit with a mission in line with your organization needs a place to conduct meetings, so you decide to rent out the facility to them. You’re helping another organization better the community, which is essentially part of your mission. So this would not be considered a UBI activity.

If the space was rented out by a business for a private event, however, the income would be considered unrelated as it does not follow the organization’s mission. The renting party matters, as well as whether you’re trying to make money with the activity.

This is why it’s critical to keep track of all rental activities for your facility and to whom you’re renting. The more detail you have on your invoices the better, as it makes it easier to determine what is taxable. You should also keep track of all expenses related to upkeep of the rental portion of the property. You can allocate these expenses to your rental income and reduce or potentially eliminate any tax liability.

Similarly, if your organization is a tax-exempt social club (501 (c)(7)), activities such as selling food to nonmembers and receiving money to advertise other businesses in club publications would be subject to UBIT. This is because these activities inherently earn profit that is not related to the organization and its nonprofit nature. If a museum or church has a stand-alone café selling food or drinks, this would be considered an unrelated business activity.

Now let’s assume your organization has multiple UBI activities. You sell food to nonmembers, rent out facilities and advertise for businesses. Before 2020, reporting UBI in this scenario was relatively simple. You would report everything together, and every UBI activity would be able to offset one another. For example, let’s say you had a net loss of $200 from selling food to nonmembers but earned $4,000 from renting out your facilities. The net effect — and therefore the amount subject to UBIT — would be $3,800.

However, as of 2020 these activities are now in their own categories (known as baskets). This greatly reduces the ability to offset losses. In this instance, you would have three separate baskets. Instead of netting these activities together, the net loss of $200 from food sales would result in a carryover net operating loss to be used by food sales in the future. Meanwhile, you have to pay taxes on the full $4,000 from rental activity.

At the end of the day, you have to consider your organization’s mission. Does this new revenue stream relate to the original reason for your tax-exempt status? Or is it unrelated business activity to earn some money on the side? Remember the intent of the activity as well; are they income producing or more nonprofit in nature?

Also remember that UBI does not jeopardize your tax exempt status; this is often a worry for nonprofit organizations. A potential tax liability is not necessarily a reason not to conduct an activity as long as it is anticipated and reported properly.

Consulting with an experienced nonprofit CPA can help eliminate the confusion of UBI taxation issues. Not only can this save you some headaches, it can also help you avoid penalties for not paying your tax obligations.

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