While a nonprofit organization is tax-exempt, it may still be liable for tax on its earned unrelated business income.
For most organizations, unrelated business income is earned income from a trade or business, regularly carried on, not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption.
An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T. 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 information return, Form 990, 990-EZ or 990-PF.
2017 Tax Cuts and Jobs Act
The 2017 Tax Cuts and Jobs Act made two notable changes to unrelated business income tax that negatively impact nonprofits.
First, the bill imposes restrictions on how nonprofits can calculate unrelated business income streams, prohibiting organizations from using losses from one activity to offset gains in another. Research conducted by George Washington University and Urban Institute, commissioned by Independent Sector, found that reporting unrelated income streams separately would redirect about $15,000 per year away from each affected nonprofit’s mission. In the long-term, nonprofits may be reluctant to look for new sources of sustainable revenue through social enterprise in the future.
The second provision in the bill marks a significant departure in the purpose and use of tax treatment of unrelated business income. The 2017 bill used UBIT, designed to tax revenue unrelated to an organization’s mission, as a vehicle to tax nonprofit expenditures, as well. Nonprofit organizations now are required to pay a 21 percent federal tax on the cost of employee transportation benefits, including transit and parking. The same study by GWU and Urban Institute found that the new tax on transportation fringe benefits would divert an average of about $12,000 away from each nonprofit’s mission per year. As a percentage of budget size, this tax is a bigger burden on smaller nonprofits. Also, about 10 percent of nonprofits are considering dropping these benefits entirely as a result of this policy.
Independent Sector is working closely with our coalition partners and the charitable sector to call on Congress to repeal these provisions. Tell your members of Congress to repeal the UBIT increases enacted in 2017.
Current UBIT Exceptions
The Internal Revenue Code recognizes a number of modifications, exclusions, and exceptions to unrelated business income. Dividends, interest, certain other investment income, royalties, certain rental income, certain income from research activities, and gains or losses from the disposition of property are generally excluded. In addition, the following activities are specifically excluded from the definition of unrelated trade or business:
- Volunteer labor (ex. volunteer operated bake sales)
- Convenience of members (ex. school cafeterias, university gyms)
- Selling donated merchandise (ex. many thrift store operations of exempt organizations)
- Bingo games
There are also certain exceptions for organizations that are tax-exempt under section 501(c)(7), 501(c)(9), 501(c)(17), or 501(c)(20). Learn more about these exceptions on the IRS website.
Learn more about unrelated business income through a IRS Stay Exempt course.
The 2017 tax law created two new sections of the tax code that increase taxes on nonprofit organizations. Diverting charitable funds into federal coffers through these two provisions creates profound financial and administrative burdens on charities and the people they serve. Please tell members of Congress to choose #MissionNotTaxes by repealing the Unrelated Business Income Tax (UBIT) increases enacted in the 2017 tax law.