Unrelated Business Income Tax
Unrelated Business Income Tax (UBIT) in the U.S. Internal Revenue Code is the tax on unrelated business income, which comes from an activity engaged in by a tax-exempt 26 USCA 501 organization that is not related to the tax-exempt purpose of that organization.
For most organizations, a business activity generates unrelated business income subject to taxation if it fails to sufficiently relate to the tax-exempt purpose of that tax-exempt organization if it meets three requirements:
- It is a trade or business,
- It is regularly carried on, and
- It is not substantially related to furthering the exempt purpose of the organization
A university runs a pizza parlor that sells pizza to students and non-students alike. The university is a tax-exempt organization and its pizza parlor generates unrelated business income. While the tuition and fees generated by the university is tax exempt, its income from the pizza parlor is not tax-exempt because the pizza parlor is unrelated to the university's education purpose.
A counter-example is a social-service nonprofit that holds a bake sale. While the sale is unrelated to their mission, it is tax exempt because it is not regularly carried on. Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations.
There are other types of unrelated business activities that are not taxable, for example, if the goods that are sold were donated or substantially all of the labor involved in the business is performed by volunteer labor.
Also any trade or business is excluded as taxable unrelated business if it is carried on by an organization described in section 501(c)(3) of the Internal Revenue Code or by a governmental college or university primarily for the convenience of its members, students, patients, officers, or employees. A typical example of this is a school cafeteria or a pizza parlor run by a university when the establishment would be primarily for the students, faculty and other persons who have business at the university.
The IRS taxes unrelated business income at the corporate tax rates (IRC section 11) except for certain section 511(b)(2) trusts which are taxed at trust tax rates. See IRS Publication 598.
UBIT in an IRA
IRAs generally are subject to tax on income that is taxable to most U.S. tax-exempt entities under 26 U.S.C. §511. 26 U.S.C. §408 contains many of the rules governing the treatment of IRAs. §408(e)(1) states: "Any individual retirement account is exempt from taxation under this subtitle unless such account has ceased to be an individual retirement account by reason of paragraph (2) or (3). Notwithstanding the preceding sentence, any such account is subject to the taxes imposed by section 511(relating to imposition of tax on unrelated business income of charitable, etc. organizations)."
In addition, the IRS unequivocally confirms this in the first few paragraphs of Chapter 1 of the November 2007 revision of Publication 598 that IRAs are "subject to the tax on unrelated business income."
- IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations
- IRS Unrelated Business Income Defined