Unrelated Business Income Tax Explained
A tax-exempt status can be tricky to navigate for religious groups or churches because of shifting tax laws and regulations. For example, the unrelated business income tax can trip up well-meaning organizations that tread beyond the confines of tax exemption.
The risks of misunderstanding unrelated business income tax, or UBIT, are sizable enough to keep a close eye on the sources of your finances.
Testing for unrelated business income
When the IRS granted tax-exempt status to your church or group, it recognized that the organization's mission wasn't focused on creating profits. Therefore, it agreed not to tax the income your group generates in connection with fulfilling its goals.
That doesn't necessarily mean that every dollar you bring in is automatically tax-free. To allow for the fact that some activities will generate revenues that don't directly support the mission, the IRS created an unrelated business income classification. For example, if your church's soup kitchen opens its doors once a week to paying customers or regularly sells parking spots to attendees to a nearby music venue, those revenues don't fall under tax-exempt guidelines.
To help determine whether your organization is generating non-tax-exempt income, ask yourself the following questions, which are based on IRS's criteria for unrelated business income:
- Is the activity designed to make a profit?
- Does it operate on an ongoing basis?
- Does it fall outside the scope of the organization's core purpose?
If the answer is yes to all three, then it's likely unrelated business income. The soup kitchen that feeds the homeless can't charge diners for weekly dinners and claim the proceeds are tax-exempt. Similarly, the money raised by opening the parking lot to concert-goers isn't treated in the same way as the funds collected during an annual stewardship campaign.
Not surprisingly, the IRS considers non-core revenues taxable, which is why it implemented UBIT.
UBIT is a tax assessed on more than $1,000 of an organization's unrelated business income in a year. The income is charged at a corporate tax rate and may be adjusted for expenses directly related to the unrelated business, such as raw materials and wages.
Additionally, if you expect your organization to owe more than $500 in taxes in a year, it must make quarterly estimate payments or it risks additional penalties.
Clarifying what's subject to UBIT
Allowing for the sometimes fuzzy line between mission-based fundraising and profit-focused revenues, the IRS has identified a series of UBIT exceptions and exclusions.
For example, the following may not count as taxable income:
- Dividends and interest
- Funds raised from activities that rely solely on volunteers
- Businesses that exist for the convenience of church members
- Sales of donated items in a thrift shop or bake sale
- Select bingo games
As with any tax matters, consulting with your organization's accountant is essential to ensure any business decisions align with IRS rules and regulations. You'd hate to have a misstep take away a chunk of hard-earned revenue, whether it's tax-exempt or not.
Financial insights for your business
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.