The Unrelated Business Income Tax (UBIT) is imposed by the IRS on nonprofits that earn profits from businesses not related to their charitable mission. For example, a university that owns a macaroni company would have to pay UBIT on its net profit. UBIT is paid at corporate tax rates, which range from 15% to 35%. If your nonprofit earns $1,000 or more in income from a regularly carried on unrelated business, you will have to file a UBIT tax return.
In realty, few nonprofits pay UBIT. It applies only to businesses regularly carried on by nonprofits. It doesn't apply to income nonprofits earn from selling donated merchandise. Moreover, rental income, capital gains, and income from any passive investments is generally not subject to UBIT.
Even if your nonprofit is making money from an unrelated business, it's usually easy to avoid UBIT. Here are some simple strategies any nonprofit can use to avoid UBIT:
Convert income to royalties by contracting with a third party to carry on the activity and pay your nonprofit a portion of the earnings. For example, income from the publication and sale of a book on a topic unrelated to a nonprofit’s exempt purpose is unrelated business income subject to UBIT. However, if you transfer the publication rights to a commercial publisher, you can receive royalty income which is not subject to UBIT. (Rev. Rul. 69–430.)
Any profit-making activity where substantially all the work is performed by unpaid volunteers is exempt from UBIT. For example, the Girl Scouts organization doesn’t pay any tax on its Girl Scout cookie income because substantially all the work related to earning that income is done by volunteer Girl Scouts. Any income-producing activities your nonprofit undertakes are likewise exempt from UBIT if they are conducted by volunteers. For example, income from raffles, casino nights, and similar gambling activities (other than bingo) is ordinarily subject to UBIT. However, if the raffle or other game of chance is conducted by volunteers, the income earned will be UBIT-free.
You may be able to turn an unrelated business into a related business by changing the structure or nature of the activity. For example, in one case, the IRS said that foreign travel tours sponsored by a nonprofit were an unrelated business because they had no formal educational component. Hiring teachers to accompany the tours and requiring tour members to complete a formal course of study could turn this into a related activity.
In some cases, a nonprofit can make a profit-making activity a related business by expanding or amending its exempt purposes. This is usually done by amending the nonprofit’s articles of incorporation. For example, an educational nonprofit that wants to engage in conservation work could add conservation as one of its exempt purposes. If you change your nonprofit’s exempt purposes, you must notify the IRS when you file your annual information return--Form 990 or 990-EZ--and possibly amend your articles of incorporation.