Unrelated Business Income Tax ("UBIT")
The George Washington University is an exempt organization under §501(c)(3) of the Internal Revenue Code, i.e., the university is not required to pay Federal income tax on income related to its exempt purposes of education and research. However, the university may engage in other activities that do not directly relate to its exempt purposes, thus generating unrelated business income (UBI) on which it is subject to income tax. The UBIT provisions are primarily designed to prevent tax exempt organizations from having an unfair advantage compared to for-profit business that do pay tax on income generated in the same manner.
The activities in question are those that produce income, not those in which the money will be used. Conducting a taxable activity and using that income for scholarships, for example, does not render the income tax-exempt.
In order to determine whether a particular activity that the university engages in will generate UBI, the following three criteria must all be present.
- Substantially Unrelated to the Exempt Purpose
The first criteria in determining whether an activity is taxable is to determine whether the activity is "substantially unrelated" to the exempt purpose of the organization. Conversely, to be considered related nontaxable income, there must be a substantial causal relationship between the activity that generates revenue and the exempt purpose of the organization (i.e., the activity must contribute importantly to the accomplishment of the exempt purpose other than the university's need to produce income).
- Trade or Business
Activities cannot be considered taxable unless they are deemed to be a "trade or business". A trade or business includes any activity carried on for the production of income from selling goods or performing services.
- Regularly Carried On
Whether a trade or business is “regularly carried on” is determined by reference to the frequency and continuity of the activity and the manner in which it is pursued. Relevant factors include the typical time span of activities and whether the activities are engaged in only discontinuously or periodically without the competitive and promotional efforts typical of commercial endeavors.
However, year round activities are regular even if they are conducted only one day a week. Further, seasonal activities may be regularly carried on even though they are conducted only for a short period each year.
Departmental activities will be evaluated by the tax department. Activities that are determined to produce UBI will be included on the university’s Form 990-T (Exempt Organization Business Income Tax Return) and the applicable state UBI returns, to be prepared each year for submission to the Internal Revenue Service and the state tax authorities.
UBI Exceptions and Exclusions
Even if an activity is considered to generate UBI based on the above three criteria, there are a number of statutory exceptions modifications to income that are available under the UBIT regulations.
- Convenience Exceptions
UBI does not include income from any trade or business in which substantially all the work is performed without compensation; or which is the selling of merchandise substantially all of which has been received as gifts or contributions; or which is carried on, in the case of a university, primarily for the convenience of its students, officers or employees. The convenience exception can be applied to certain goods and services provided and sold by the university, including articles that are of a recurrent demand and do not have a useful life of more than one year.
Certain Investment Income
Dividends, interest, payments with respect to securities, loans, annuities, and other substantially similar income for routine and ordinary investments are excluded from UBI.
Royalties and all deductions connected with royalties are excluded from UBI except in the case of debt-financed income and receipts from controlled organizations. Generally, a royalty is a payment for the use of a valuable right such as a trademark, trade name, service mark, or copyright, regardless of whether the property represented by the right is used. If the payment for such rights is coupled with a duty to perform services by the grantor, however, it is not treated as a royalty for tax purposes. But, if a licensor retains quality control rights with respect to the licensed product, it does not cause payments to the licensor to lose their character as royalties.
Except in the case of debt-financed income and receipts from controlled organization, rents from real property and incidental rents from personal property leased with real property are excluded from UBI. Rents from personal property are “incidental” only if they do not exceed 10% of the total rents from all the property leased. However, if rents from personal property exceed 50% of the total rents, all rents (including the rent from real property) are UBI. Furthermore, rent loses its characterization as passive and excluded income if the organization provides substantial services to occupants.
- Income from Scientific Research
Income from research is excluded from UBI in the following situations: income derived from research for (a) the United States, or any of its agencies or instrumentalities, or (b) any state or political subdivision thereof; in the case of a college, university or hospital, income derived from research performed for any person; and in the case of an organization operated primarily for purposes of carrying on fundamental research the results of which are freely available to the general public, all income derived from research for any person. Note that ordinary testing or inspection of products may not qualify as research for purposes of the UBI determination.
The following are examples of activities that may generate UBI.
- Advertising Income
As a general rule, advertising income is UBI. The IRS considers general consumer advertising in an exempt organization's journal as "trade or business" since it does not "contribute importantly" to its exempt purpose. On the other hand, advertising in a university newspaper as part of an instructional program or advertising that serves an "informational function" (as opposed to serving a means of stimulating demand for products) may be considered related to an organization's exempt purpose.
Consumer advertising may be regarded as related to the exempt purpose if students are actively involved in the solicitation, sale and publication of the advertising under the supervision and instruction of the university/agency. For example, a campus newspaper operated by students publishes paid advertising. Although the services rendered to the advertisers are of a commercial character, the advertising business contributes importantly to the university's educational program through the training and participation of students involved. However, just because students are involved, the activity is not automatically considered exempt from UBIT. The deciding factor lies with the overall purpose of the program. If the greatest portion of time is devoted to commercial activities and not student training, the advertising activity will be deemed taxable.
Corporate Sponsorship Payments
A corporation or a business makes a payment to the university in return for some mention or acknowledgement of the business's products or services. The issue is whether this is fundraising and acknowledgement, or the sale of advertisements. Under the Treasury regulations a qualified sponsorship payment is not UBI. A qualified sponsorship payment occurs when a payment is made to an organization by a person engaged in a trade/business and there is no expectation the person will receive a "substantial return benefit" in exchange. It does not matter whether the sponsored activity is related or unrelated to the exempt purposes of the organization or whether the activity is temporary or permanent. The regulations apply to ongoing events like annual fundraisers.
A substantial return benefit is any benefit other than a use or acknowledgement of the payor's name or logo in connection with the organization's activities, or certain goods/services with an insubstantial value. A use or acknowledgement can include logos or slogans that do not contain qualitative or comparative descriptions of the payor's products, services, facilities or company. Such logos/slogans need to be an established part of the payor's identity. A good/service has an insubstantial value when the aggregate fair market value of all the benefits provided to the payor/persons designated by the payor in connection with the payment during the organization's taxable year is not more than 2% of the payment amount.
- Direct Operation of Parking Lots/Garages
The operation of parking lots and parking garages by an exempt organization is considered provision of services for the convenience of the occupant, and therefore the income received is not rent from real property subject to the exclusion from UBI. The IRS has adopted the position that the direct operation of a parking lot for use by the general public is an unrelated trade or business. However, income generated by the operation of parking lots and parking garages that are necessary for the normal conduct of the university's mission (i.e. for the use of students, faculty, staff, vendors and others on premises for official university business or to participate in university programs) would be nontaxable.
- Museum Gift Shop Operations
UBIT can be an issue for museum shop products. The IRS looks at each line of merchandise sold in a museum shop to determine whether or not it generates UBI. Items that are reproductions or feature reproductions of collection pieces are less likely to fall under UBIT, because a museum can further its educational goals and raise public awareness about its mission by including information relating the item to the museum’s collection. Thus the sale of posters and greeting cards featuring a reproduction of a work in the collection, instructional literature and scientific books and souvenir items concerning the history and development of art generally does not give rise to UBI.
On the other hand, the sale of scientific books and souvenir items of the city where the museum is located has no causal relationship to art or to artistic endeavor and, therefore, does not contribute importantly to the accomplishment of the museum’s exempt educational purposes.
- Partnerships, Joint Ventures, and Limited Liability Companies
A university may have UBI issues as a member of a partnership, a joint venture or a limited liability company that is treated as a partnership for federal income tax purposes. If the university is a member of a partnership that regularly carries on a trade or business that is unrelated, it must include its share of the partnership UBI as though it had operated the business itself.
- Recreational and Athletic Facility Membership Fees
Usage to students, faculty, and staff is considered for the convenience of the members and therefore is not taxable. However, it was determined by the IRS that fees from the following groups constitute UBI: (1) spouses and children of students, (2) spouses and dependents of university employees, (3) alumni of the university, (4) guests of members of the facility, and (5) general public. If membership fee income is collected from spouses, dependents, alumni, or guests/general public, then that income is UBI subject to tax.
- Room Rentals to Third Parties
Certain university facilities are available for rent to outside parties. The majority of the income associated with rental of our classroom or conference space is not subject to tax because the events are related to our educational purpose. However, certain rental arrangements for events that are not primarily educational in nature, that include the provision of services, e.g. event planning and audio visual support services, may give rise to UBI. Use the Rental UBI Worksheet (PDF) as a reference guide for determining whether any room rental income is subject to UBIT.
- Unrelated Business Income Tax Policy
- IRS Unrelated Business Income Tax Website
- Form 990-T, Exempt Organization Business Income Tax Return