Understanding the unique terminology of the UBIT is key to applying the provisions. This page defines the terms used in the UBIT and includes appropriate references to the Internal Revenue Code.
Charitable contribution. For UBIT purposes, a charitable contribution is a gift from an exempt organization to an organization that is eligible to receive deductible contributions under §170. Exempt organizations are allowed to deduct charitable contributions, even if not directly connected to an unrelated trade or business, up to 10% of gross income from an unrelated trade or business.
Debt-financed income. Debt-financed income is income derived by an exempt organization from property acquired with borrowed funds. See debt-financed property.
Debt-financed property. When an exempt organization borrows to purchase an asset, part of the income from the asset is subject to the UBIT, even if such income would not otherwise be subject to taxation. For example, stock purchased with borrowed funds is debt-financed property. Dividends paid on the debt-financed stock is subject to the UBIT although dividends are normally excluded from the scope of the UBIT.
Destination of income test. Prior to the UBIT, business income of an exempt organization was eligible for exemption so long as the income was used in the organization’s exempt activities. The UBIT changed the law so that income from an unrelated business is taxable, regardless of the use, or destination, of the income.
Exempt activity. An activity conducted by an exempt organization that furthers its exempt purposes.
Exempt organization. An exempt organization is a not-for-profit organization that is exempted from income taxation under §501(a) of the IRC. There are over 30 categories of organizations that qualify for tax exemption. The most well-known exempt organizations are charitable organizations, such as educational, religious, scientific, and other organization serving charitable purposes. Virtually all exempt organizations are subject to the UBIT.
Exempt purpose. To qualify for tax exemption, an organization must be organized and operated for a specific exempt purpose or purposes. For example, a charitable organization must be organized and operated for educational, …….purposes. The exempt purpose is found in the specific paragraph under §501(c) that describes the organization eligible for exemption.
Form 990, Return of Organization Exempt From Income Tax. Form 990 is an annual information return required to be filed with the IRS by most organizations exempt from income tax under section 501(a), certain political organizations, and nonexempt charitable trusts.
Form 990-EZ, Short Form Return of Organization Exempt From Income Tax. Form 990-EZ is an annual information return that may be filed by an organization with gross receipts of less than $200,000 and total assets of less than $500,000.
Form 990-T, Exempt Organization Business Income Tax Return. An organization that receives $1,000 or more in gross income from an unrelated trade or business must file Form 990-T.
Modifications. UBTI is computed by subtracting the allowable deductions from an exempt organization’s gross income from an unrelated trade or business. The gross income and deductions are generally determined under the general income tax rules, except as provided in §512(b). For example, dividends, interest, royalties, and some rents are not included in an exempt organization’s gross income from an unrelated trade or business. The deduction for charitable contributions is allowed, but limited to 10% of UBTI. The adjustments,19 in all, required to be made under §512(b) are referred to as modifications.
Neighborhood Land Rule. The neighborhood land rule applies when an exempt organization finances the acquisition of real property for future use in its exempt function. If the requirements of the neighborhood land rule are met, the property is not treated as debt-financed property for a 10-year period (15 years for churches). To satisfy the rule, the land must be in the neighborhood of other property owned by the organization and used in an exempt purpose. The neighborhood requirement is not applicable to churches. To use the exception after the fifth year, an organization must request a ruling showing that it is reasonably certain to use the land in the exempt use before the expiration of the 10-year period (15 years for churches). §514(b)(3).
Private foundation. A private foundation is a charitable organization that is not broadly supported by the general public, other charities, or the government. The family foundation is the typical private foundation. Private foundations are subject to the UBIT; they are also subject to a tax on net investment income and a series of excise taxes designed to prevent them from engaging in improper activities.
Section 501(c) of the IRC. Most organizations eligible for tax exemption are described in the subparagraphs of §501(c). For example, charitable organizations are described in §501(c)(3).
Specific deduction. An exempt organization is allowed a specific deduction of $1,000 in determining its UBTI.
Substantially related use exception. Mortgaged property acquired by an exempt organization is not debt-financed property if substantially all of the use of the property is related to the organization’s exempt purposes; even if substantially all of the use of the property is not substantially related to the exempt purposes, the property is not debt-financed property to the extent that the use is substantially related. When the substantially related use exception applies, income from substantially related use property is not debt-financed income. §514(b)(1)(A).
UBIT blocker. Large pension and retirement funds and other exempt organizations use foreign corporations to invest in hedge funds and other alternative assets that would produce debt-financed income if purchased directly. Under the dividend exclusion, the dividends from the foreign corporation are not included in UBTI.
Unrelated business income tax (UBIT). The UBIT is imposed on the unrelated business taxable income of most exempt organizations.
Unrelated business taxable income (UBTI). UBTI is the income of an exempt organization from the regular conduct of a trade or business that is not related (other than to acquire funds for use in its charitable work) to the organization’s exempt purposes.