What is UBIT ?

Unrelated Business Income Tax (UBIT) is a tax applied to typically tax-exempt organizations or trusts. The tax is applied to the net income that is derived from any activity that is not related to the tax-exempt purpose of that organization or trust.  An unrelated activity is defined as 1) a trade or business, AND 2) is regularly carried on, AND 3) is not substantially related to furthering the exempt purpose of the organization.

The origin of UBIT comes from “Not For Profit” organizations having “For Profit” business segments.  The IRS felt that to even the playing field and promote fair business practices, certain types of income from normally tax-exempt organizations or trusts should be taxable.

Why would the IRS need to even the playing field?

Picture a public university that owns and operates a sandwich shop year round. What if you owned a competing sandwich shop across the street from the one owned by the university?  Your sandwich shop has to pay taxes on the income it makes, so it builds the tax into the price paid by your customers.  If your competitor (university sandwich shop) didn’t have to pay taxes, it could lower its prices below yours and still make the same profit margin. Assuming most customers are rational and the sandwiches are of the same quality, why would someone pay more at your shop to receive the same product across the street? This type of dilemma was the genesis of Unrelated Business Income Tax.

The profits from the university sandwich shop have nothing to do with furthering the tax-exempt purpose of the university, so profits from the university’s "for profit" business sector are subject to UBIT.  This is done so the sandwich shop cannot unfairly compete with businesses that pay normal taxes.

Tax on unrelated business income applies to most organizations exempt from tax under section 501(a), but also applies to certain trusts as defined in section 401(a), in addition to IRAs & HSAs.  It is applicable when unrelated income is derived from:

  1. The sale of goods or services - aka Unrelated Business Taxable Income (UBTI)
  2. Income as of the result of Debt Financing - aka Unrelated Debt Financed Income (UDFI)

Exclusions include but are not limited to: Non-leveraged rents from real property, appreciable gains, dividends, interest, annuities &, royalties.

If an IRA is engaged in an activity or investment that produces either Unrelated Debt Financed Income or Unrelated Business Taxable Income, UBIT will most likely be applicable.  Points of consideration:

  • UBIT will need to be calculated and the IRA will need to file form 990-T
  • IRA Tax Services can perform 990-T preparation
  • Estimated quarterly payments should be made if estimated UBIT is greater than $500
  • Unrelated Business Taxable Income losses can usually be carried forward to offset future gains
  • Trust rates are used to calculate UBIT