Page 116 - Washington Nonprofit Handbook 2018 Edition

CHAPTER 33. Unrelated Business Income (“UBI”)

a. Tax Liability

While a 501(c)(3) organization is not generally subject to federal income
taxation, it will be taxed on any net income derived from an “unrelated trade or
business.” Such income is referred to as unrelated business income, or “UBI.” UBI
is taxed at graduated rates similar to those that apply to taxable corporations or
trusts (depending on the legal form of the organization involved).

The purpose of the UBI tax is to treat exempt organizations in the same
manner as their taxable counterparts when they are regularly engaging in income-
producing activities that do not further a charitable purpose. An organization’s tax
exemption may be jeopardized if a substantial part of its activities constitutes UBI.
As with lobbying activities, there is no precise standard for how much unrelated
business activity is too much.

b. Unrelated Trade or Business

An exempt organization’s activity is an unrelated trade or business if all of
the following three factors are present:

(i) Trade or Business

A “trade or business” activity is defined as any activity carried on for the
production of income from selling goods or performing services;

(ii) Regularly Carried On

The trade or business activity is frequent, continuous, and pursued in a
manner similar to comparable activities of non-exempt organizations; and

(iii) Not Substantially Related

The trade or business is not substantially related to the organization’s
exempt purpose. An activity is substantially related if the activity has a substantial

causal relationship to the organization’s exempt purposes (other than the
production of income). In short, the activity must contribute importantly to the
organization’s exempt purposes. It is not enough that the net income from the
activity will be used to further charitable purposes. The conduct of the activity must
itself be charitable. For example, the operation of a restaurant where all net
income will be used for charitable purposes is not charitable. On the other hand,

WASHINGTON NONPROFIT HANDBOOK -105- 2018