Unrelated Business Income (UBIT)

Just because your organization is tax-exempt doesn't mean all of its income is tax-free. If your nonprofit regularly earns money from activities that aren't connected to your mission, the IRS considers that unrelated business income, and it's taxable at normal corporate tax rates.

For income to be classified as UBIT, it has to meet three tests: it must come from a trade or business, that business must be regularly carried on (not a one-time event), and it must not be substantially related to your exempt purpose. All three conditions must be true. A church that runs a weekly parking lot during football games? That's probably UBIT. A museum that sells reproductions of its art in the gift shop? That's related to its educational mission — not UBIT.

There are important exceptions. Volunteer-run businesses, businesses conducted for the convenience of members (like a college bookstore), and the sale of donated merchandise (like a thrift store) are all excluded. Passive income like dividends, interest, royalties, and rental income from real property is generally excluded too — with some caveats around debt-financed property.

UBIT matters for two reasons. First, if your nonprofit has more than $1,000 in gross unrelated business income, you have to file Form 990-T and pay taxes on it. Forget to file, and you're looking at penalties and interest. Second, if unrelated business income becomes too large a portion of your total revenue, the IRS may question whether your organization is really operating for an exempt purpose — potentially putting your tax-exempt status at risk.

The line between related and unrelated income isn't always obvious, which is why many nonprofits consult a tax professional before launching revenue-generating activities.