Nonprofit Accounting Basics

Common UBIT Myth Related to Nonprofit Revenue and Tax Impact

Originally Posted: September 8, 2021
Author: 
Topics: 
Federal Tax Issues

Myth: “It doesn’t matter how I get the money in the door as long as I spend it on charitable activities.”

Fact: The source of the revenue will determine whether it’s taxable income to the tax-exempt organization.

History:  A 1950s cry for ending a macaroni monopoly at NYU created the starting point for the unrelated business income tax (UBIT) as we know it today. Hard to believe but true! Prior to congress approval of the law change, there was a “destination of income test” which meant that revenues could be earned tax-free by a tax-exempt entity no matter the source, so long as the destination of the income furthered the tax exempt’s purpose. In 1947, certain influential alumni donated their shares of ownership in the Mueller Pasta Co. to the New York University (NYU) School of Law, the former being a for-profit and the latter being a nonprofit. The controversy arose when for-profit competitors cried foul since NYU was earning tax-free income on the pasta maker’s commercial product. The response from the lawmakers led to the removal of the destination test and the addition of unrelated business income tax provisions. This change was widely viewed as creating parity or “leveling the playing field” between for-profits and nonprofits regarding business activities that were unrelated to the exempt purpose of the nonprofit.

Takeaway:

Tax-exempt organizations should review all revenue streams and document taxation implications for purposes of documentation under ASC 740 Uncertain Income Tax positions (the old FIN 48 that is still referenced on the Form 990 Part IV Line 11f).

  • The standard here, as described in the typical financial statement footnote, is a greater than 50% standard, or more-likely-than-not, that the position taken for income tax will be upheld should it be put to the test of an IRS examination.
  • Pro Tip: Be sure to analyze your organization’s miscellaneous revenue as well all other new and unusual sources of revenue.
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Revenues for nonprofits will fall into one of these 4 categories:
1) Contributions 
2) Revenues from programs or other sources related to exempt purpose – examples:
a. Membership dues 
b. Conference and meeting revenues
c. Publications or Research Journals 
d. Tuition payments
e. Education and training
3) Revenues excluded from income tax – examples:
a. Interest income
b. Rental income (from unrelated parties with no services performed)
c. Capital gains on sale of securities
d. Royalties (no substantial services performed)
e. Trade show income
4) Revenues from unrelated trades or business – examples:
a. Sale of advertising space (online or print)
b. Online job placement service 
c. Passthrough income from partnership investment
d. Debt financed rental income
 
 
The good news: The first three categories are tax-free to a tax-exempt organization.
 
 
The other news: The fourth category is for types of income generally subject to tax. As is always true in the grey and complex world of tax, there usually are many rules and interpretations within each of these examples. There could be many exclusions and exceptions to each rule. Consequently, it is important to review and fully understand the facts and circumstances surrounding unusual and exposed revenue sources in your nonprofit organization with your CPA and/or tax preparer. 
 

Show Me How: Here is a simple example that documents an organization’s oversight and determination of revenue streams income tax impacts for the applicable tax year:

Compliant Charity, Inc. (Sample Organization for Discussion Purposes)
Revenue Stream Documentation for purposes of ASC 740
Tax year ending December 31, 2020