Definition
Unrelated business income is income from a trade or business that is regularly carried on and not substantially related to the organization's exempt purpose. Sections 511 through 514 impose tax on that income. An exempt organization with $1,000 or more of gross income from an unrelated business must file Form 990-T, in addition to its annual return, and organizations expecting to owe $500 or more in tax must pay estimated tax. Common examples include advertising sales, rental of debt-financed property and a business run alongside a program.
Why it matters in an audit or review
Management must record a current tax liability, and the organization may need a deferred tax. Auditors review how revenue and shared costs are allocated to the unrelated activity, since inconsistent allocation can understate tax, and consider whether activities threaten tax-exempt status.
Example
Illustrative: a museum earns $60,000 selling advertising in its magazine and has $45,000 of directly connected expenses. Net unrelated income is $15,000, above the $1,000 Form 990-T threshold on gross income, so the museum files Form 990-T and records tax on the net amount at the applicable corporate rate.
Common mistakes
- Allocating all overhead to the exempt programs.
- Assuming a tax-exempt organization never has a tax provision.
Sources
- Internal Revenue Code sections 511 to 514: https://www.law.cornell.edu/uscode/text/26/511
- IRS, Unrelated Business Income Tax: https://www.irs.gov/charities-non-profits/unrelated-business-income-tax
- FASB ASC 740-10-15, scope of income tax guidance for not-for-profits
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error