How a CPA Cuts Unrelated Business Income Tax for Non-Profits

Non-profit organizations are created to serve communities and make a lasting impact, but even with tax-exempt status, they aren’t always free from tax obligations. When a non-profit earns revenue from activities outside its core mission, it may be subject to Unrelated Business Income Tax (UBIT), which can put a strain on its financial resources.

Without proper planning, UBIT can eat into funds meant for vital programs and initiatives. Fortunately, for non-profits in and around Nashville, a skilled CPA like Evan Hutcheson can help navigate these complexities, ensuring compliance while strategically minimizing tax liability.

Understanding UBIT and Its Implications

UBIT applies when a non-profit earns income from activities unrelated to its tax-exempt purpose. The IRS considers income taxable under UBIT if it meets three criteria:

• It is derived from a trade or business
• It is regularly carried on
• It is not substantially related to the organization’s exempt purpose

Common examples include rental income from non-mission-related properties, advertising revenue, and sales of merchandise not directly connected to the organization’s purpose.

Strategic Approaches to Minimize UBIT

A CPA experienced in non-profit taxation can provide valuable strategies to reduce UBIT exposure. Here are several ways a CPA can help:

1. Structuring Revenue Streams Properly

One of the most effective ways to minimize UBIT is to structure revenue sources in a way that aligns with the organization’s mission. For instance, if a museum gift shop sells items related to exhibits and educational programs, that income may qualify as mission-related and thus avoid UBIT.

2. Utilizing the Volunteer Exception

The IRS allows a UBIT exemption if substantially all of the work related to an unrelated business activity is performed by volunteers. Non-profits can leverage this by structuring certain revenue-generating activities around volunteer support rather than paid employees.

3. Taking Advantage of Passive Income Exemptions

Certain passive income sources are exempt from UBIT, offering non-profits a way to generate revenue without triggering tax liabilities. These include:

• Dividends, interest, and annuities: Income from investments, such as stocks and bonds, is generally exempt unless the investment is debt-financed.
• Rental income from real estate: If a non-profit owns property and rents it out, the income is usually exempt from UBIT, provided the property is not financed with debt. However, special rules apply if services beyond basic maintenance are provided to tenants.
• Royalties from intellectual property: Earnings from licensing trademarks, patents, or copyrighted materials can be UBIT-exempt, so long as the non-profit is not actively involved in the production or marketing of those assets.

4. Leveraging Subsidiaries

Non-profits can establish for-profit subsidiaries to manage unrelated business activities. The for-profit entity would pay taxes on its income, but the parent non-profit would remain unaffected. This strategy helps protect the organization’s tax-exempt status while still generating revenue.

5. Allocating Expenses to Offset UBIT

If a non-profit does have taxable income, it can deduct related expenses to reduce its taxable amount. For example, if a non-profit operates a café on its premises, it can deduct the costs of rent, utilities, wages, and supplies associated with running the business. A CPA can help properly allocate these expenses to maximize deductions.

While UBIT can present challenges for non-profits, proactive planning can help minimize tax burdens and ensure more funds are directed toward the organization’s mission. If you’re concerned about UBIT, do not hesitate to consult a trusted CPA.