Unrelated Business Taxable Income (UBTI) considerations
The purpose of this memo is to highlight federal income tax issues concerning
unrelated taxable business income (UBTI) for PTO’s. Income determined
to be UBTI is subject to federal income tax using the corporate tax rate schedule. Form
990-T is used to calculate and report taxable net income from UBT.
PTO income currently comes from a variety of sources:
- dues and donation from members
- contributions from businesses such as for technology
- interest income on bank account balances
- contributions from sponsors for directory or other publications of the PTO
- donations of goods or supplies used for prizes, decorations or event set-up
- donations of goods, services or supplies by individuals and/or local businesses used in events for fund raising such as silent auctions income from crafts fairs where goods for sale are made by PTO members or
- donated by businesses
- spring fairs with games, rides and prizes open to the community.
PTO income from dues, interest and donations received (whether of cash or goods and services) are not subject to UBTI taxation because they do not involve a trade or business. Income from crafts fairs, spring fairs, bazaars, rummage sales or other events will have to be reviewed based on the individual event parameters. Generally, these may be treated as exempt from UBTI when:
- the event is operated entirely by volunteers
- it is not regularly carried on: it is only a once a year event
- proceeds from sales are entirely of donated items
- the event (such as a spring fair) contributes importantly to the overall functions of the PTOs – that of community building for students and families [see Sponsoring entertainment events example in the section following which provides pertinent IRS language.]
Income from sponsorships or “advertising” in publications, such as school directories published by a PTO, will need to be assessed for each instance. Advertising income is specifically UBTI whereas sponsorship (or a listing of an organization/individual and their products, see more on this below) is not UBTI.
Reference information from the IRS
The information provided below is from the Internal Revenue Service (IRS)’s guidelines on UBTI for nonprofits –Publication 598, Tax on Unrelated Business Income of Exempt Organizations. Key sections of Publication 598 which pertain to PTO coperations and activities follow for reference purposes. However: Please note, this is not intended to be an exhaustive reference, rather, to highlight items which the writer determined at a point in time relate to PTO activity. Review more information in the publication itself. The stars below highlight particularly useful considerations.
Generally, the following IRC Provisions apply to earnings of a nonprofit:
An exempt organization is not taxed on its income from an activity that is substantially related to the charitable, educational, or other purpose that is the basis for the organization’s exemption. Such income is exempt even if the activity is a trade or business.
However, if an exempt organization regularly carries on a trade or business that is not substantially related to its exempt purpose, except that it provides funds to carry out that purpose, the organization is subject to tax on its income from that unrelated trade or business.
The IRS defines UBTI as:
Unrelated business income is the income from a trade or business that is regularly carried on by an exempt organization and that is not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity. Trade or business. The term ” trade or business ” generally includes any activity carried on for the production of income from selling goods or performing services. …Similarly, soliciting, selling, and publishing commercial advertising is a trade or business even though the advertising is published in an exempt organization’s periodical that contains editorial matter related to the organization’s exempt purpose. Regularly carried on. Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations.
For example, a hospital auxiliary’s operation of a sandwich stand for 2 weeks at a state fair would not be the regular conduct of a trade or business. The
stand would not compete with similar facilities that a nonexempt organization would ordinarily operate year-round. However, operating a commercial parking
lot every Saturday, year-round, would be the regular conduct of a trade or business. Not substantially related. A business activity is not substantially related to an organization’s exempt purpose if it does not contribute importantly to accomplishing that purpose (other than through the production of funds). Whether an activity contributes importantly depends in each case on the facts involved.
The Guide further explains trade or business activities to include or exclude certain activities. The items presented below are not all inclusive,
rather items which the writer determined at a point in time as related to PTO activity.
Examples
The following are examples of activities that were determined to be (or not to be) unrelated trades or businesses using the definitions and principles just discussed.
School handicraft shop. An exempt vocational school operates a handicraft shop that sells articles made by students in their regular courses of instruction. The students are paid a percentage of the sales price. In addition, the shop sells products made by local residents who make articles at home according to the shop’s specifications. The shop manager periodically inspects the articles during their manufacture to ensure that they meet desired standards of style and quality. Although many local participants are former students of the school, any qualified person may participate in the program. The sale of articles made by students does not constitute an unrelated trade or business, but the sale of products made by local residents is an unrelated trade or business and is subject to unrelated business income tax.
Yearbook advertising. An exempt organization receives income from the sale of advertising in its annual yearbook. The organization hires an independent commercial firm, under a contract covering a full calendar year, to conduct an intensive advertising solicitation campaign in the organization’s name. This firm is paid a percentage of the gross advertising receipts for selling the advertising, collecting from advertisers, and printing the yearbook. This advertising activity is an unrelated trade or business.
Directory of members. A business league publishes an annual directory that contains a list of all its members, their addresses, and their area of expertise. Each member has the same amount of space in the directory and its format does not emphasize the relative importance or reputation of any member. The directory contains no commercial advertisement and is sold only to the organization’s members.
The directory facilitates communication among the members and encourages the exchange of ideas and expertise. Because the directory lists the members in a similar noncommercial format without advertising and is not distributed to the public, its sale does not confer private commercial benefits on the members. The sale of the directory does contribute importantly to the organization’s exempt purpose and is not an unrelated trade or business. This directory differs from the publication discussed next because of its noncommercial characteristics.
Sales of advertising space. A national association of law enforcement officials publishes a monthly journal that contains articles and other editorial material of professional interest to its members. The journal is distributed without charge, mainly to the organization’s members.
The organization sells advertising space in the journal either for conventional advertising or to merely identify the purchaser without a commercial message… [which either] identifies the purchaser in a separate space, [or]… consists of listings of 60 or more purchasers per page …
The organization solicits advertising by personal contacts. … The organization also solicits advertising in form letters appealing for corporate and personal contributions.
An exempt organization’s sale of advertising placed for the purchaser’s commercial benefit is a commercial activity. Goodwill derived by the purchaser from being identified as a patron of the organization is usually considered a form of commercial benefit. Therefore, advertising in an exempt organization’s publication is generally presumed to be placed for the purchaser’s commercial benefit, even if it has no commercial message. … Therefore, the sale of separate spaces… is an unrelated trade or business.”
Sponsoring entertainment events. An exempt university has a regular faculty and a regularly enrolled student body. During the school year, the university sponsors the appearance of professional theater companies and symphony orchestras that present drama and musical performances for the students and faculty members. Members of the general public also are admitted. The university advertises these performances and supervises advance ticket sales at various places, including such university facilities as the cafeteria and the university bookstore. Although the presentation of the performances makes use of an intangible generated by the university’s exempt educational functions—the presence of the student body and faculty—such drama and music events contribute importantly to the overall educational and cultural functions of the university. Therefore, the activity is not an unrelated trade or business.
Despite otherwise being considered part of a UBTI activity, certain circumstances specifically preclude an event from being unrelated trade or business. Note that t he items presented below are not all inclusive, rather, ones which were determined at a point in time as related to PTO activity.
The following activities are specifically excluded from the definition of unrelated trade or business.
Volunteer workforce. Any trade or business in which substantially all the work is performed for the organization without compensation is not an unrelated trade or business.
Qualified sponsorship payment. This is any payment made by a person engaged in a trade or business for which the person will receive no substantial benefit other than the use or acknowledgment of the business name, logo, or product lines in connection with the organization’s activities. “Use or acknowledgment” does not include advertising [see following] the sponsor’s products or services. The organization’s activities include all its activities, whether or not related to its exempt purposes.
For example, if, in return for receiving a sponsorship payment, an organization promises to use the sponsor’s name or logo in acknowledging the … support for an educational or fundraising event, the payment is a qualified sponsorship payment and is not subject to the unrelated business income tax.
Distinguish Advertising vs. Sponsorship:Adv.= UBTI, Sponsorship not.
Take care with information provided on sponsors.
Advertising. A payment is not a qualified sponsorship payment if, in return, the organization advertises the sponsor’s products or services. For information on the treatment of payments for advertising, see Exploitation of Exempt Activity — Advertising Sales in chapter 4. Advertising includes:
- Messages containing qualitative or comparative language, price information, or other indications of savings or value,
- Endorsements, and
- Inducements to purchase, sell, or use the products or services.
And, to determine the income subject to UBTI tax, certain income would in any event be specifically excluded from activities otherwise determined to be UBTI:
Generally, unrelated business income is taxable, but there are exclusions and special rules that must be considered when figuring the income. Exclusions The following types of income (and deductions directly connected with the income) are generally excluded when figuring unrelated business taxable income:
- Dividends, interest, annuities and other investment income…
- … Gains and losses from disposition of property [this encompasses sale of stock that might be contributed to the organization].”