Unrelated Business Taxable Income (UBTI): Overview

KEY TAKEAWAYS

• Unrelated business taxable income (UBTI) is money frequently made from taxable activities by a tax-exempt organization.
• UBTI places restrictions on tax-exempt entities’ ability to engage in commercial activities. These are activities unrelated to their principal objectives.
• Dividends, interest, and capital gains are examples of passive income that aren’t considered to be UBTI.

What Is Unrelated Business Taxable Income (UBTI)?

Unrelated business taxable income (UBTI) is income that a tax-exempt organization frequently makes. Specifically, this is from taxable activity. It is not necessary to create the majority of the entity’s income. This income is unrelated to the primary purpose of the business.

The Internal Revenue Service (IRS) has released proposed guidelines. This is for calculating UBTI as of April 23, 2020. Taxpayers are given instructions on how to apply the UBTI silo rules for tax-exempt organizations in these guidelines.

What Criteria Generate UBTI?

The criteria of UBTI are through the following types of investments:

• Limited Partnerships (LPs): These are businesses that are owned by more than a single person. The owner will have limited liability for the debt of the business.
• Master Limited Partnerships (MLPs): These are a form of LP that is publicly traded. They are often found within the energy sector. 

Unrelated Business Taxable Income Rules

UBTI came into effect in 1950. This was in order to ensure that tax-exempt firms competed fairly with taxable enterprises. This is when it comes to profit-generating activities.

UBTI either stops or restricts tax-exempt corporations from participating in unrelated industries. 

Dividends, interest, and capital gains from the sale or exchange of capital assets are a few examples of passive income that aren’t considered to be UBTI.

The UBTI regulations will most likely not apply to certain investors. These are investors that own an Individual Retirement Arrangement (IRA) that only invests in certain things. Such as conventional stocks, mutual funds, and ETFs. 

However, the fund might have to pay taxes if it produces income that counts as UBTI. An IRA receives money from a restaurant, for instance, and this income is taxable and liable to UBTI.

What Is Considered Unrelated Business Taxable Income?

The following transactions count as unrelated business activity:

• Purchasing and selling a large number of properties within the same year.
• Operating businesses that create active income and are run through a pass-through corporation. These include things such as a limited liability company (LLC) or master limited partnership (MLP). This would include businesses like restaurants, convenience stores, lodging inns, petrol stations, etc.
• Using margin to buy stocks.
• Taking out several private loans in a single year.

What Is Excluded From Unrelated Business Taxable Income?

Numerous tax-exempt and mutually beneficial organizations are granted tax-exempt status. This is under Internal Revenue Code (IRC) Section 501.

For example, a nonprofit or educational organization that is a tax-exempt entity might be held tax responsible. This is if it engages in and receives money from unrelated economic activity.

Summary

Unrelated business taxable income is a tax on any income that is regularly generated through a tax-exempt entity. It’s important for people to understand and realize what sections of their income will count as UBTI. This is so it can be correctly taxed and the holder can avoid having to pay any penalty fines for not adhering to their tax payments. 

For more information, check with the IRS to see what you could potentially owe.