501: Unrelated Business Income
Fiscal Operations Manual
Section 500: Financial Accounting and Analysis
The Revenue Act of 1950 established the “Unrelated Business Income Tax” (UBIT) that applies to tax-exempt organizations. The UBIT was established for two reasons: 1) To give the IRS a procedure by which it could penalize a tax-exempt organization that engaged in commercial business activities without having to revoke its exempt status; and 2) to put tax-exempt organizations that engage in business activities on a level playing field with for-profit companies that engage in the same business activity and pay taxes on the income they earn.
Three elements must exist in order for an activity engaged by a college or university to be treated as an "unrelated business income" activity.
- A trade or business
- Regularly carried on
- Not substantially related to the conduct of the school’s educational or scientific research purposes
A trade or business is conducted with a profit motive. Revenues in excess of expenses constitute taxable income where goods are sold or services rendered that are not related to the educational/research mission of the institution.
"Regularly carried on" means performed in the same manner or time frame as it would be in the commercial sector. Thus, the activity may be seasonal and still subject to UBIT.
"Substantially related" means that the activity contributes importantly to the exempt purpose. Bookstore sales to students/faculty, advertising sales by the school newspaper, etc. are examples of exempt activities.
Examples of College/University Activities that Could be Subject to UBIT:
- Dormitory rentals to the general public
- "Testing" activities which are not research and is not done by volunteers
- Advertising income not related to the college newspaper
- Corporate sponsorship payments – where the payor receives substantial return benefit other than acknowledgement of the name, logo or product lines of the payor
- Travel tours
- Participation in partnerships
- Use of recreational facilities by the public
- Professional entertainment events
- Summer sports camps
- Concession sales
- Conferences, meetings, and training programs
- Athletic events/television and broadcast rights
- Exclusivity contracts (e.g. "pouring rights")
It should be noted that the University pays UBIT only on the profit (residual income after expenses) and the tax is assessed in the following year.
How does OSU Determine UBIT?
- Rates applied by OUS are:
- 0-$50K profit @ 15%
- $50-$75K profit @ 25%
- $75-100K profit @ 34%
- $100-335 K profit @ 39%
These are IRS corporate tax rates and are subject to change.
How OSU Departments can Minimize Tax Exposure
- Research activities are clearly part of OSU’s mission. Therefore, bona fide research activities are exempt from UBIT. In addition, all governmentally sponsored research is exempt. However, testing activities where income is derived from private sources is generally subject to UBIT. When reviewed by the IRS, anything that is called “testing” is automatically looked at as UBIT.
Testing activities may qualify as research when carried on in the public interest. Meaning, the results of the research must be published. One way to minimize the UBIT would be to file the results in the OSU library. Another way would be to use the data (in published form) in a classroom setting. Also, testing services may be exempt where no alternative source exists within a “reasonable distance”. Documenting the lack of other testing sources may be another way to minimize UBIT. If the argument is made that the student needs to do testing as part of his/her curricula, then the student cannot be paid for the work. (This includes GRA or GTA appointments.) In that case, there would be no tax.
Commercial testing usually involves 1) ordinary and routine testing, 2) repetitive work, 3) performance by scientifically unsophisticated employees, and 4) testing for quality control or certification purposes.
- Sponsorships are exempt from UBIT but are qualified by IRS guidelines. A sponsorship is a “flat payment to a tax exempt entity which allows the exempt organization to recognize the sponsor, display the sponsor’s logo, acknowledge the sponsor by name, etc. It may not include 1) any quality comparisons with similar businesses, 2) any call to action (i.e. to buy from the sponsor), or 3) any price comparisons. If there are violations of the “qualified sponsorship” then it becomes advertising and subject to taxes.
Keep qualified sponsorship agreements separate from advertising agreements. If the donating entity will receive benefits other than simple recognition and a ‘thank you’ it will be an advertising agreement. Don’t mix the two. Also, if a sponsor will be receiving any ‘in-kind’ consideration such as sky box rights, free game tickets, etc., the fair market value of those items counts as advertising income to OSU. Keep these items separate along with any related expenses.
- Royalties are fixed payments either on a per unit basis for rights to use intangibles such as trademarks or ‘flat’ payments not subject to revenue amounts generated. Bona fide royalties are tax exempt. Any agreement linking income for OSU to revenues/profits generated by another agency are likely to be regarded as taxable income. Use separate agreements to keep royalty income separate from profit sharing arrangements.
- Document all expenses related to UBIT subject income and keep Business Affairs informed of any change in status regarding your operation.