Unrelated Business Income

The three-element test (§513(a))

• Trade or business (§513(c)): any activity carried on for the production of income from selling goods or performing services, entered into with the dominant hope of profit. An activity keeps its own identity inside a larger aggregate of activities (the fragmentation rule — the pharmacy’s sales to the public are a business even though the pharmacy serves patients; the advertising in the journal is a business even though the journal is educational). Marketing and advertising, a commercial look-and-feel, and consistent profits point to a business; consistent losses point to no profit motive, which cuts the other way on the 990-T (no loss allowed, §183 principles).
• Regularly carried on (Reg. §1.513-1(c)): frequency and continuity compared with how for-profits run the same activity. A sandwich stand for two weeks at the state fair, a Christmas dance, a St. Valentine’s Day dance — not regular. A parking lot run one day every week all year — regular. A yearbook sold with advertising once a year — not regular, unless the advertising is solicited year-round (Rev. Rul. 73-424), and a contractor’s year-round solicitation is attributed to the organization on an agency theory (State Police Association of Massachusetts, T.C. Memo 1996-407, aff’d 125 F.3d 1 (1st Cir. 1997): 46 weeks a year of soliciting). Annually recurring is not the same as regular (Reg. §1.513-1(c)(2)(iii)); what matters is whether the organization competes the way a business does. [Final Q50, D; marked]
• Not substantially related (Reg. §1.513-1(d)): the activity must contribute importantly to the exempt purpose, other than by producing funds. An activity can be partly related and the excess scale unrelated. Dual-use facilities — the university field house, the tennis courts, the church hall — host both; the question is asked activity by activity, not building by building. Dual use does not threaten exemption. [SQ 26, B]
• Selling the product of an exempt function in the state in which the function produced it is related (milk from the experimental dairy herd); processing it further is not (ice cream from the milk) unless the processing itself furthers the purpose (Ex. 4.4). Articles made by handicapped trainees are related; a factory line is not.

When UBTI threatens the exemption

• Rare, but real above about 15% of total revenue (some advisors say 10%), or where the unrelated business is the primary activity by time and attention even if small in dollars. [Final Q48, C; marked]
• The remedy is a taxable subsidiary: it pays its own 21% tax; its income is not attributed to the parent; its dividends are excluded under §512(b)(1) (the course says (b)(3)); rent, interest and royalties it pays the parent are caught by §512(b)(13) only to the extent above arm’s length. [SQ 28, D; Review image22, D]

The §513 exclusions

• Volunteer labor (§513(a)(1)): substantially all — 85% — of the work done without compensation, measured by hours. The thrift shop, the gift shop, the booster-club concession stand. Tips are compensation (the glossary says so; the Tax Court agreed in the bingo cases), so a tipped volunteer bartender can break the exclusion. [SQ 31, D]
• Convenience (§513(a)(2)): a (c)(3) or a state college or university carrying on the business primarily for the convenience of its members, students, patients, officers or employees — the cafeteria, the dorm laundry, the hospital pharmacy’s sales to patients. The IRS bifurcates: the bookstore’s textbooks and sundries are convenience, its televisions and plane tickets are not; the pharmacy’s sales to the public are not.
• Donated goods (§513(a)(3)): substantially all (85%) of the merchandise sold was received as gifts — the thrift store again, even with paid staff. [Final Q51, B; marked]
• Qualified sponsorship payments (§513(i), Reg. §1.513-4): a payment for which the sponsor gets nothing but acknowledgment — name, logo, slogan, product line, address, phone, web link, value-neutral description — is a contribution, not advertising. It becomes advertising, and UBTI, if it carries qualitative or comparative language, price information, an endorsement, or an inducement to buy; if the payment is contingent on attendance or ratings (contingent on the event occurring is fine); or if the sponsor gets goods or services worth more than 2% of the payment (then only the excess is a sale). Periodical and convention advertising are outside the safe harbor. Not in the course; this is the most common question the office gets from gala committees. added 2026
• Bingo (§513(f)): a game in which wagers are placed, winners determined and prizes distributed in the presence of all the players, lawful under state and local law, and not ordinarily carried on commercially by for-profits in the jurisdiction (the state, or the locality where state law lets localities decide). Pull-tabs and instant bingo are not bingo (Julius M. Israel Lodge of B’nai B’rith, 5th Cir. 1996). Not available to social clubs, VEBAs, political organizations or homeowners’ associations. A Connecticut church’s weekly bingo where for-profit bingo is illegal is excluded (Ex. 4.7). [Final Q37/SQ 37, A]
• Low-cost articles (§513(h)(1)(A)): items costing not over $13.90 (2026; $13.60 for 2025; the course’s $11.30 was 2021) distributed unsolicited with a request for a gift and a note that the recipient may keep it either way, by an organization eligible for deductible contributions. [Final Q52, D; marked; updated] updated 2026
• Mailing lists (§513(h)(1)(B)): exchanging or renting donor and member lists with other organizations eligible for deductible contributions. Renting to a for-profit is outside the statute but usually a royalty (below).
• Conventions and trade shows (§513(d)(3)): a (c)(3), (4), (5) or (6) that regularly holds a show as a substantial exempt purpose excludes exhibitor space rental even where exhibitors sell and take orders; suppliers’ exhibits (vendors to the members rather than members themselves) are arguably in, and in any event a once-a-year show is seldom regularly carried on (Suffolk County Patrolmen’s, 77 T.C. 1314). [Final Q53, D; marked]
• Fairs and expositions (§513(d)(2)): qualified public entertainment at an agricultural and educational fair, under a state law that limits the activity to such organizations or licenses it for not more than 20 days at a lower rate.
• Research (§512(b)(7)–(9)): for the United States or a state; or by a college, university or hospital (any research); or by an organization whose research results are freely available to the public. The income and the related deductions both come out. [SQ 32, D; Review image24, D]
• Also out: a (c)(3) hospital’s services to small hospitals at cost (§513(e)); qualified pole rentals; distributing low-cost articles; public-entertainment activities; and, since 2019, the parking-lot fringe benefit tax of §512(a)(7) is repealed retroactively (the 2025 House bill tried to bring it back and failed). added 2026

The §512(b) modifications

• Dividends, interest, annuities, payments on securities loans, and income from notional principal contracts (§512(b)(1)): out, with their deductions. A return on invested capital competes with nobody.
• Royalties (§512(b)(2)): out — payments for the right to use intangible property, including the organization’s name and logo (Sierra Club, 86 F.3d 1526 (9th Cir. 1996): mailing-list rental and the affinity credit card are royalties; Oregon State University Alumni Association, 193 F.3d 1098 (9th Cir. 1999): the bank’s payments were royalties, not fees for promotional services; Common Cause, 112 T.C. 332 (1999): list management, storage and brokerage handled by agents were all royalty-related). The line is services: a royalty for the name is passive; a payment that buys the organization’s staff time, endorsements, mailings or event appearances is a fee, and a mixed contract gets split. Keep the services in a separate agreement for a separate fee. The 2025 House bill would have taxed name-and-logo royalties; it was dropped. updated 2026
• Rents (§512(b)(3)): real-property rents out; personal-property rents out only if incidental — 10% or less of total rent under the lease (measured when the property is first placed in service) excludes everything, more than 50% taxes everything, in between only the real-property rent is excluded (Ex. 4.9: $3,000 of $10,000 is equipment rent → the $3,000 is taxed); redetermine if personal property is added that doubles the share or the lease is modified. Rent tied to the tenant’s income or profits (other than a fixed percentage of gross receipts) is all taxable. Services to the occupant beyond what landlords customarily provide take the payment out of “rent”: maid service is a service to the occupant; heat, light, cleaning public areas and trash collection at the dumpster are not. Hotels, boarding houses, tourist camps, parking lots, warehouses and storage garages do not produce rent (Reg. §1.512(b)-1(c)(5)); leasing the parking lot to an operator may (GCM 39825). A church’s staffed hotel and attended parking lot are not rent (Ex. 4.8). [Final Q57, B; Q59, A; Q34, B; marked]
• Gains and losses (§512(b)(5)): sales of property out, including lapsed options and forfeited deposits in investment activities — not inventory, not property held for sale to customers, not debt-financed property, not an organization in the business of writing options.
• Debt-financed income (§512(b)(4), §514) comes back in, in proportion to the debt. See the next page.
• Controlled organizations (§512(b)(13)): interest, rent, royalties and annuities from an entity the exempt organization controls — more than 50% of a corporation’s stock by vote or value, more than 50% of a partnership’s profits or capital, more than 50% of the beneficial interests of anything else, with §318 attribution so second-tier subsidiaries count — are UBTI to the extent the payment reduced the subsidiary’s net unrelated income (computed as if it were exempt). Since the Pension Protection Act, only the excess over an arm’s-length §482 amount is included, with a 20% penalty on the excess; the course says that rule expired after 2011 — it was extended repeatedly and the PATH Act of 2015 made it permanent. Animal Shop pays its parent shelter $20,000 of rent that is $12,000 over fair rental → $12,000 is UBTI (Ex. 4.26). Schedule R and Part IV line 35a report the transactions; Form 990-T Schedule A Part VI computes the inclusion. updated 2026
• Partnerships (§512(c)): the exempt partner looks through to the partnership’s activities — a share of an unrelated business is UBTI, a share of a related one is not, a share of investment income is modified out unless debt-financed. S corporations (§512(e)): a (c)(3) may hold S stock, but all of the income allocated to it, and the gain on sale, is UBTI — the price of being a qualified S shareholder. An employee stock ownership plan is the exception.
• Social clubs, VEBAs and SUB trusts ((c)(7), (9), (17)) run backwards under §512(a)(3): everything is taxable except exempt-function income (member dues and fees, and income set aside for charitable or benefit purposes), including investment income; gain on exempt-function property is deferred if replaced within one year before or three years after.

Expenses: directly connected, dual use, exploited activities

• Only deductions directly connected with the unrelated business — a proximate and primary relationship (Reg. §1.512(a)-1) — and otherwise allowable (§162 ordinary and necessary, §168 depreciation, §263A on manufactured or resold goods). The restaurant staff’s wages against the church’s restaurant (Ex. 4.1); 10% of a $200,000 president’s salary for 10% of her time (Ex. 4.2); 20% of $100,000 is $20,000 (SQ 29). [SQ 27, A; SQ 29, B]
• Dual-use facilities and personnel: allocate on a reasonable basis. Rensselaer Polytechnic, 732 F.2d 1058 (2d Cir. 1984): hours of actual use for each purpose is reasonable for the field house; the IRS wanted hours of unrelated use over all 8,760 hours in the year, lost, and still argues it. Document the method and keep it consistent.
• Exploited exempt activities (Reg. §1.512(a)-1(d)): when the unrelated business trades on an exempt activity — the logo licensed onto commercial gear, the brochures mailed to the member list for a fee (Ex. 4.3, 4.25), the endorsements the laboratory sells (Ex. 4.24) — the expenses of the exempt activity are not deductible against the UBTI: they are incidental to the exempt function and lack the proximate relationship. The exception: if the unrelated business is one taxable businesses run and the exempt activity is one they would run in doing it, the exempt activity’s expenses in excess of its own income may be deducted, but never to create a loss and never against a different unrelated business. [Final Q49, D; corrected in blue; SQ 30, A; Review image23, A]
• Periodical advertising (Reg. §1.512(a)-1(f)) follows the same ordering: advertising income less direct advertising costs; if circulation income is less than readership costs, the readership shortfall reduces the advertising profit but cannot produce a loss. Four cases on the 990-T Schedule A Part IX: direct costs exceed advertising income → the loss is allowed; advertising profit with circulation income covering readership → report advertising less direct costs; advertising profit and readership costs over circulation income → total periodical income less total costs; readership shortfall larger than the advertising profit → zero, no loss.
• No profit motive: an activity that consistently loses money counting direct and indirect costs is not a trade or business, and its loss is not deductible against anything (§183 principles on the 990-T, and the silo rules besides).

Separate businesses (§512(a)(6)) — added 2026

• Since 2018, UBTI is computed separately for each unrelated trade or business; a loss in one is not deducted against income in another, and the $1,000 specific deduction and the charitable deduction apply once at the organization level. Final regulations (T.D. 9933, Reg. §1.512(a)-6, December 2020): identify each business by its two-digit NAICS code (so all the organization’s retail activities are one business, all its rental activities another); all investment activities — qualifying partnership interests, debt-financed property, S corporation stock check — are one silo; a partnership interest is a qualifying partnership interest if the organization holds no more than 2% of profits and capital (de minimis) or no more than 20% of capital with no control (control test), with §318-style attribution of affiliates; a look-through applies otherwise. added 2026
• Pre-2018 NOLs are taken against total UBTI on the 990-T core form (Part I line 6) before the silo rules; post-2017 NOLs stay with the business that generated them (Schedule A Part II line 17), carry forward indefinitely and are limited to 80% of that business’s income. [Final Q61, D; SQ 36, C; marked]

Study questions 25–32

• “Produced for an educational function” is not one of the three elements of unrelated business income. [SQ 25, B; Review image21, B]
• Dual-use assets do not automatically cost the exemption; the university tennis facility is the example. [SQ 26, B]
• Expenses attributable solely to producing UBTI are deductible; corporate rules apply; mixed expenses are allocated on a reasonable basis. [SQ 27, A]
• A for-profit subsidiary’s taxable income is not attributed to the exempt parent; the parent keeps its exemption and its dividends are excluded. [SQ 28, D]
• President paid $100,000 spending 20% of her time on the unrelated business: $20,000 deductible. [SQ 29, B]
• Expenses of the exempt activity exploited by an unrelated business are incidental to the exempt function and not deductible. [SQ 30, A]
• Volunteer exclusion: at least 85% of the work. [SQ 31, D]
• A college, university or hospital excludes all research income but may not deduct the research expenses against other UBTI. [SQ 32, D]

Private reference, not client advice. Notes taken from a continuing-education course, Form 990: A Practical Guide (Thomson Reuters Checkpoint Learning, 12 hours, 2022 edition written on 2021 law and the 2021 forms). Figures and rules brought current to 2026 in October 2026 (P.L. 119-21, Rev. Proc. 2025-32, T.D. 9933, T.D. 9898, the 2025 form instructions). Items tagged check are to be confirmed against primary sources before they are relied on.