Non-profit organizations enjoy the luxury of operating under the umbrella of tax exempt status. However, often times these organizations may be involved in for profit activities that may be subject to taxation. UBTI is used for this exact purpose of preventing organizations from using their tax exempt status to engage in for profit activities that are not related to their mission. UBTI is a tax imposed on “Unrelated Business Taxable Income”. With UBTI, there may be questions regarding the type of revenue non-profit organizations generate and what is or isn’t taxable. One of these types of income is investment income.
Non-profit organizations may use money donated to them to purchase investments that will generate gains to help them in their mission. Some of these types of investments include real property, stocks, bonds, and ownership interest in another entity. Sections §512(b)(1) and Sections §512(b)(5) of the Internal Revenue Code indicate that interest dividends, and capital gains/losses are excluded from the computation of UBIT. This indicates that interest income from holding a bond would not be subject to taxation. Neither would dividends income from holding stock. Capital gains or losses would also not be subject to tax. This includes gains or losses from the K-1 and those gains or losses recognized by the non-profit in the event of the sale of ownership interest. These gains or losses should be calculated for accurate reporting on the Form 990 but are not subject to UBIT.
Non-profit organizations that receive a Form K-1 from ownership interest in another entity may sometimes receive income reported to them that is neither interest, dividend, nor capital gains/losses. IRS Publication 598 provides that it is the responsibility of the K-1 Issuing entity to compute the UBTI component of all amounts reported to the receiving organization and reflect that amount on Schedule K-1, Line 20V. This unfortunately is not common among K-1 issuing entities. We strongly advise that if a non-profit receives a K-1 from their ownership interest in another entity that they as the issuing company properly compute UBTI on Line 20V if applicable. If unable to do so, there are conservative measures for self calculation of UBTI on forms K-1. If you have any questions, please do not hesitate to contact one of our tax professionals.