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Unrelated Business Income - How Is It

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#unrelated income
#taxes on unrelated income
# difference between related and unrelated income
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Monazza AarfaWriter : Monazza Aarfa Zaina RafiqueVoice : Zaina Rafique United States 3095 Listens

Introduction

If you are a student of Business Studies, or an individual willing to get a job that includes dealing with taxes; you might have come across the term "Unrelated Business Income" or UBI. If you're a part of a nonprofit organization, you must know what unrelated business income is. It is important to understand the difference between related and unrelated business income terms to avoid future complication in reporting to the government agencies.

We will cover in today's program about criteria to recognize and report unrelated income from a nonprofit organization.

You're with your host Zaina Rafique at DueFlixVoicFM. In our programs, we invite individuals who have a successful record and have made outstanding achievements in specialized areas.

We urge you to support DueClixVoice.FM in any way you can, so that you help us propagate information across the globe. We roll out information in the simplest, most precise and most accurate way.

Joining us today as our guest is Monazza Aarfa as spokesperson of InfoTaxSquare.com which has registered thousands of religious and nonreligious organizations across the United States for US residents and non-United States residents.

Frequently Asked Questions

How would you describe Unrelated Income to our listeners?
Unrelated Business Income - What is it and how is it generated? +

Unrelated Business Income is more common and general than we think. We might know of, or even be part of activities that generate unrelated income.

In simple words, if a nonprofit organization such as a charitable trust or an NGO receives income from providing services, selling products or doing activities that do not support the main purpose of the organization, it generates unrelated business income.

Consider this as an example - An association which provides shelter for blind people, set up a cafeteria on its premises. The cafeteria offers services to people who work there and also to people from outside. There are paid employees working in the cafeteria. The income gained by the association from the sales of the cafeteria will be unrelated business income since it does  not promote the key purpose of helping the blind people.

How does unrelated income help an exempt organization?
The ways through which unrelated business income supports a nonprofit organization +

In case some non-profit organization does not have any incoming funds in the form of charity, funding programs or funds from the government, the unrelated income becomes a temporary financial support of that organization. It provides stability and helps them achieve their core Objectives.

Taking reference of the previous example, the association can function well and can arrange for basic necessities within the premises from the money earned through the cafeteria.

Can it be said that unrelated income is always a white and fair flow of money?
UBI - Fair flow of money? Or the opposite? +

It is hard to give a definite answer to this. One cannot confidently say that the flow cycle of unrelated business income is a black-and-white one. It is to be understood that there may exist some gray areas that need to be taken care of.

Since some gray areas exist, can taxations be considered a way to keep a check? How does tax come into perspective here?
Taxations into picture - Keeping a check and allowing exemptions on Unrelated Income +

A profit business income invites tax. These taxes are levied on the basis of the amount being earned as well as the purpose of the firm whereas nonprofit organizations enjoy certain tax exemptions owing to the social purpose they serve.

Just to keep the flow cycle in check, the unrelated income gets exemption too. Tax laws are generally very complex so we highly advised to consult an attorney to avoid future complications.

When and why the Internal Revenue Services created a code for unrelated income?
IRS and the necessity to create laws for unrelated business income +

It was introduced. In 1950, Congress amended the tax law to introduce the concept of unrelated business income. Congress introduced the law as nonprofits were having an unfair advantage of competing in the same activities as a for-profit organization. Since then, tax exemptions have been based on the source of funds, rather than the use of funds.

The potential tax liability for unrelated business income requires every nonprofit to know where its income is coming from, and to determine whether any of its income is taxable under the UBIT (Unrelated Business Income Tax) regulation.

Are there any legal restrictions on the amount of unrelated income?
The amount of UBI that can be earned - Legal Restrictions +

As per the Internal Revenue Services, a nonprofit can make up to $1000 of unrelated income before they have to pay taxes on it. Anything more than this, and the firm will have to abide by the laws and pay both state and federal corporate income taxes. A nonprofit can pose a danger to its exempt status by earning too much income in the form of UBI.

Could you cite an example of how these laws may be feeble in some areas?
Laws may not be reaching out everywhere - hence deemed feeble +

Consider this - A Youtuber starts his own YouTube Channel about reviewing some movies under a nonprofit statue. His channel fails to attract a large amount of audience and so, the videos, even though monetized might not give him the desired results in the form of money.

So he decides to collaborate with other non-virtual firms to sell T-shirts, shoes and other accessories. He promotes this sale through his channel and earns a significant amount of money. This too, is a form of unrelated income. But if he earns too much from these sales; sooner or later, the non-virtual firm(or store) will start to rely on his audience for their brand to propagate.

What happens if the IRS is reported of too much unrelated income being earned?
IRS and its measures on too much unrelated income being generated +

There is no definite amount of unrelated income by the Internal Revenue Services which may be received under a nonprofit organization.

Emily Chan, an attorney who specializes in nonprofit issues, offered her opinion on how much unrelated income is too much: "Nonprofit organizations are generally limited in the number of unrelated business activities they can conduct. But the IRS has not been specific about how much permissible earned income can be generated by unrelated sources."

But, if by some chance, in some noticeable and prominent nonprofit organization, the IRS feels that these exemptions are being taken for granted, the nonprofit may lose the exemption status.

What could be the possible reasons for these restrictions to be imposed on the Flexibility of tax exemptions?
Restrictions on tax exemptions and the reasons behind them +

There may not be any fixed limitations, but the two main reasons can be identified as to why UBI raises concern for public charities and most other exempt organizations under Internal Revenue Code Section 501(C). Firstly, UBI is taxable at the corporate tax rate, which is subject to the UBIT.

Second, an exempt organization cannot engage in more than an insubstantial amount of UBI activities without the risk of losing its exempt status.

Are there any exceptions to losing the exempt status if more UBI is earned?
Not losing tax exempt status even if more UBI earned +

Yes, there are a number of exceptions to this as mentioned in Section 512(B) most notable of which are dividends, interest, royalties, rents from real property, capital gains and losses, income from research. So, if a university gains funds for its research-based programs, it won't be considered taxable regardless of the income.

Apart from the source and the amount of income, it also becomes necessary to identify whether any of the activities fall under the category of unrelated business income.

What income can be identified as unrelated and at what point it is no longer?
Criteria for the income to be termed as Unrelated Business Income +

There are three major factors that help us narrow down the idea of unrelated business income.

Firstly, it should be a trade or a business, and it typically competes with commercial business activities. If an Environmental organization distributes saplings to its visitors on the occasion of any formal meet or event, that won't be considered UBI.

Secondly, it must be an activity which is regularly carried out. An NGO for autistic children sets up a stall outside their premises for lemonade made by the children to be sold to outsiders, for two weeks, in summer. This might as well be considered a regular activity and not one that generates unrelated income.

On the other hand, a prison sets up a shop where the prisoners with mild punishments can make food and sell it to outsiders under the supervision of the authorities. The money earned by selling the food can directly go to the prison funds that can be used to improve facilities inside the prison and provide a better work environment for the officials on duty. Since this money keeps coming on a regular basis, it is unrelated business income.

The third and most important criteria is that the activity must not be substantially related to furthering the core purpose of the organization. If a museum makes money by selling items that are replica of the artefacts to the visitors, or by arranging and conducting school trips, it will be generating related income.

Similarly, take the example of a daycare. If a daycare is being operated as a non-profit organization ad that earns a certain amount from the government. However, they decide to take customers on a private basis and earn from them. Here, the objective is the same and Serves their core purpose. Hence, it won't be considered UBI.

Are there officially listed activities that generate UBI?
Officially declared types of activities that generate unrelated income +

As per Form 990-T, the following activities come under UBI.

  • Sale of certain products
  • Rental of personal property by various departments.
  • Sale of internet connectivity
  • Public parkin
  • Partnership investment generated UBI

What must be taken care of, while earning Unrelated Business Income?
Things to keep in mind regarding unrelated business income +

With these reforms being made, and to make sure that one is on the right track with regard to the taxes, it is advisable that each nonprofit has experienced legal advice to help them navigate these tricky issues.

Also, in order to generate more and more unrelated income, organizations may not lose the sight of their core purpose and objectives. Even if it is unrelated, it's a business and it must add to and not violate your brand name.

It would also be advisable to do Competitive Analysis, which means to have knowledge of how other similar firms generate and handle their unrelated income.

With gaining this knowledge about UBI, the question that arises is that why must an individuals be aware of such a concept?
Awareness and knowledge of concepts such as these - why should you know about Unrelated Income? +

You may or may not be a part of the process of Unrelated Business Income gained by a firm. However, these terms do relate to the laymen as one must be aware, informed and an active part of the practical world.

Conclusion

It's ironic that Unrelated Business Income is related to the common folks some way or the other. There is a lot of confusion regarding the concept of Unrelated Income. There often is a lack of concise information for individuals to refer to.

Thank you so much Monazza Aarfa for sharing this information with us. You not only mentioned the official and legal perspectives but also provided real life situations and examples, which, I am pretty sure have helped our audiences clear out the nebulous sight of Unrelated Income.

Programs with guests like these help serve as a reminder as to why we must educate ourselves with these relevant concepts and keep ourselves informed with the correct information!

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