Unrelated Business Income Tax (UBIT)

Almost all exempt organizations must pay tax on income earned in an unrelated trade or business. To be considered unrelated, a trade or business must be regularly carried on and not substantially related to the performance of an organization’s exempt purposes other than its need to raise money to carry on its programs.

The term “trade or business” includes any activity carried on for the production of income whether from selling goods or performing services. Business activities are regularly carried on if they are conducted frequently or continually, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations. Unless the business activities, apart from the income generated, contribute importantly to the accomplishment of the organization’s exempt purposes, they are not substantially related.

Certain activities have been specifically excluded from the definition of unrelated trade or business by Congress. The exclusions that apply to veterans’ organizations include:

a. Volunteer Labor: Any business in which substantially all the work is performed by volunteers

without compensation. Compensation may include tips and non-cash benefits. For example, if your members volunteer to sell tickets to the general public for your sponsored dances, and substantially all the work in organizing and conducting the event is done by volunteers without compensation, the activity is not an unrelated trade or business.

b. Selling Donated Merchandise: A business that consists of selling goods substantially all of

which have been received as gifts or contributions. For example, the income generated from a thrift shop selling donated goods, with the proceeds going to the exempt organization, is not an unrelated trade or business.

c. Certain Bingo Games: To qualify for this exclusion, the bingo game must be legal and must be

conducted in a jurisdiction that does not permit commercial bingo. The game must be one in which wagers are placed, the winners determined, and prizes are distributed in the presence of all persons placing wagers in that game. The definition of bingo does not include the sale of pull-tabs, instant bingo or similar raffles. Bingo also does not include any other gambling activities.

d. Low Cost Articles: For organizations eligible to solicit charitable contributions, the distribution of

low cost articles, such as stationery or candies, incidental to the solicitation is not an unrelated trade or business.

e. Exchange or Rental of Member Lists: The exchange or rental of member or donor lists

between posts of war veterans eligible to receive tax-deductible contributions is not considered an unrelated trade or business.

Once it has been determined that a business activity is unrelated, there are several special rules that apply to computing the amount of the income that will be taxable. Certain dividends, interest, annuities, royalties and rents may be excluded in whole or in part. The expenses, depreciation and similar items directly connected with the conduct of the unrelated business may also be deducted. For example, the salaries of full-time employees conducting the business and depreciation of a building used entirely in the conduct of the business are deductible. There are special rules for determining the amount of taxable income generated from debt-financed property. Publication 598 provides more information on the computation of UBIT. Whether a specific activity is taxable often depends on the IRC section under which a veterans’ organization is exempt. This chapter provides answers to general UBIT questions, as well as to questions relating specifically to IRC 501(c)(19), (4), (7), (8) and (10).

General UBIT Questions

A post hires employees to operate its bar and dining facility that is open to the public on a limited basis. Will the income from these facilities be subject to UBIT?

Yes. How much of the income is taxable depends on the IRC section under which the veterans’ organization is exempt.

The operation of a bar and restaurant for use by members or the general public is not an exempt activity for an IRC 501(c)(4) organization. Because this activity is a trade or business, regularly carried on, and not substantially related to exempt purposes, all the income is taxable. If the bar and restaurant is the primary activity, exemption may be lost.

Social activities, such as the operation of the bar and restaurant, are appropriate for veterans’ organizations exempt under IRC 501(c)(19), 501(c)(7), 501(c)(8) and 501(c)(10), as long as the activities are limited to members and their bona fide guests. Permitting nonmember use of these facilities is not related to the accomplishment of exempt purposes and will result in the income from the nonmembers being taxable. For an IRC 501(c)(7) organization, nonmember income that exceeds 15 percent of gross receipts will jeopardize exemption.

Are weekly fundraisers that are open to the general public, such as spaghetti dinners, breakfasts and dances, subject to UBIT?

Yes. Charging admission for fundraising activities, such as dinners, breakfasts and dances, is a trade or business. [Admissions paid by members may be considered related income if social or recreational activities further exempt purposes.] Because the activity is conducted on a weekly basis, it is “regularly carried on,” and because the activity is open to nonmembers, it is not “substantially related” to the exempt purposes of a veterans’ organization under any IRC section. Unless one of the exceptions, such as the volunteer labor exception, applies, the income from these activities is taxable.

Can a member of a post sell tickets to a social function to nonmembers without generating Unrelated Business Taxable Income (UBTI)?

Selling tickets to social functions to nonmembers is an unrelated activity for all veterans’ organizations. If this activity only occurs occasionally, it may not be considered “regularly carried on” and will not be taxable. If the activity is regularly carried on, the income may still be excluded from tax under the “volunteer labor exception.”

Example: A post member who is a volunteer sells his neighbor tickets to the post’s weekly shrimp dinner. The dinner is prepared and served, and the facility is cleaned by volunteers. This activity would meet the volunteer labor exception.

Is income from the sale of advertising in flyers, newsletters and programs taxable as UBTI?

Yes. Income generated from the sale of advertising in a post’s flyers, newsletters, programs and bulletins is unrelated to the exempt purposes of veterans’ organizations under any IRC section. Unless one of the exceptions applies, the income from this source is taxable.

Does advertising a social function to the public by “word of mouth” affect whether the social function generates UBTI?

No. The method of advertising does not change the nature of the activity.

How should a post treat the income from the rental of its banquet hall to members and nonmembers for weddings and similar functions? How should it treat income from the rental of its facilities to other exempt or community organizations?

The rental of banquet facilities on a regular basis to both members and nonmembers for weddings and similar personal functions is an unrelated trade or business for veterans’ organizations exempt under any IRC section. Whether the rental of the facilities to other exempt or community organizations is an unrelated trade or business depends on the IRC section under which the organization is exempt. The rental of these facilities may be related to the permissible purposes of organizations exempt under IRC 501(c)(4), 501(c)(19), 501(c)(8) and 501(c)(10). An IRC 501(c)(7) organization may not rent its facilities to nonmembers without realizing UBTI.

If the rental of the facility is unrelated to the organization’s exempt purposes, the rental income may or may not be taxable. The rents from real property are excluded in computing the tax. If the rent includes personal services, such as catering or decorating, it is not considered rent from real property and would be taxed. Rents from personal property rented with the real property [mixed lease] may also be excluded if the rents attributable to the personal property do not exceed 10 percent of the total rent. The rental exclusion does not apply to the rental of personal property or to the rental of debt-financed property.

If a post sponsors a baseball team (with member and nonmember players) and hosts the games, may all the players purchase food and beverages at the post snack bar without generating UBI?

No. The unrestricted use of post facilities by nonmembers is not related to the exempt purposes of the post. The sale of food and drinks to nonmembers may result in the income being taxed unless the volunteer labor exception applies. The operation of a snack bar is not an exempt activity for an IRC 501(c)(4) organization and all the income generated from this business would be taxable.

Is income from selling liquor or food to members or the public for consumption off the premises subject to UBIT?

Yes. Selling liquor and food for consumption off the premises does not further the exempt purposes of a veterans’ organization. All income from off-premises sales is subject to UBIT, unless a specific exception applies.

Is income from the operation of a thrift shop subject to UBIT?

No. Generally, operating a thrift shop is not considered an unrelated business because substantially all the merchandise has been donated. The volunteer labor exception may also apply if the shop is operated by volunteers.

Is the income from a post’s golf course, swimming pool and snack bar that is open to the public on a regular basis subject to UBIT?

Yes. Recreational facilities open to the public for a fee do not further the exempt purposes of veterans’ organizations. Because these facilities are operated in a commercial manner, the income is taxable.

Under a reciprocal agreement, is income from veterans belonging to unrelated veterans’ organizations subject to UBIT?

Yes. Income received under reciprocal agreements allowing members of unrelated veterans’ groups to use post facilities is subject to UBIT.

Is income from the canteen from members of an unrelated veterans’ organization co-sponsoring a patriotic event, such as a parade, and meeting before and after at your post subject to UBIT?

No. The sale of food and beverages to members of unrelated veterans’ organizations co-sponsoring a parade and assembling at one or the other’s canteen either before or after the event is substantially related to the exempt purposes of either organization.

Is income from the sale of souvenir liquor bottles bearing the organization’s emblem subject to UBIT?

Yes. The sale of souvenir liquor bottles is not substantially related to any exempt purpose of a veterans’ organization. If the sales are regularly carried on and no exceptions apply, all income from this source is taxable.

Is income from poker machines in a post’s bar and from monthly “Las Vegas Nights” subject to UBIT?

Gambling among members is considered a recreational activity rather than an unrelated trade or business for posts exempt under IRC 501(c)(19), 501(c)(7), 501(c)(8) and 501(c)(10). Income from members and bona fide guests is not subject to tax. Allowing members of the general public to use post facilities to gamble or engage in other recreational activities is not a related activity. Income from nonmember sources is subject to tax. Nonmember income in excess of 15 percent may jeopardize exemption under IRC 501(c)(7). Gambling and recreational activities are not exempt activities under IRC 501(c)(4) and, if primary, may jeopardize exemption. Income from these sources is taxable unless a specific exception applies.

Is the income from weekly bingo games subject to UBIT if the games are open to the general public?

No. Bingo is not treated as an unrelated trade or business. Bingo is considered a business activity, however, and may jeopardize exemption under IRC 501(c)(4). If conducted by an IRC 501(c)(7) organization, all receipts from bingo are considered nonmember income and if in excess of 15 percent will jeopardize exemption.

IRC 501(c)(19)

May members of a parent organization and its subordinate posts be granted reciprocal privileges to participate in social and recreational activities and use the facilities of related posts without generating UBTI for those posts of which they are not members?

Yes. Permitting members of the related posts to participate in the social and recreational activities of each post furthers exempt purposes.

May members of the auxiliary be granted privileges by the post it is affiliated with to use the post’s facilities and participate in its social and recreational activities without generating UBTI?

Yes. If the auxiliary unit is exempt under IRC 501(c)(19), its members’ participation in the social and recreational activities of the post is substantially related to the post’s exempt purposes.

May members of a parent organization’s separately organized auxiliary be granted reciprocal privileges to participate in social and recreational activities and use the facilities of related posts without generating UBTI?

Yes. If the auxiliary unit is exempt under IRC 501(c)(19), its members’ reciprocal participation in the social and recreational activities of related posts furthers exempt purposes.

Can a member of a post bring his or her family to the post’s weekly social function without generating UBTI?

Yes. Family participation in weekly social functions furthers the IRC 501(c)(19) purpose of providing social activities for the members.

Are social functions, such as spaghetti dinners, breakfasts and dances for members and their bona fide guests, subject to UBIT?

No. One of the purposes of a 501(c)(19) organization is to provide social and recreational activities for its members.

IRC 501(c)(19) & Fraternal Organization UBI Reporting Requirements

Is UBTI generated when access to the bar and dining facilities is restricted by use of a key card system, or the doorman checks membership cards upon entry? Members of the general public unaccompanied by a member are not admitted, nor are guests allowed to pay their bills separately.

No. Social and recreational activities for members and their bona fide guests further exempt purposes. In a key card situation, no one is admitted unless they are members or bona fide guests of members.

Is income generated by the nonveteran members of the post from use of the bar subject to UBIT?

No. Provided the nonveterans are a class of bona fide members described in the post’s creating document or bylaws and are within the percentage allowable for exemption, they would be considered members for UBIT purposes.

Is income from the use of a post’s bar and restaurant on a regular basis by active duty military personnel who are not members subject to UBIT?

Yes. Active duty military personnel are eligible to be post members. However, if they choose not to join, they are treated as nonmembers.

Is income from the operation of a hotel facility for nonmember active duty military personnel subject to UBIT?

Yes. Unless the hotel is being used by active duty military personnel during a national emergency or armed conflict, the income from nonmembers is subject to tax.

A hotel with a bar, restaurant and meeting rooms operated for use of the members is substantially related, as it provides a place for the members, including those from out of town, to gather for social and recreational activities.

IRC 501(c)(19) & Fraternal Organization UBI Reporting Requirements

Are membership dues from posts that are not recognized as exempt under IRC 501(c)(19) taxable to the state or national parent as UBTI?

No. Dues income is considered related to exempt purposes.

IRC 501(c)(4)

One of the activities of a post is the operation of a canteen (bar and restaurant) that is open to the public. The primary use is by the veteran members and their guests. Is income from the veteran members and their guests subject to UBIT?

Yes. Income from the operation of a canteen (bar and restaurant) by an IRC 501(c)(4) organization is subject to UBIT, whether the income is from members or nonmembers unless one of the exceptions to UBIT applies. The bar and dining activities do not further a social welfare purpose under IRC 501(c)(4). If this activity, coupled with other nonexempt activities, is the post’s primary activity, the organization will not qualify for tax exemption.

Is the income from weekly bingo games conducted by a veterans’ organization exempt under IRC 501(c)(4) subject to UBIT?

No. Bingo is not treated as an unrelated trade or business for purposes of UBIT. It is, however, a business activity that is not an exempt activity under IRC 501(c)(4). If business activities, along with all other nonexempt activities, are the primary activities, the organization will not qualify for tax exemption.

IRC 501(c)(7)

Is a 501(c)(7) veterans’ organization subject to UBIT on its investment income?

Yes. All income from nonmember sources, including investment income, is taxable as UBTI.

Is a 501(c)(7) veterans’ organization subject to UBIT on its rental income?

Rental income from members is generally not taxable. Rental income from nonmembers is taxed.

Is the income from weekly bingo games subject to UBIT if the games are open to the general public?

All nonmember income, including bingo income, is considered unrelated business income subject to tax for 501(c)(7) organizations. Detailed records may be kept to differentiate between member and nonmember income.

If these records are available, only the nonmember income will be taxable. If adequate records are not available, all income from bingo will be taxable. Nonmember income from all sources, if in excess of 15 percent, may jeopardize exemption under IRC 501(c)(7).

If a nonmember pays to participate in gaming activities at the club, is the income subject to UBIT?

Yes. If a nonmember, including a guest of a member who pays his own way, gambles in the club facility, the income is subject to UBIT.

Is the income from the sale of package liquor or carry out food subject to UBIT?

The sale of liquor or food for outside consumption is a business regularly carried on and is considered a non-traditional activity for a social club. If these activities are more than incidental to the operation of the club, its tax exemption will be jeopardized. Any amounts generated from a non-traditional business, whether with members or nonmembers, will be subject to UBIT.

Is the income from a fundraiser for the local veterans’ hospital, which is open to the general public and held in the club facility, subject to UBIT?

A social club may conduct some charitable activities in addition to its social activities. The income must be set aside for charitable purposes. If this set-aside is subject to section 501(c)(3) restrictions, this income is not subject to UBIT.

Is the income generated from the use of club facilities by a member of another veterans’ organization subject to UBTI?

Yes. Amounts paid to a social club by visiting members of another club are amounts paid by nonmembers. For example, members of other clubs who participate in a Calcutta (wagering pool) are not guests of members of the host club, but are considered members of the general public. This income is subject to UBIT and may adversely affect the club’s exempt status if the relevant percentage limitations are exceeded.

IRC 501(c)(8) and (10)

Are organizations described in IRC 501(c)(8) and (10) subject to UBIT?

Yes.

Is income from gambling other than bingo subject to UBIT?

Gambling among members and their bona fide guests is a recreational and fraternal activity and not subject to UBIT. Nonmember participation in lodge activities, including gambling, is not in furtherance of exempt purposes and will result in the receipts received from nonmembers being subject to UBIT.

Is income from nonmember use of the bar and restaurant subject to UBIT?

Yes.

Is income from the rental of the lodge to nonmembers subject to UBIT?

Yes, unless it meets one of the exceptions noted above.

501(c)(7) Social Club UBI Reporting Requirements

No Form 990-T

needed.

You must file

Form 990-T.