Specialized Returns and Taxpayers · Exempt organizations
Unrelated business taxable income
tax year · reviewed 2026-08-21 · Draft for I. Ohu review
Exemption is from tax on income related to the exempt purpose. It was never a licence to run an ordinary business tax-free, and IRC § 511 says so by taxing what is left over at ordinary corporate rates. The difficulty is not the tax; it is deciding what falls inside it, and that is a question with three parts that must all be answered yes.
The rule
The tax. a tax computed as provided in IRC § 11 — the corporate rate — is imposed for each taxable year on the unrelated business taxable income of every organization exempt under IRC § 501(a), other than an IRC § 501(c)(1) instrumentality or a trust taxed under IRC § 511(b), and of any state college or university and any corporation wholly owned by one (IRC § 511(a))TY2026 unrelated business taxable income means the gross income an organisation derives from any unrelated trade or business regularly carried on by it, less the deductions directly connected with carrying it on, both computed with the modifications in IRC § 512(b) (IRC § 512(a)(1))TY2026 The return is separate — Form 990-T is an income tax return rather than part of the information return (Reg. § 1.6012-2(e)): every organisation described in IRC § 511(a)(2) and subject to the IRC § 511(a)(1) tax must file Form 990-T for a taxable year in which it has gross income included in computing unrelated business taxable income of $1,000 or more, and filing it does not relieve the organisation of any other return (Treas. Reg. § 1.6012-2(e))TY2026
Three cumulative tests. the three tests are cumulative: the activity must be a trade or business, it must be regularly carried on, and it must not be substantially related to the exempt purpose. Failing any one of the three takes the activity outside the taxTY2026 unrelated trade or business means any trade or business the conduct of which is not substantially related — aside from the organisation’s need for the income or funds, or the use it makes of the profits — to the exercise of the purpose constituting the basis for its exemption (IRC § 513(a))TY2026 Read the parenthetical in that definition carefully — the need for money and the charitable use of the profits are expressly excluded from the relatedness inquiry. An activity is not related because it funds the mission.
Regularly carried on. frequency and continuity, and the manner of pursuit, decide whether a business is regularly carried on, measured against comparable commercial activity — a hospital auxiliary running a sandwich stand for two weeks at a state fair is not regular, while a commercial parking lot operated one day a week all year is (Treas. Reg. § 1.513-1(c))TY2026
Fragmentation. trade or business includes any activity carried on for the production of income from the sale of goods or performance of services, and an activity does not lose its identity as a trade or business merely because it is carried on within a larger aggregate of similar activities or within a group of other activities that may or may not be related to the exempt purpose (IRC § 513(c))TY2026 A single department, a single publication, even a single page of advertising in an otherwise exempt journal, can be carved out and taxed on its own.
Three statutory exceptions. the term excludes a trade or business in which substantially all the work is performed for the organisation without compensation; one carried on by an IRC § 501(c)(3) organisation or a state college primarily for the convenience of its members, students, patients, officers or employees; and the selling of merchandise substantially all of which was received as gifts or contributions (IRC § 513(a)(1)-(3))TY2026 Each is a complete answer where it applies, regardless of how commercial the activity looks. The volunteer labour exception turns on who does the work, not on what the work is; the convenience exception turns on who is served; the donated merchandise exception turns on where the goods came from.
Sponsorship is not advertising. soliciting and receiving qualified sponsorship payments is not an unrelated trade or business; a qualified sponsorship payment is one made with no arrangement or expectation of any substantial return benefit beyond use or acknowledgement of the payer’s name, logo or product lines — acknowledgement does not extend to advertising, which includes qualitative or comparative language, price information, indications of savings or value, endorsements or inducements to purchase (IRC § 513(i))TY2026 a payment contingent on event attendance, broadcast ratings or other measures of public exposure is not a qualified sponsorship payment, the safe harbour does not reach periodicals or qualified convention and trade show activities, and a payment is split into qualifying and non-qualifying portions where only part of it would qualify on its own (IRC § 513(i)(2)(B), (3))TY2026 The line falls between saying a company’s name and saying something good about its product.
Mailings and lists. distributing low cost articles incidentally to the solicitation of charitable contributions, and exchanging or renting donor or member names and addresses with another such organisation, are not unrelated trades or businesses for an organisation contributions to which are deductible under IRC § 170(c)(2) or (3); a low cost article is one costing the distributing organisation no more than the indexed statutory amount, with all items sent to one distributee in a calendar year aggregated (IRC § 513(h))TY2026 for taxable years beginning in 2026, a low cost article for purposes of IRC § 513(h)(2) is one costing $13.90 or less — the statutory figure is $5, indexedTY2026
The modifications take most investment income back out. dividends, interest, payments with respect to securities loans, consideration for agreements to make loans, annuities and all directly connected deductions are excluded, as are royalties and their directly connected deductions (IRC § 512(b)(1), (2))TY2026 rents from real property are excluded, along with rents from personal property leased with it where the personal property rents are an incidental amount of the total determined when that property is placed in service — but the exclusion fails if more than 50 percent of the total rent is attributable to the personal property, or if the rent depends on the income or profits derived by any person from the leased property other than by a fixed percentage of receipts or sales (IRC § 512(b)(3))TY2026 gains and losses from the sale, exchange or other disposition of property are excluded, other than inventory and property held primarily for sale to customers in the ordinary course of business; also excluded are gains and losses from the lapse or termination of options on securities or real property held in investment activities and from forfeited good-faith deposits (IRC § 512(b)(5))TY2026 These exclusions are why a charity’s endowment is not taxed, and why the rent from an office building it owns outright is not taxed either.
Two rules that put it back in. a specified payment — interest, annuity, royalty or rent — received directly or indirectly by a controlling organisation from an entity it controls is included as gross income from an unrelated trade or business to the extent it reduces the controlled entity’s net unrelated income or increases its net unrelated loss, notwithstanding the exclusions for interest, royalties and rents (IRC § 512(b)(13))TY2026 income from debt-financed property is included as unrelated business income in the proportion that the average acquisition indebtedness for the year bears to the average adjusted basis of the property, capped at 100 percent, with deductions allowed in the same proportion (IRC § 514(a); IRC § 512(b)(4))TY2026 debt-financed property is any property held to produce income and subject to acquisition indebtedness at any time during the taxable year — or within the 12 months ending on disposition — excluding property substantially all the use of which is substantially related to the exempt purpose, property whose income is already counted in an unrelated trade or business, and property whose income is excluded under IRC § 512(b)(7), (8) or (9) (IRC § 514(b)(1))TY2026 Debt financing is the one that surprises people: the same rent that is excluded when the building is owned free and clear becomes partly taxable the moment there is a mortgage on it.
The specific deduction. a specific deduction of $1,000 is allowed, except in computing the net operating loss; a diocese, province of a religious order or convention or association of churches gets a further specific deduction for each local unit equal to the lower of $1,000 or that unit’s gross income from unrelated trade or business (IRC § 512(b)(12))TY2026
Silos. an organisation with more than one unrelated trade or business computes unrelated business taxable income separately for each, including for net operating loss purposes and without the specific deduction; total unrelated business taxable income is the sum of those amounts less one specific deduction, and no single activity may contribute less than zero (IRC § 512(a)(6))TY2026 each separate unrelated trade or business is identified by the first two digits of the NAICS code that most accurately describes it, working from the more specific six-digit code for the activity; the code must describe the unrelated activity rather than the exempt one, and each two-digit code is reported only once (Treas. Reg. § 1.512(a)-6(b))TY2026 The practical effect is that a loss from one unrelated business no longer shelters income from another.
Current figures
| Item | 2026 |
|---|---|
| The tax | a tax computed as provided in IRC § 11 — the corporate rate — is imposed for each taxable year on the unrelated business taxable income of every organization exempt under IRC § 501(a), other than an IRC § 501(c)(1) instrumentality or a trust taxed under IRC § 511(b), and of any state college or university and any corporation wholly owned by one (IRC § 511(a))TY2026 |
| Definition | unrelated business taxable income means the gross income an organisation derives from any unrelated trade or business regularly carried on by it, less the deductions directly connected with carrying it on, both computed with the modifications in IRC § 512(b) (IRC § 512(a)(1))TY2026 |
| Statutory exceptions | the term excludes a trade or business in which substantially all the work is performed for the organisation without compensation; one carried on by an IRC § 501(c)(3) organisation or a state college primarily for the convenience of its members, students, patients, officers or employees; and the selling of merchandise substantially all of which was received as gifts or contributions (IRC § 513(a)(1)-(3))TY2026 |
| Qualified sponsorship | soliciting and receiving qualified sponsorship payments is not an unrelated trade or business; a qualified sponsorship payment is one made with no arrangement or expectation of any substantial return benefit beyond use or acknowledgement of the payer’s name, logo or product lines — acknowledgement does not extend to advertising, which includes qualitative or comparative language, price information, indications of savings or value, endorsements or inducements to purchase (IRC § 513(i))TY2026 |
| Low cost article | for taxable years beginning in 2026, a low cost article for purposes of IRC § 513(h)(2) is one costing $13.90 or less — the statutory figure is $5, indexedTY2026 |
| Rents modification | rents from real property are excluded, along with rents from personal property leased with it where the personal property rents are an incidental amount of the total determined when that property is placed in service — but the exclusion fails if more than 50 percent of the total rent is attributable to the personal property, or if the rent depends on the income or profits derived by any person from the leased property other than by a fixed percentage of receipts or sales (IRC § 512(b)(3))TY2026 |
| Specific deduction | a specific deduction of $1,000 is allowed, except in computing the net operating loss; a diocese, province of a religious order or convention or association of churches gets a further specific deduction for each local unit equal to the lower of $1,000 or that unit’s gross income from unrelated trade or business (IRC § 512(b)(12))TY2026 |
| Silo rule | an organisation with more than one unrelated trade or business computes unrelated business taxable income separately for each, including for net operating loss purposes and without the specific deduction; total unrelated business taxable income is the sum of those amounts less one specific deduction, and no single activity may contribute less than zero (IRC § 512(a)(6))TY2026 |
| Debt-financed income | income from debt-financed property is included as unrelated business income in the proportion that the average acquisition indebtedness for the year bears to the average adjusted basis of the property, capped at 100 percent, with deductions allowed in the same proportion (IRC § 514(a); IRC § 512(b)(4))TY2026 |
| Return threshold | every organisation described in IRC § 511(a)(2) and subject to the IRC § 511(a)(1) tax must file Form 990-T for a taxable year in which it has gross income included in computing unrelated business taxable income of $1,000 or more, and filing it does not relieve the organisation of any other return (Treas. Reg. § 1.6012-2(e))TY2026 |
How it works in practice
Run the three tests in order and stop at the first no. Most activities that worry a board fail the second test rather than the third: an annual fundraising auction is plainly a trade or business and plainly unrelated, but it happens once a year and is not regularly carried on. The regulation’s own examples — the two-week sandwich stand against the year-round Saturday parking lot — are the right calibration.
When the activity survives all three tests, look next for a statutory exception, and look at the facts rather than the label. A hospital gift shop is not exempt because it is a gift shop; it is outside the tax to the extent it serves patients and their visitors, which is the convenience exception, and the same shop selling to passing shoppers from the street is not. A thrift store stocked entirely with donated goods is outside the tax however commercially it is run, and the same store buying inventory wholesale is not.
For any income that looks like investment income, work through IRC § 512(b) before concluding anything. Dividends, interest, royalties, rents from real property and capital gains are all excluded, which disposes of most of an endowment. Then check the two provisions that reverse the exclusion: is the payer an entity the organisation controls, and is the property subject to acquisition indebtedness? Either one converts excluded income into unrelated business income.
Since 2018 the arithmetic has to be done business by business. Identify each unrelated trade or business by its two-digit NAICS code, compute each separately, floor each at zero, and take the single specific deduction against the total. An organisation with a profitable parking operation and a loss-making advertising operation cannot net them.
The journal that carries advertising
A professional association exempt under IRC § 501(c)(6) publishes a quarterly journal of peer reviewed articles. The journal is central to its exempt purpose. Each issue carries about sixteen pages of paid advertising for laboratory equipment, sold by a member of staff on commercial terms. Advertising revenue for the year is $210,000; the costs directly connected with selling and producing the advertising pages are $84,000.
The journal is related and the advertising is not. IRC § 513(c) is explicit that an activity does not lose its identity as a trade or business merely because it is carried on within a larger aggregate of activities that are related — so the advertising is fragmented out and tested on its own. It is a trade or business, it is carried on with each issue throughout the year, and selling equipment advertising does not further the association’s exempt purpose. The $126,000 of net advertising income is unrelated business taxable income, reduced by the specific deduction, and Form 990-T is required because gross income counted toward UBTI is far above the filing floor.
The mortgage on the office building
A charity owns a four-storey building. It occupies the top two floors and leases the bottom two to unrelated commercial tenants for $96,000 a year. In year one the building is owned outright and the charity reports no unrelated business income from it. In year two the charity borrows $600,000 against the building to fund a programme expansion. Average acquisition indebtedness for year two is $580,000 and the average adjusted basis of the building is $1,450,000.
Year one is right: rents from real property are excluded by IRC § 512(b)(3), and leasing space is not an unrelated trade or business when the exclusion applies. Year two is different. IRC § 512(b)(4) overrides the rent exclusion for debt-financed property, and the debt-financed percentage is $580,000 over $1,450,000, or 40 percent. So 40 percent of the rental income from the leased portion — and 40 percent of the directly connected deductions — enters the UBTI computation. The exempt-use portion of the building is carved out under IRC § 514(b)(1)(A), so only the two leased floors are in the calculation to begin with. Nothing about the charity’s use of the borrowed money changes the answer.
The sponsor who wanted a little more
A charity’s annual conference is supported by a corporate sponsor paying $40,000. The agreement gives the sponsor its logo on the programme and a banner reading “Presented with the support of Meridian Systems.” Midway through negotiation the sponsor asks to add a half-page in the programme reading “Meridian Systems — 30% faster than the leading alternative, and priced lower too,” and to tie $10,000 of the payment to the final attendance figure.
The original arrangement is a qualified sponsorship payment. Use or acknowledgement of the name and logo is exactly what IRC § 513(i)(2)(A) permits, and soliciting and receiving such a payment is not an unrelated trade or business. Both additions break it. The half-page contains comparative language and price information, which the statute expressly excludes from acknowledgement, so that portion is advertising. The $10,000 contingent on attendance is outside the definition altogether under IRC § 513(i)(2)(B)(i). The saving grace is IRC § 513(i)(3): the payment is split, and the portion that would qualify on its own remains a qualified sponsorship payment. Only the advertising portion and the contingent portion are exposed.
Destination of income is not relatedness. IRC § 513(a) excludes the organisation’s need for funds and its use of the profits from the relatedness inquiry, in the definition itself. Every answer choice reasoning that “the profits go to the charitable programme, so the income is related” is wrong, and the same reasoning fails again under IRC § 502 for feeder organisations.
Rent is excluded until it is financed. Practitioners remember IRC § 512(b)(3) and forget IRC § 512(b)(4). Acquisition indebtedness on income-producing property drags a proportion of otherwise excluded rent, interest and gain into the tax, and the proportion is average debt over average adjusted basis — not the loan-to-value ratio, and not the interest expense.
The rent exclusion has two switches that turn it off. More than half the rent attributable to personal property leased with the real property, or rent measured by the tenant’s income or profits, defeats it. A percentage-of-gross-receipts lease is fine; a percentage-of-net-profits lease is not.
Silos are not optional and losses do not cross. Since IRC § 512(a)(6) applied for years beginning after 2017, each unrelated trade or business stands alone and cannot report less than zero into the total. A calculation that nets a loss-making activity against a profitable one, or that takes the specific deduction more than once, is wrong twice over.
How this has changed
The silo rule at IRC § 512(a)(6) was added by Pub. L. 115-97 § 13702 for taxable years beginning after 31 December 2017 and remains the most consequential change to this area in a generation. The final regulations at Treas. Reg. § 1.512(a)-6 settled the identification method on two-digit NAICS codes, with a separate regime for partnership investment interests. Pre-2018 net operating losses are used against total UBTI while post-2017 losses stay with the business that generated them.
The companion provision did not survive. IRC § 512(a)(7), which had increased UBTI by the cost of certain employee fringe benefits — the “parking tax” — was struck out by Pub. L. 116-94 in December 2019, retroactive to its enactment. Organisations that had filed and paid on it were able to claim refunds, and no exempt organisation owes it for any year.
Qualified sponsorship payments are a 1997 answer to a decade of dispute over college bowl games: IRC § 513(i) was added by Pub. L. 105-34 § 965 and codified a safe harbour the Service had been resisting. The distinction it draws between acknowledgement and advertising is now the operative test, and it is drawn in the statute rather than left to facts and circumstances.
Exam focus
The three tests, in order, are the backbone of every question here. Expect a fact pattern designed so that one of the three fails, and expect the tempting wrong answer to be the one reasoning from where the money goes.
Know the three IRC § 513(a) exceptions by their trigger: unpaid work, convenience of members or patients, donated merchandise. Know that qualified sponsorship payments are excluded and that comparative or price language turns acknowledgement into advertising.
Know that Form 990-T is required at the gross income floor, that the IRC § 512(b)(12) specific deduction is taken once and only once, and that debt-financed property brings back into the tax a proportion of income that IRC § 512(b) would otherwise exclude.
Check yourself
1. A museum’s shop sells reproductions of works in its collection and also sells souvenir sweatshirts bearing the city’s name. Is the shop’s income unrelated business income?
Answer: Partly. Under IRC § 513(c) the shop is fragmented rather than tested as a whole. The reproductions further the museum’s educational purpose and are substantially related; the city souvenirs do not and are not. The income from each line is tested separately, and the answer that treats the shop as one activity — in either direction — is wrong.
2. A charity’s volunteers run a car wash every Saturday throughout the year, raising $22,000. No one is paid. Is the income taxable?
Answer: No. It is a trade or business, and operating every Saturday all year is regularly carried on under Treas. Reg. § 1.513-1(c)(2)(i) — the regulation’s own parking lot example. But IRC § 513(a)(1) excepts a trade or business in which substantially all the work is performed without compensation, and that disposes of it. Note the order: the exception is reached only after the three tests, and it answers the question on its own.
3. A university owns an apartment block, subject to a mortgage, and rents it to members of the public. Average acquisition indebtedness is $2,000,000 and average adjusted basis is $8,000,000. Rental income is $700,000 and directly connected deductions are $450,000. What enters UBTI?
Answer: The debt-financed percentage is $2,000,000 over $8,000,000, or 25 percent. So $175,000 of gross income and $112,500 of deductions enter the computation, for $62,500 of unrelated business taxable income before the specific deduction. Renting to the general public is not substantially related, so no part is carved out under IRC § 514(b)(1)(A).
4. An exempt organisation runs two unrelated businesses. The first produces $30,000 of net income; the second produces a $12,000 loss. What is its unrelated business taxable income?
Answer: $29,000. Under IRC § 512(a)(6) the two are computed separately, the loss activity is floored at zero and contributes nothing, and one specific deduction of $1,000 is taken against the $30,000 total. The intuitive answer of $17,000 — netting first, then deducting — was correct only for years beginning before 2018.
5. A trade association sells its member mailing list to a commercial marketer for $15,000. Is the income excluded under IRC § 513(h)?
Answer: No. IRC § 513(h)(1) covers exchanging or renting names and addresses only between organisations described in IRC § 501 and contributions to which are deductible under IRC § 170(c)(2) or (3) — and only with another such organisation. A trade association exempt under IRC § 501(c)(6) is not one, and a commercial marketer certainly is not. The income is tested under the ordinary three tests, and a regularly repeated sale of a list on commercial terms will fail them. Whether the payment is instead a royalty excluded by IRC § 512(b)(2) turns on how passive the association’s role is, which is where these cases are actually fought.
Change log
- Initial draft. Sets out the three cumulative tests of IRC § 513(a) and Treas. Reg. § 1.513-1, the statutory exceptions for volunteer labour, member convenience and donated merchandise, the IRC § 513(c) fragmentation rule, qualified sponsorship payments under IRC § 513(i), the IRC § 512(b) modifications that pull most investment income back out, the IRC § 512(b)(13) controlled entity rule, IRC § 514 debt-financed income, and the IRC § 512(a)(6) silo rule with the NAICS identification method of Treas. Reg. § 1.512(a)-6(b).