Form 990-T - tax-exempt organizations are not always tax-free

Tax-exempt organizations aren’t always tax-free. Many generate revenue outside their exempt purpose to support operations. Veterans of Foreign Wars (VFW) posts operate bars. American Legion halls host restaurants. Charitable organizations run thrift stores. Self-directed IRAs invest in partnerships, leveraged real estate or operating businesses.

When those activities produce unrelated business taxable income (UBTI), Form 990-T, Exempt Organization Business Income Tax Return, may be required. For tax professionals, the challenge isn’t just filing a return; it’s knowing when UBTI exists, how to allocate income and expenses properly and how to calculate the correct tax. Errors in any of these areas can create significant compliance risk. 

When income becomes unrelated

Under Internal Revenue Code §§511-514, UBTI generally exists when three elements are present:

• The activity is a trade or business
• It is regularly carried on
• It is not substantially related to the organization’s exempt purpose

All three must apply. For example, a VFW post operating a year-round bar open to the public may generate UBTI. In contrast, a nonprofit running a one-time fundraising event likely does not, if the activity isn’t regularly carried on. Facts and circumstances matter.

Passive income, such as most interest and dividends, is generally excluded from UBTI. However, debt-financed income can trigger UBTI under §514. This includes leveraged real estate investments held inside self-directed IRAs. Rental income that appears passive at first glance can quickly become taxable if acquisition indebtedness is involved.

Partnership investments also deserve scrutiny. Schedule K-1 footnotes often identify UBTI, but custodians don’t always calculate it for IRA owners. Tax professionals may need to dig deeper to ensure proper reporting.

Understanding the filing threshold

An exempt organization, including an IRA, must file Form 990-T if it has $1,000 or more of gross income from an unrelated trade or business. The threshold is based on gross income, not net income. Even if the activity ultimately produces a loss, a filing requirement may still exist.

Most exempt organizations pay tax at corporate rates. IRAs and certain trusts are subject to trust tax rates. Estimated tax payments are required if the organization expects to owe $500 or more in tax. Don’t overlook state implications; many states follow federal UBTI rules but impose separate filing requirements.

Allocating income and expenses correctly

Once UBTI is identified, allocation becomes critical. Only income and deductions directly connected with the unrelated trade or business are included in the UBTI calculation. Direct expenses are typically clear, but indirect expenses require a reasonable allocation method.

For example, if a nonprofit operates a thrift store in the same building used for exempt activities, shared expenses such as rent, utilities, and administrative salaries must be allocated using a consistent and reasonable method, such as square footage or time spent. Over-allocating expenses to unrelated activities can artificially reduce taxable income and invite IRS scrutiny. Proper documentation is essential. 

UBTI continues to grow as nonprofits diversify revenue and retirement accounts expand into alternative investments. The rules are technical, and the margin for error is narrow. Tax professionals who understand Form 990-T provide measurable value to exempt organizations and IRA clients navigating complex income streams.

Ready to sharpen your expertise?

Join us for our webinar Form 990-T Requirements and Reporting on Oct. 8. The webinar is also available on demand after the live event.

Earn CPE while walking through real-world examples of identifying UBTI, allocating expenses, calculating taxable income and completing Form 990-T accurately. If you advise exempt organizations or self-directed IRA clients, this webinar is the next step in strengthening your compliance strategy and delivering confident guidance.