20.10 Unrelated Business Income Tax

Policy Information

Purpose and Summary

The University of Arizona (University) is tax-exempt as an instrumentality of the State of Arizona under Internal Revenue Code (IRC) § 115. The University is exempt from federal income tax when engaging in activities related to the exempt purpose of state colleges and universities to include: research and discovery, teaching and learning, outreach and public service, and fostering national or international amateur sports competition. However, under IRC § 513, the University is not exempt from income tax imposed on activities which are substantially unrelated to those exempt purposes.  

Departments providing products or services to external customers may be subject to unrelated business income tax (UBIT) if the activity is all of the following:

• Operated like a trade or business,
• Regularly carried on, and
• Substantially unrelated to the exempt purpose(s) of the University.

The use of unrelated income for the University’s tax-exempt purposes does not disqualify the activity from being taxable as unrelated business income (UBI). It is the activity that determines the distinction, not the use of funds.

Departments and colleges are responsible for self-reporting potential UBI to Tax Services at the Financial Services Office (FSO). This policy and procedure provides guidance to assist departments with identifying activities subject to UBIT as well as the steps to follow if UBI is identified.

Source

Internal Revenue Code, including but not limited to: §§ 511, 512, 513, 1.511, 1.512, and 1.513

Scope

This policy applies University-wide, including Main Campus, the Arizona Health Sciences Campus, the Phoenix Biomedical Campus, and University of Arizona – South. In addition, this policy applies to all extension off-site campus units, both domestic and international.  

Definitions

1. Exempt Purposes of the University: Those that are research and discovery, teaching and learning, outreach and public service, and fostering national or international amateur sports competition.
2. External Customers: Those that are not University students, faculty or staff. Alumni, members of the general public and outside entities are all external customers.
3. Intent to Profit: Business conducted in a competitive manner, similar to how a non-exempt entity would conduct the same activity.
4. Regularly Carried On:  With a frequency and manner comparable to that of the same or similar activity by a taxable organization. Regularly carried on is further expanded upon in the Procedures section.
5. Research: All fundamental and applied research. For the purposes of UBI, the term research does not include activities normally conducted as incident to commercial or industrial applications, such as testing or inspecting materials or products, or designing or constructing equipment or buildings.
6. Trade or Business: An activity carried on with intent to profit after deducting all direct and indirect costs. Trade or business is further expanded upon in the Procedures section.
7. UBIT Questionnaire: A questionnaire developed by FSO Tax Services that assists with gathering the initial information needed to determine if an activity is subject to UBIT.
8. Unrelated Business Income (UBI):  Income from external customers from a regularly carried on trade or business that is not substantially related to the exempt purpose(s) of the University. Not substantially related is further expanded upon in the Procedures section.
9. Unrelated Business Income Tax (UBIT): The tax associated with UBI is a graduated tax and is calculated annually based on the net profit of UBI activities for the University as a whole.

Policy

1. The University will comply with the Internal Revenue Code and will annually report on Form 990-T and associated schedules the University's unrelated business income for the prior fiscal year and remit any balance due.
2. The University will annually prepare and remit an estimated payment of unrelated business income tax for the fiscal year in progress.
3. To ensure that the University maintains compliance, departments will abide by Procedures to identify UBI producing activities and submit to FSO the information required for reporting. 
4. Departments will be responsible for providing funds to cover any corresponding tax liability as well as any applicable interest and penalty for failure to identify or accurately report activities retroactively found to be subject to UBIT.

Procedures

Identifying Unrelated Business Income

1. If a department is providing sales or service to external customers on a regular basis as a trade or business, a UBIT Questionnaire is to be completed and submitted to FSO Tax Services at taxservices@fso.arizona.edu. Tax Services may also request a UBIT Questionnaire for activities discovered on independent review. When completing the questionnaire, departments should include the contact information of the individual with the most knowledge of the activity.
2. Additional facts and circumstances may be needed to make an appropriate determination, and all information is to be submitted in writing. Further guidance to include flowcharts and determinations for specific activities are located on the FSO Tax Services UBIT webpage.
3. To determine if an activity is subject to UBIT, the following expanded definitions are to be taken into consideration. An activity is subject to UBIT only if it is a trade or business, regularly carried on, and not substantially related to the exempt purposes of the University.
   1. The term “trade or business” generally includes any activity conducted for the production of income from selling goods or performing services. An activity must be conducted with intent to profit to constitute a trade or business.
      1. Business conducted in a competitive manner is considered strong evidence of intent to profit.
      2. Where an activity carried on for profit is an unrelated trade or business, the trade or business is not excluded merely because it does not result in profit.
      3. Sustained, significant, and repeated losses generated by unrelated activities may not be considered trade or business for lack of profit motive.
      4. If the University charges substantially below the cost of its goods or services, then the activity is not a trade or business, and the losses are not allowed to offset net UBI from profitable unrelated business activity.
   2. Business activities are considered “regularly carried on” if they show frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations.
      1. An activity should not be considered regularly carried on if it is on a very infrequent or one-time basis.
      2. Activities over a period of only a few weeks or days are not "regular" for the University if the same kind of activity is normally conducted by a nonexempt business on a year-round basis.
      3. Year-round activities are regular even if they are conducted only one day a week.
      4. Seasonal activities may be considered regularly carried on, even though they are conducted only for a short period each year.
   3. A business activity is “not substantially related” to the University’s exempt purpose if it does not contribute importantly to accomplishing that purpose other than through the production of funds. Whether an activity contributes importantly depends in each case on the facts involved. To establish whether or not activities contribute importantly to the accomplishment of an exempt purpose, the following principles apply. This list of determination factors is not exhaustive.
      1. The size and extent of the activities must be considered in relation to the nature and extent of the exempt function that they intend to serve. If an activity is conducted on a scale larger than is reasonably necessary to perform an exempt purpose, it does not contribute importantly to the accomplishment of the exempt purpose. The part of the activity that is more than needed to accomplish the exempt purpose is an unrelated trade or business.
      2. Dual use for both exempt and commercial purposes will not necessarily exempt the income derived from commercial use, unless the business activity contributes importantly to the accomplishment of exempt purposes (see FAQ for example – Dual use).
      3. Selling products of exempt functions (see FAQ for example – Product of exempt function).

4. Exclusions - The following activities are specifically excluded from the definition of unrelated trade or business:
   1. Activities provided by a volunteer workforce - Any trade or business in which substantially all of the work (more than 85%) is performed without compensation is not unrelated trade or business.  In assessing the contribution made by volunteers, the IRS considers factors such as the monetary value of the respective service rendered, the number of hours worked, the intrinsic importance of the volunteer work performed, and the degree of reliance placed upon volunteers.
   2. Activities provided for the convenience of members - Any activity carried on primarily for the convenience of University members, such as students, faculty or staff is not unrelated trade or business.
   3. Income generated by selling donated merchandise - A trade or business that consists of selling merchandise, substantially all (more than 85%) of which the University received as gifts or contributions, is not an unrelated trade or business.
   4. Qualified sponsorship payments - Any payment made by a person engaged in a trade or business for which the person will receive no substantial benefit other than the use or acknowledgment of the business name, logo, or product lines in connection with the University’s activities is considered a qualified sponsorship payment. “Use or acknowledgment” does not include advertising the sponsor's products or services.
5. Exceptions - The following activities are generally exempt from UBI:
   1. Dividends, interest, annuities and other investment income,
   2. Royalty income,
   3. Rents from real property (rents from personal property are potentially subject to UBIT),
   4. Gains or losses from disposition of property.

Reporting Unrelated Business Income

6. For departments with activities determined to be UBI, the department is responsible for providing the fiscal year’s UBI and associated expenses to FSO Tax Services on or before the last business day of August, annually.
   1. UBI and associated expenses are to be submitted to FSO Tax Services along with the program’s total income and expense. Supporting financial documentation to consist of Analytics reports, worksheets and any other relative information are to be included.
      1. Direct costs that can be apportioned to UBI are deductible; those that cannot be apportioned directly will be reasonably allocated by FSO Tax Services as defined and accepted under IRS guidance.
   2. With the submission of annual UBI and associated expenses, the department is also responsible for submitting an estimate of program total income and UBI and associated expense for the following fiscal year.
   3. When completing reports each year, departments should include the contact information of the individual with the most knowledge of the reports.
   4. It is the department’s responsibility to ensure any related UBIT liability can be covered by the appropriate department account.
7. FSO Tax Services is responsible for making an appropriate estimated payment of UBIT for the fiscal year in progress on or before October 15, annually.
   1. FSO Tax Services receives the departments’ reports providing estimated program total income and expense and estimated UBI activity income and expense on or before the last business day of August, annually.
   2. If additional information is needed to clarify estimated income or expense, FSO Tax Services will request detail as necessary to be submitted in writing.
   3. FSO Tax Services combines the estimates of all departments and makes payment to the US Treasury based on anticipated UBIT liability.
8. FSO Tax Services is responsible for the preparation and submission of US Treasury Form 990-T, associated schedules, and any related payment on or before November 15, annually.
   1. FSO Tax Services receives the departments’ reports providing program total income and expense as well as UBI activity income and expense on or before the last business day of August, annually.
   2. If additional information is needed to clarify income or expense, FSO Tax Services will request detail as necessary to be submitted in writing.
   3. FSO Tax Services will obtain the necessary data if a space allocation is to be applied to indirect expenses.
   4. FSO Tax Services compiles the financial data of departments with UBI activity, and prepares Form 990-T and associated schedules for submission to the IRS, with payment if applicable.

Paying Unrelated Business Income Tax

9. Each department with UBI profit will be allocated a charge of actual UBIT by FSO Tax Services via a Disbursement Voucher on or before November 30, annually.

Frequently Asked Questions

1. Isn’t the University exempt from Federal Income Tax?
   The University is exempt from federal income tax for engaging in activities which include research and discovery, teaching and learning, outreach and public service, and fostering national or international amateur sports competition. 
2. What type of income is not exempt from federal income tax?
   The University is not exempt from income tax imposed on activities which are substantially unrelated to the University’s exempt purposes, even though these activities may bring in funds to support the University’s exempt operations.
3. What is unrelated business income (UBI)?
   Unrelated business income, for most organizations, is income produced from an activity that is a trade or business, regularly carried on, and not substantially related to the exempt purpose of the organization.
4. What is unrelated business income tax (UBIT)?
   The calculated tax associated with unrelated business income.
5. What are some of the factors used to determine if an activity is or is not substantially related to the exempt purposes of the University?
   1. If applicable, dual use of a facility for both exempt and non-exempt activity must be reviewed.
      Example: Product testing and research for commercial or industrial application may occur in the same lab where testing and research related to the University’s exempt purpose occurs. The income generated from standard product testing represents UBI as it does not meet the definition of research for this purpose.
   2. The selling of products of exempt functions is not subject to UBIT.
      Example: The College of Agriculture and Life Sciences operates a Farmer’s Market selling tomatoes grown by students in the program. As the tomatoes are a product of the exempt function of teaching and learning, their sale to external customers is not an unrelated activity. However, if tomato sauce was also made and sold, the income generated from sauce sales would represent UBI as the product is no longer the original product of the exempt function.
6. Our department is planning to carry on an activity that may be subject to UBIT. What should we do?
   Any activity generating external income requires the completion of a UBIT Questionnaire, to be sent to FSO Tax Services at taxservices@fso.arizona.edu.
7. Who should fill out the UBIT Questionnaire?
   The questionnaire can be filled out by the individual in charge of the project, such as the Principal Investigator (PI) or activity coordinator.
8. Where can the UBIT Questionnaire be obtained?
   The questionnaire is located on the Research Gateway website under Contracting Forms and Templates.
9. My department and FSO Tax Services have determined an activity to be carried on will be subject to UBIT. What deductions can be used to offset UBI?
   Both direct and indirect costs related to the production of UBI may be deducted.
10. Are there any exceptions to or exclusions from UBI?
    The Internal Revenue Code (IRC) allows for certain exceptions, with most centering on passive income activities such as investment income, real property rental, or disposition gains and losses. The IRC also allows for specific exclusions related to volunteer workforces, convenience of members, donated merchandise and qualified sponsorships.
11.  What are some examples of activity typically subject to UBIT
    1. Catering services provided to the general public
    2. Use of recreational facilities by alumni and the general public,
    3. Parking lot services provided to the general public,
    4. Product testing and research for commercial or industrial application.
12.  What are some examples of activity typically not subject to UBIT?
    1. Sales of farm and agricultural products produced by an exempt function,
    2. Student dormitories rented to enrolled students,
    3. Revenue from University sporting events, including admissions and TV/radio rights,
    4. In general, research activities that are not routine, not for consumer product testing, or not for commercial or industrial application.
13.  What types of research income are excluded from UBI?
    All fundamental and applied research performed by the University is excluded from UBI.

Related Information

UBIT Questionnaire
Internal Revenue Code, including but not limited to: §§ 511, 512, 513, 1.511, 1.512, and 1.513
IRS Publications, including but not limited to: Publication 598, IRS Colleges and Universities Compliance Project Final Report