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Policy: XV.G.4

Issued: May 16, 1988

Owner: Executive Vice President and Chief Operating Officer

Latest Revision:

ANALYSIS OF UNRELATED BUSINESS INCOME

1.0 Purpose

This policy describes the general guidelines for the analysis of unrelated business income.

2.0 Policy [Top]

Summary of the Unrelated Business Income Tax

2.1 Introduction

(This analysis is a summary of the unrelated business income tax law as of February 19, 1988. It is meant as a companion to Policy XV.G.3, "University Services and Activities.")

The Federal Income Tax laws have traditionally exempted from tax those organizations whose activities benefited society, a category which included colleges and universities. An entity which met the requirements for tax exempt status was not taxed on any income, even from business activities. However, Congress enacted legislation in 1950 which taxed the "unrelated trade or business income" of a tax exempt entity, although it did not prohibit tax exempt entities from engaging in business activities. This legislation was intended to prevent unfair competition by tax- exempt organizations with tax-paying, commercial enterprises. In fact, the impetus for the legislation was commercial activity by a state university.


2.2 Unrelated Business Income (UBI)

For the income from an activity of the University to be taxed, the income must be from an "unrelated trade or business." This is defined as any TRADE OR BUSINESS which is REGULARLY CARRIED ON and which is NOT SUBSTANTIALLY RELATED to the University's educational, tax-exempt purpose.


2.3 Trade or Business

The term "trade or business" means any activity carried on for the production of income from the sale of goods or the performance of services. This is a very broad definition which includes many University activities. Except for specific statutory exceptions, only investment activities (producing income in the form of rents, royalties, interest or dividends) escape this classification. Further, the University's operations are viewed as a "bundle of activities" which the Internal Revenue Service (IRS) can examine independently for the characteristics of unrelated business. Under this "fragmentation rule," 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 larger complex of other endeavors which may be related to the exempt purposes of the University.


Unrelated Business Income (Cont'd)
Trade or Business (Cont'd)

Although the policy behind the tax is the elimination of unfair competition between tax-exempt and taxable entities, demonstrating that an activity does not compete with a taxable business is not sufficient by itself to avoid application of the tax. Also, the activity need not actually generate a profit; only the PURPOSE of generating profit is required for the activity to be a trade or business.


2.4 Regularly Carried On

To be taxable, the trade or business must be "regularly carried on." The test of "regularly carried on" considers the FREQUENCY, CONTINUITY, and MANNER in which the activities are conducted compared with similar commercial activities carried on by taxable businesses. Activities normally conducted year-round in a commercial context are not "regularly carried on" if the University conducts them only for a few weeks. Intermittent activities are evaluated with special emphasis on the manner in which they are carried out, comparing the competitive and promotional efforts with those of comparable taxable businesses.


2.5 Not Substantially Related

A regularly conducted trade or business is subject to tax if it is also not substantially related to the exercise or performance of any charitable or educational function of the University. To be substantially related, the activity must have a substantial causal relationship to the achievement of an exempt purpose, other than the University's need for income.

Two other concepts are encompassed by the "substantially related" test. First, the activities should be conducted on a scale no larger than is necessary for the performance of the exempt functions. Activities in excess of the needs of exempt functions constitute the conduct of an unrelated business. Second, the University may sell a product or by-product of the performance of its exempt function without being considered to be engaged in an unrelated trade or business if the product is sold in substantially the same state it is on completion of the exempt function, and is not further used in a business activity. For example, the sale of milk produced by a college dairy farm is not an unrelated business, but further processing the milk into ice cream for sale would be an unrelated business.


2.6 Exempted Activities

The federal tax laws list several activities which are exempted from the UBI tax, even though they would otherwise have the characteristics of an unrelated trade or business. Two exempted activities are applicable to the University. First, any trade or business which is carried on by the University primarily for the convenience of its members, students, patients, officers, or employees is exempted from the UBI tax. An exemption also applies to all income derived from research performed by the University for any person. "Research" within the meaning of this exemption does not include activities of a type ordinarily carried on as an incident to commercial or industrial operations, such as the ordinary testing or inspection of materials or products or the designing or construction of equipment, buildings, etc. The IRS will scrutinize applied research funded by commercial sponsors, especially if the research involves a physical product, such as a drug. In these cases, it is important for the University to articulate its academic or educational interest in the performance of the research.


2.7 Reporting Requirements

Any tax-exempt organization which realizes unrelated business income must file a tax return with the IRS for the year involved whether or not the income produced a net profit. The income reported in this filing can be aggregated for all of the unrelated trades or businesses engaged in by the University, so that gains from one business could be offset by losses in another business. In addition, any resulting net income can be reduced by specific deductions provided in the tax laws.

THE UNIVERSITY HAS DECIDED THAT IT WILL NOT GENERATE OR ALLOW ITS DEPARTMENTS TO GENERATE ANY UNRELATED BUSINESS INCOME, WHETHER OR NOT SUCH INCOME MAY BE OFFSET BY LOSSES, UNLESS SPECIFICALLY APPROVED BY THE UNIVERSITY COMPTROLLER.


2.8 University-specific Issues

There are several specific areas addressed by the tax law, regulations, court decisions, and IRS rulings which are applicable to current and potential University activities. The rules announced in these sources for several specific fact situations are summarized in the following paragraphs.


Athletics and Athletic Facilities:

A university's receipt of revenues from the sale of television and radio broadcasting rights to athletic events is not subject to UBI tax.

Money received by a university for leasing athletic facilities to a professional football team for summer camp, without providing meals or maid service, is exempt from UBI tax because it is rental income.

Money received by a school from a contract with an individual who conducts a summer tennis camp, under which the school furnished tennis courts, housing and dining facilities, and hired instructors, recruited attendees and provided supervision, is unrelated business income.


Campus Activities:

The operation of a network-affiliated television station by a university is not substantially related to the school's educational purpose.

The operation of a music theater by a liberal arts college is not an unrelated trade or business.

Sponsoring professional theater companies and symphony orchestras that give performances to which the general public is invited does not create unrelated business income.

The conduct of conferences or seminars open to the general public is an activity related to a school's exempt purpose.

Income from testing devices submitted by private commercial companies is unrelated business income.

Income from public use of a parking lot is unrelated business income.

Income from a medical school's forensic psychiatry program is related to the school's exempt purpose.


Sale of Goods:

The sale of toiletries, books and records, and the leasing of television sets and refrigerators by a university-sponsored bookstore are not subject to UBI tax, but the sale of watches is.

The sale of a business school journal to the general public is a related activity.

The sale of advertising space in programs for sports events or music or drama performances does not create unrelated business income, nor does the sale of advertising space in a student newspaper.


Travel Services:

The conduct of travel study tours that include courses on the culture of foreign countries and nature studies taught by certified teachers is exempt from UBI tax.

The operation of a travel tour program for alumni association members and their families is an unrelated trade or business.

3.0 Definitions [Top]

4.0 References [Top]

5.0 Approvals and Revisions [Top]


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