Tax Exemption And Unrelated Business Income Tax (UBIT): The Framework (Part 1 Of 3)

• Published date: 19 May 2022
• Subject Matter: Tax, Income Tax
• Law Firm: Freeman Law
• Author: Cory Halliburton

This Insights blog is Part 1 of a 3-Part series that provides a focused overview of the unrelated business income tax rules for the nonprofit organization that is tax-exempt pursuant to section 501(c)(3) of the Internal Revenue Code (the "Code").

This Part 1 sets the framework and provides an overview for the organizational and operational tests applicable to tax-exempt organizations and, without getting into too much detail (yet), the why or when the unrelated business income tax rules come into play for the organization.

General Rule for Tax Exemption Under Section 501(c)(3) of the Code.

To be exempt as an organization described in section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in section 501(c)(3) of the Code. See 26 U.S.C. ' 501(c)(3); 26 C.F.R. ' 1.501(c)(3)-1(a)(1). If an organization fails to meet either the organizational test or the operational test, the organization is not qualified for tax exemption under section 501(c)(3) of the Code.

The Organizational Test.

Section 1.501(c)(3)-(1) of the Treasury Regulations contains the organizational test:

Organizational test-(1) In general. (i) An organization is organized exclusively for one or more exempt purposes only if its articles of organization (referred to in this section as its articles) as defined in subparagraph (2) of this paragraph: (A) Limit the purposes of such organization to one or more exempt purposes; and (B) Do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes.

26 C.F.R. ' 1.501(c)(3)-1(b)(1) (emphasis added).

An organization is organized exclusively for one or more exempt purposes only if its articles of organization: (A) Limit the purposes of such organization to one or more exempt purposes; and (B) Do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes.

Id. at ' 1.501(c)(3)-1(b)(1)-(b)(1)(i)(B) (emphasis added).

In no case shall an organization be considered to be organized exclusively for one or more exempt purposes, if, by the terms of its articles, the purposes for which such organization is created are broader than the purposes specified in section 501(c)(3).

Id. at ' 1.501(c)(3)-1(b)(1)(iv) (emphasis added).

The...