Will That Be Taxable? The Ins and Outs of Unrelated Business Income in Higher Education

When it comes to the financial operations of colleges and universities, the rules can sometimes feel like a labyrinth. While these institutions enjoy federal income tax exemptions on most of their revenue, it can be challenging to figure out when taxes are due.

One particularly intricate area involves understanding and managing Unrelated Business Income (UBI). Examples of situations in which higher education institutions may encounter the question of whether UBI comes into play include:

• Sales of non-educational materials: Bookstores selling gift items or non-educational merchandise.
• Pass-through investment income: Income generated from investments that isn’t directly related to the educational mission.
• Facility rentals for non-exempt purposes: Renting out campus facilities for events unrelated to education.
• Sales of advertising: Revenue earned from selling advertising space in publications or on campus property.
• Fitness and golf facilities: Charging the general public for use of these facilities.
• Parking services: Offering parking to the general public for events or purposes unrelated to the institution’s mission.
• Food and drink sales/catering: Providing catering services or selling food and beverages at events not directly related to the university.

Understanding UBI for Higher Education Institutions

Under Section 501 of the Internal Revenue Code, colleges and universities are generally exempt from federal income tax on the income they generate. However, this exemption does not extend to income derived from activities unrelated to their educational mission. This is where UBI comes into play.

Three conditions must exist for income to be classified as UBI:

Trade or Business: The organization must be engaged in a trade or business, such as selling goods or providing services, to generate income.

Regularly Carried On: The business activities must be conducted with a frequency and continuity comparable to similar commercial activities of nonexempt organizations.

Unrelated to Exempt Purpose: The activity generating income must not be substantially related to the organization’s educational mission.

Challenges and Considerations

Determining whether an activity qualifies as educational or falls under UBI can be nuanced. Some activities, like bookstores selling educational materials, clearly align with the institution’s mission and remain tax-exempt. However, others, such as facility rentals for non-educational events or sales of advertising space, may trigger UBI concerns.

To further complicate matters, there are statutory exemptions that may shield certain activities from UBI taxation. For example, if an activity relies predominantly on volunteer labor, serves primarily for members’ convenience, or involves sales from donated merchandise, it may qualify for an exemption.

By understanding the criteria for UBI, recognizing potential exemptions and carefully evaluating revenue-generating activities, higher education institutions can ensure compliance with tax regulations while maximizing resources for their educational mission. For more information or assistance with determining UBI expenses for your institution, contact us. We are here to help.

Authored by Sara Burkhart

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