Unrelated Business Income (UBI)

This article is the second edition of the tax series, which aims to provide you with practical guidance on tax topics that may arise in university operations. In this edition, we focus on Unrelated Business Income (UBI). Universities are generally exempt from federal income taxes because of their educational, research, and public service missions. However, when a university generates revenue from activities that are not substantially related to those purposes, the income may be subject to federal taxation. Understanding what UBI is, why it exists, and how it applies to university activities can help departments make informed decisions when considering new revenue-generating opportunities. This article explains the basics of UBI, provides examples of activities that may generate UBI, and outlines how Ohio University evaluates, tracks, and reports these activities.

What is UBI?

UBI refers to income that a nonprofit organization, like a university, earns from activities that are not related to its primary educational, research and public service purpose. Even though universities are tax-exempt under IRS rules, UBI is subject to taxation because it comes from activities that are not aligned with the institution's core mission.

In simpler terms, if a university operates a business that is not related to its mission activities (e.g., renting out space to outside businesses, running a campus store, or is in a business that competes with the private sector), the income generated from those activities may be considered UBI and could be subject to federal taxes.

Why Does UBI Matter for Universities?

In Ohio, state-public universities are exempt from paying state income taxes, including UBI. However, the IRS taxes UBI to ensure that tax-exempt organizations don’t unfairly compete with for-profit businesses in unrelated commercial ventures. The goal is to avoid tax-exempt institutions using their status to gain an unfair advantage over taxable entities.

How UBI Can Benefit Universities

While UBI is often associated with potential risks and challenges, universities can strategically leverage UBI to supplement their resources and support their educational missions. When handled properly, UBI can offer universities several important benefits, from enhancing financial stability to providing funds for critical initiatives. Let’s explore how UBI can be beneficial for universities:

Supplemental Revenue for Core Educational Activities 

Universities face significant financial pressures due to fluctuating state funding, rising tuition costs, and the increasing demand for research and student services. By generating UBI from activities unrelated to their core educational mission, universities can diversify their revenue streams, reducing their dependence on tuition and government funding. By diversifying income, universities can weather financial downturns and maintain a level of service to students, faculty, and staff, even when traditional funding sources may fall short.

Supporting Strategic Initiatives and Campus Improvements

UBI can be used to fund special projects or capital improvements that support the university’s long-term goals. For example, if a university rents out space to commercial businesses or runs a successful conference center, the profits can be reinvested into the university’s infrastructure or strategic initiatives. This kind of supplemental income provides universities with the flexibility to invest in new opportunities and make long-term improvements that benefit both students, faculty, and staff.

Enhancing Community Engagement and Collaboration 

UBI can also be generated from activities that foster community engagement and partnerships with external organizations, businesses, or local governments. By offering conference and event space, hosting public seminars, or partnering with local businesses, universities can serve as valuable hubs for community interaction and public service. In some cases, universities may offer programs or services that are attractive to the private sector or the local community. Not only do these activities generate UBI, but they also align with the university's mission of service and outreach to the broader community, furthering the university's role as a public resource.

Supporting Innovation and Research 

UBI can provide universities with the funding necessary to support innovation, innovative research, and new educational programs. For example, income from licensing intellectual property (e.g., patents from research) or revenue from university-run innovation centers can directly support the mission. By investing UBI back into research and development, universities can foster a culture of innovation and drive breakthroughs that contribute to scientific advancement and societal benefit. 

Special Note: Public service-related activities must be carefully evaluated for UBI, not all public service activities are exempt.

While UBI can provide valuable supplemental resources, universities must carefully weigh these benefits against potential risks and compliance obligations.

Considerations Before Engaging in UBI Activity

One of the primary reasons for a university's tax-exempt status is to enable it to focus on its educational, research, and public service missions without the burden of competing with for-profit businesses. However, when universities engage in unrelated business activities that directly compete with private sector businesses, several concerns can arise, both from a public policy perspective and in terms of maintaining tax-exempt status. Here are a few to keep in mind when considering UBI:

Protecting the Public Trust and Mission

Public universities are established to serve the public good, and their resources are often funded by taxpayers (via state share of instruction, capital appropriations), tuition, and external grants (often from the federal and state governments). These institutions are granted tax-exempt status because they exist primarily for educational purposes, not for profit-making. 

When a university engages in commercial activities that compete directly with private businesses, it can create the perception that public resources are being used to operate a business enterprise. This perception may undermine public trust and blur the line between the university’s educational mission and commercial interests.

Unequal Competitive Advantage 

Universities benefit from tax-exempt status because they serve a broader public purpose. However, this tax status can create an uneven competitive landscape if a university operates businesses unrelated to its mission. Unlike private businesses, universities generally do not pay federal income tax on mission-related activities and may also receive public funding and other types of support. 

If a university enters the commercial marketplace in areas unrelated to its mission, it could potentially offer goods or services at lower prices than private competitors. The taxation of UBI helps address this concern by ensuring that universities do not gain an unfair financial advantage over for-profit businesses when operating unrelated commercial ventures.

Resource Diversion and Mission Creep

Another important consideration is the potential for resource diversion. Universities are granted tax-exempt status because their primary focus is education, research, and public service. If a university begins to invest considerable time, staff, or funding into commercial activities, resources that could support academic programs, scholarships, or research initiatives may instead be directed toward operating those businesses.

Over time, this can lead to mission creep, where the institution’s priorities gradually shift away from its educational purpose toward business-oriented objectives. Maintaining a strong focus on the university’s mission helps ensure that resources remain directed toward the activities that justify the institution’s tax-exempt status.

Maintaining Focus on Public Benefit 

The core principle behind universities' tax-exempt status is that they exist to serve, advance knowledge, provide accessible education, and contribute to society through research and service. Unlike private businesses, they do not exist to generate profits for shareholders or owners.

When universities expand into commercial ventures unrelated to their mission, they risk losing sight of this broader public purpose. The private sector already plays the primary role in providing goods and services in the marketplace.

Universities serve a different function, supporting students, advancing research, and contributing to the public good. Remaining mindful of this role helps institutions maintain their integrity and uphold their responsibilities as public stewards.

Legal and Tax Implications

Engaging in unrelated business activities also introduces legal and tax considerations. While universities are generally tax-exempt, income from activities unrelated to their educational mission may be subject to Unrelated Business Income Tax (UBIT).

Generating significant UBI may lead to several potential consequences, including:

• Increased scrutiny by the IRS, which may review whether the university is maintaining its tax-exempt status.
• Federal tax obligations on UBI, reducing the net financial benefit of the activity.
• Possible state or local taxes or regulatory requirements depending on the nature of the activity.

The Administrative Burden of UBI

While Unrelated Business Income (UBI) can provide universities with valuable supplemental revenue, it also introduces administrative complexity. Tracking, reporting, and complying with tax regulations requires time, coordination, and institutional resources.

Universities must carefully manage these obligations to ensure compliance while minimizing the impact on their primary educational and research responsibilities. Several key administrative challenges arise when managing UBI:

Tracking and Segregating UBI Activities 

Universities must first identify and track each activity that may generate UBI. The IRS requires that income from unrelated business activities be reported separately from income generated through mission-related activities such as tuition or research funding.

This means institutions must maintain systems that clearly distinguish between related and unrelated revenue streams.

In addition, universities must monitor the frequency and regularity of certain activities to determine whether they qualify as UBI. Proper classification requires ongoing monitoring and documentation. For example, a one-time rental of university equipment may not qualify as UBI, but ongoing rentals of that same equipment likely would.

Ensuring Compliance with UBI Regulations 

UBI regulations can be complex and require careful interpretation. The IRS has specific criteria for determining whether an activity qualifies as unrelated business income.

Universities must periodically review their activities to confirm that they meet these criteria and remain properly classified. In addition, tax regulations and IRS interpretations may change over time. Institutions must stay informed about regulatory developments and adjust their practices as needed to remain compliant.

Resource Allocation and Staff Time 

Managing UBI also requires dedicated staff time and expertise. Accounting, tax, and legal professionals may need to work together to ensure that UBI activities are properly tracked and reported.

These responsibilities may include:

• Monitoring UBI-generating activities
• Preparing tax filings such as Form 990-T
• Evaluating the tax implications of new revenue-generating initiatives
• Consulting with external advisors when necessary

Because of these requirements, universities may need to devote significant internal resources to UBI administration.

Managing Financial Risk and UBIT Liability

In addition to administrative costs, universities must also manage the financial risks associated with UBI. When income is classified as UBI, it becomes subject to UBIT. This may reduce the financial benefit of the activity and create additional reporting requirements. Potential risks include:

• Unexpected tax liabilities if an activity is later determined to be UBI
• Reduced profitability after taxes and compliance costs
• Increased audit risk if activities are not properly documented or classified

Careful oversight and documentation help mitigate these risks.

Potential Impact on Institutional Reputation

Finally, universities must consider how UBI activities may affect their reputation. If commercial ventures become too prominent, stakeholders may perceive that the institution is prioritizing business activities over its educational mission.

Students, faculty, staff, donors, and the public expect universities to focus primarily on education, research, and public service. Excessive reliance on UBI to fund operations could raise questions about institutional priorities.

Evaluating Each Activity on Its Own

When determining whether an activity generates UBI, it is important to evaluate each activity independently. The IRS does not assess UBI based on a university's overall operations. Rather, we must look at each individual business activity to see if it meets the IRS three-part test to determine if income is UBI:

1. The activity is a trade or business.
2. The business is regularly carried on (not sporadic).
3. The business is not substantially related to the university’s exempt purpose (e.g., teaching, research, public service, student services, etc.).

Evaluating university UBI is based on the facts and circumstances involved in each individual activity and the details can make a difference.

Examples of Unrelated Business Income at a University:

Here are some common examples of activities at a university that may generate UBI:

• Campus Retail Stores or Operations: If the university operates retail stores and sells items not related to its educational mission (such as non-academic books, clothing, or other retail items), the income from those sales could be considered UBI. In addition, external customer sales are most often considered UBI.
• Conference and Event Hosting: If a university rents out its facilities for conferences, weddings, or other non-educational events, the income from these rentals could be considered UBI.
• Real Estate: If a university rents or sells property (like buildings or land) to businesses or individuals, the income might be UBI, especially if the property isn’t used directly for mission related purposes.
• Research or Patents: If a university holds patents or conducts research that results in income from commercial ventures unrelated to its core educational or research missions, this may generate UBI.

When Is UBI Not Taxable?

Not all income from business activities is taxable under UBI rules. There are certain exceptions and exclusions:

• Substantially Related: If the activity generating the income is substantially related to the university’s exempt purpose, the income is not considered UBI. For example, income from providing student housing can often be exempt from UBI, as it is closely tied to the university’s mission to support students.
• Convenience Exception: If the university operates a small business for the convenience of its students or faculty and staff, such as selling snacks in a campus café, this may not generate UBI.
• Income from Activities of Students: Income generated from student-run businesses or activities that are an integral part of the educational experience (like a student-run café or art sales) may not be subject to UBI.

How is UBI Reported and Taxed?

UBI generated by universities is subject to specific reporting and taxation requirements established by the IRS. While universities generally enjoy tax-exempt status due to their educational, research, and charitable missions, any income derived from activities unrelated to these purposes is taxable. Understanding how UBI is reported and taxed is crucial for ensuring compliance with federal tax regulations and protecting the university's tax-exempt status.

• IRS Form 990-T: Universities must file Form 990-T if they have $1,000 or more in gross UBI, even if the university owes no tax. This form reports the UBI and calculates any tax due and includes: 
  • Total UBI generated during the year from unrelated activities,
  • Expenses and deductions related to those activities,
  • Net UBI subject to tax, and
  • UBI tax is owed based on applicable rates.
• Tax Rates: The income from UBI is generally taxed at the flat corporate tax rate, which can be as high as 21% for federal taxes (rate based on current tax rates). 
• Deductions: Universities can deduct certain business expenses related to the generation of UBI (e.g., wages, rent, supplies), reducing the amount of income subject to tax.
• Form 990-T is typically due by the 15th day of the 5th month after the close of the university’s fiscal year. Failure to file this form accurately or on time can lead to penalties and interest charges, and in some cases, may threaten the university's tax-exempt status.

Ohio University Processes

The university has established a structured approach to identify, track, report, and pay taxes on UBI, in accordance with IRS guidelines. Below is a detailed look at the related processes for managing UBI at Ohio University:

STEP 1. Identifying UBI-Generating Activities - The first step in managing UBI is to identify activities that generate UBI. University departments and units involved in business activities should be performing an annual review process to determine whether their operations may generate UBI. This process includes:

• A review of new activities, such as renting facilities, running conferences, or operating non-educational services.
• An assessment of existing activities, ensuring that those currently classified as UBI-generating remain in compliance with IRS regulations.
• For new revenue generating activity, a form is available to assist in this review process, the  Revenue Producing Account Questionnaire . The information on this form allows the university to make a proper determination for UBI.

STEP 2. Tracking and Documenting UBI Income and Expenses - Once UBI-generating activities are identified, Finance will work with the unit to develop a system to track the income and related expenses for each activity. This step is crucial for accurate reporting on Form 990-T and for calculating the UBIT owed. All UBI activities must be tracked in the university’s financial system.

• Source: In some cases, a unique source will be established that allows both the income and expenses for the UBI activity to be accumulated in a consolidated way.
• Income: All income generated from UBI activities is categorized under a separate revenue code to ensure easy identification. 
• Expenses: Direct expenses related to the UBI activities are recorded separately. These include costs for marketing, staff salaries, supplies, utilities, and any other costs necessary for conducting the business activities.

STEP 3. Allocating Shared Costs

Given that some resources are shared between UBI and non-UBI activities, Ohio University employs a cost allocation methodology to distribute shared expenses accurately. The university may use several common methods to allocate these costs, including:

• Revenue-based allocation: Expenses are allocated based on the relative revenue generated by each activity.
• Square footage allocation: Costs like utilities and rent are divided based on the square footage occupied by UBI and non-UBI activities.

Finance works closely with departments to ensure that the allocation is fair and reasonable, reflecting the actual use of resources. Accurate allocation is critical to avoid over-reporting or under-reporting UBI-related expenses, which could lead to audit issues or tax penalties.

STEP 4. Filing IRS Form 990-T

Ohio University is required to file IRS Form 990-T annually to report its UBI and calculate the tax liability. This form is filed with the Internal Revenue Service (IRS) and includes the following key information:

• Total UBI income: Income from all UBI-generating activities during the year.
• UBI-related expenses: Detailed breakdown of expenses directly related to UBI activities, including shared costs.
• Taxable UBI: The net UBI after allowable expenses are subtracted from gross income.
• Tax owed: The calculated UBIT based on the university's taxable UBI.

Ohio University’s accounting team submits Form 990-T by the due date. The university also ensures that all necessary documentation, such as financial statements, invoices, and allocation methods, are available to support the reported figures.

STEP 5. Calculating and Paying UBIT

After determining the taxable UBI, Finance calculates the UBIT, which is levied on the net income from each unrelated business activity. Once UBIT is calculated, Finance processes the payment of the tax to the IRS. Payments are typically made electronically, and Finance ensures that the tax is paid by the due date to avoid penalties and interest charges. Subsequently, the UBIT is distributed back to the units that had a tax liability via an internal transfer. Because if units choose to engage in UBI activities, they must bear the cost of the related taxes. Special Note: If units fail to identify and report to Finance UBI activity, the unit will be responsible for all charges associated with correcting the situation, including back taxes, penalties, fines, interest, and any other associated costs for addressing the issue.

STEP 6. Monitoring Compliance and Evaluating UBI Activities

The University strives to continually monitor its UBI-related activities to ensure compliance with tax regulations. Finance work with various departments conducting regular reviews of UBI-generating operations or potential UBI activities.

If the university discovers that any activity no longer qualifies as UBI (due to changes in the nature of the activity or changes in tax law), they will make the necessary adjustments to reclassify the income and ensure accurate reporting.

STEP 7. Reporting UBI to Executive Leadership

Finance also reviews and reports UBI and related taxes to the Vice President for Finance and Administration each year. This process ensures that the university's leadership remains informed about the impact of UBI on the university's finances, and it helps maintain accountability to stakeholders, including donors, faculty, staff, and the public.

STEP 8. Review of Tax-Exempt Status

Finally, Ohio University conducts periodic reviews to ensure that its tax-exempt status is not jeopardized by UBI activities. UBI is subject to taxation, but the university must be careful to ensure that the core mission is maintained and that commercial activities do not overshadow it. Regular assessments help ensure the university complies with IRS guidelines while benefiting from the supplemental income provided by UBI.

Balancing UBI with Mission Alignment

While it’s important for universities to be mindful of the risks and challenges associated with UBI, it can also offer significant benefits if used strategically. The key is to balance UBI with the university’s core mission to ensure that it continues to serve the public good without compromising its tax status. When managed carefully and ethically, UBI can be a valuable tool for universities to expand their impact and ensure long-term sustainability.

Questions? We are here to help! 

If your department is planning to engage in a potential UBI activity, not sure if they may be or has questions about their current UBI activities, questions regarding UBI taxability, reporting requirements, or compliance obligations, please contact the Tax Department at tax@ohio.edu