When a tax-exempt organization generates revenue from a business activity that is not substantially related to its charitable purpose, that revenue is known as Unrelated Business Taxable Income (UBTI) and is subject to taxation. Foundation Source handles these special tax filings for its clients. The tax on UBTI is meant to prevent exempt entities from having an unfair competitive advantage over commercial enterprises, which are subject to taxation.
Another way to have UBTI is to buy investments or assets using borrowed funds, i.e., acquisition indebtedness, which may partially or wholly “taint” such assets, so that income generated by those assets (e.g., interest dividends, rent) and capital gains realized upon their sale may give rise to UBTI. These calculations are complicated and beyond the scope of this booklet.
A common way to have UBTI is to invest in partnerships, either because the partnership is a business enterprise or the partnership itself borrows money to finance the acquisition of investment assets. If a partnership is made aware that a partner is a private foundation, the partnership will indicate the foundation’s share of
UBTI, if any, on the K-1’s issued to the foundation each year. Private foundations are largely precluded from directly engaging in business or owning a substantial interest in a business enterprise, so they must be wary of generating excessive UBTI.
This income is taxable at for-profit income tax rates and requires additional filings with the IRS (Form 990-T). As a result, most foundations tend to steer away from investments that generate more than normal UBTI.
Generally, interest from investments, dividends, and capital gains is not considered UBTI (unless the investments generating such income were acquired using borrowed funds). Rules and regulations regarding UBTI are complex, so it is advisable to consult with a tax advisor who is well versed on private foundations.
