What is “unrelated business taxable income” (UBTI)?

Unrelated business taxable income (UBTI) refers specifically to the income generated by a tax-exempt organization from activities that are not substantially related to its primary exempt purpose. This includes income derived from trade or business activities that the organization conducts, but which do not further its exempt mission. For example, if a charity operates a gift shop that sells unrelated merchandise, the income from that shop would be classified as UBTI if it does not contribute to the organization’s charitable goals.

This concept is critical for tax-exempt organizations because it helps to ensure that they do not engage in business activities that could threaten their exempt status while still allowing them to operate certain income-generating activities that may not be directly related to their core missions. It is designed to prevent tax-exempt entities from taking advantage of their status to gain an unfair competitive advantage in the marketplace.

In contrast to this, income from investments that relate to a tax-exempt organization’s primary purpose, or funds raised through grants or donations that adhere to the organization’s mission, would not fall under the definition of UBTI. Therefore, it's essential to distinguish between these types of income to maintain compliance with the IRS regulations surrounding tax-exempt organizations.