Unrelated Business Income Guidelines
Background
As a government entity, California State University, Sacramento is classified as a tax-exempt organization. As such, the University is not taxed on any income that results from activities that are substantially related to its mission or make an important contribution to the accomplishment of its mission. The University's mission encompasses teaching, research, and public service. Activities that are directly related to these three components would generally not result in taxable income.
It is important to also consider the five CSUS auxiliary organizations when reviewing income from activities. These organizations are granted tax-exempt status based on performing specific functions that are related to the university's mission. All activities that generate income must be reviewed to ensure that the function is directly related to their tax-exemption status. If there is no correlation between the activity and university, the income may be subject to taxation.
Unrelated Business Income
Description
Any income generated from activities not related to the university's mission is referred to as "unrelated business income." This type of income is subject to taxation. The purpose for this taxation is to impose tax liabilities on tax-exempt organizations that act outside the scope of their primary function. In addition, it was designed to protect the business community from unfair competition from these types of organizations.
The key principle revolves around the source of the income, and not how the income was spent. This income could represent a tax liability for the university, even if the funds were used to further the mission of the university. Unrelated business income represents income from an activity minus expenses directly connected with that activity.
Examples
The following examples represent activities that could generate unrelated business income.
- Requests for access to university resources in exchange for some form of compensation:
- use of University name or logo
- use of land or buildings
- use of university computer facilities
- use of recreational or athletic facilities
- use of parking lots
- Advertising income
- Career development and placement services for alumni
- Travel tours for alumni and the general public
IRS Criteria
The IRS applies three factors in deciding whether income is unrelated to the primary purpose of the University. All three factors must apply to each activity.
The income must result from selling goods or performing services.
The activity that generates the income must occur on a regular basis and operate similar to a commercial business.
The activity must be unrelated to the mission of the University. This would include activities that do not support or contribute to the university's primary functions.
Exclusions
An event that meets the definition of an unrelated activity can avoid being taxed if the following conditions apply.
Uncompensated Volunteers
An activity is exempt from tax when substantially all the work is performed by individuals who are not compensated. The IRS has defined "substantially" to mean 85% or more.
Convenience
Income from an activity is exempt from unrelated business income tax if it is conducted for the convenience of students, faculty, or staff. This includes certain retail facilities operated on campus for the accommodation of its students and faculty. Examples include photocopy machines, dining facilities, and bookstores.
Sales of Donated Merchandise
It is permissible for the university to sell donated merchandise. Any activity that involves the selling of merchandise is exempt from tax on the income if substantially all of the items were received as gifts or contributions. This applies regardless of whether the labor to operate the activity is paid or volunteered.
Passive Income Sources
Income received from royalties, investment income, and property rentals are exempt from taxation.
Sponsorship versus Advertising
Sponsorships
A sponsorship involves the use of a name or logo by the university in consideration of funds received from a business. In a sponsorship arrangement, the sponsor has no expectation of receiving any substantial return benefit, in exchange for the funds provided. Sponsorship payments are excluded from unrelated business income. The University can acknowledge a sponsor using a phase such as, "First Bank is a proud sponsor of Sacramento State Athletics."
Advertising
Revenue received from the sale of advertising is considered unrelated business income, and is therefore subject to taxation. Advertising can usually be identified through the use of certain language and phrases. Messages that include qualitative or comparative language would constitute advertising. An example would be the phrase "Smith's Market the best grocery store in town."
Any reference to pricing, cost, or discounts would also be considered as advertising. An example would be "Present your ticket stub and receive a 20% discount at Tiny's Burgers." If the announcement included a call to action or an inducement to buy that would also constitute advertising. Examples include the phase "Come Join Now and Receive the First Month Free."
An announcement that promotes products or services would be considered advertising for the organization. An example would be "We offer the best pagers on the market."
Situations
The Internal Revenue Code does not precisely define what activities constitute unrelated business for tax purposes. It is important to review activities in advance to determine if they support the University's mission, or if it would subject the University to tax liabilities.
Income Not Subject to Taxation
A university hosts an annual golf tournament to raise money to fund scholarships. The participant fee includes green fees, cart rental, appreciation gift, and money for the prize fund. After the expenses are paid, the remainder of the fee will be used to fund scholarships. The conducting of a golf tournament does not expressly advance the educational mission of the university. An annual event, even one conducted every year on a recurrent basis, is not considered to be an activity that is regularly carried on by the university. Therefore, the proceeds would not be considered taxable income.
A university hosts an annual banquet to recognize the achievements of certain students. The university uses the banquet as a forum to raise scholarship funds. The fees paid by patrons covers the cost of the dinner, plus allows the patrons to participate in a silent auction, for goods that were donated to the university. The portion of fee not directly related to the cost of the banquet is used for scholarships. Since the event is held on an annual basis, it is not considered to be an activity that is regularly carried on by the university. These proceeds would not be considered taxable income.
A university has tennis courts and dressing rooms that it uses during the regular school year in its educational program. During the summer, the facility is leased to an individual not affiliated with the university. The lease is for a fixed fee that does not depend on the income or profits derived from the leased property. Income generated from the leasing of real property is excluded from unrelated business taxable income.
During the school year, the university sponsors the appearance of professional theater companies and symphony orchestras that present drama and musical performances for the students and faculty members. Members of the general public also are admitted. The presentation makes use of the university's exempt educational function through the presence of students and faculty. Such drama and music events have an important contribution to the overall educational and cultural functions of the university. Therefore, the income received from these events is not taxable.
An art museum that exhibits modern art sells greeting cards that display printed reproductions of selected works from other art collections. Each card is imprinted with the name of the artist, the title or subject matter of the work, the date or period of its creation, and the museum's name.
The sale of greeting cards with printed reproductions of artworks contributes importantly to the achievement of the museum's exempt educational purpose by enhancing public awareness, interest, and appreciation of art. The cards may encourage more people to visit the museum and share in its educational programs. Therefore, the sales are not an unrelated business.
Income Subject to Taxation
A university has tennis courts and dressing rooms that it uses during the regular school year in its educational program. During the summer, the university operates a tennis club open to the general public. Employees of the university run the club, including collecting membership fees and scheduling court times.
The operation of the tennis facility does not advance the educational mission of the university. This activity is considered as an unrelated business, and any revenue derived from the operation is taxable income.
A university leases its football stadium during several months of the year to a professional football team for a fixed fee. Under the lease agreement, the university furnishes heat, light, and water and is responsible for all ground maintenance. It also provides dressing rooms, linen, and stadium security services for the professional team. Generally, rent received from the leasing of real property would be excluded from unrelated business taxable income. However, in this case, the university provided substantial services that went beyond services normally provided with the rental of property. Therefore, this lease situation is considered as unrelated business, and the income must be reported.
A university leases its football stadium during several months of the year to a professional football team. The rental amount for the stadium is tied to a percentage of the gate. The IRS takes the position that the income does not represent rental of property and is therefore subject to taxation.
Determination of Taxability
In most cases, revenue-producing activities can be directly related to our educational mission and are not taxable. However, departments should inform Financial Services of all revenue-producing activities so a proper review can determine whether the revenue is unrelated business income subject to taxation. Financial Services may be able to help you structure the activity to lessen or eliminate the tax liability.
Additional Information
Websites
IRS Publications
Publication 463: Travel, Entertainment, Gift, and Car Expenses
Publication 561: Determining the Value of Donated Property
Publication 598: Tax on Unrelated Business Income of Exempt Organizations
University Tax Resource
Stewart McConnell, Senior Management Auditor, extension 87968
Last Revised: May 17, 2006
