We are often asked the question “Why are community colleges subject to the unrelated business income tax, even though they don’t have to file a Form 990 information return?”. This doesn’t seem logical to most. However, the requirements for both are in two separate parts of the Internal Revenue Code and are, therefore, different.
There are many exceptions under the law that exempt organizations from filing a Form 990, 990-EZ, or 990-N. Specifically exempted under IRC §6033 and the regulations thereunder are: certain religious organizations; state institutions that derive income solely from performing essential governmental functions; and IRC §501(c)(1) corporations that are considered instrumentalities of the U.S. and that act under an Act of Congress. Also exempted are certain governmental units and affiliates (Rev Proc 95-48). In addition, certain political organizations and those tax-exempt organizations under gross receipt thresholds do not have to file the Form 990 series. Since most community colleges fall under the state institution or government units/affiliates exception they do not file any of the forms in the 990 series.
However, the unrelated business income tax (UBIT) is addressed under IRC §511-514. The imposition of the unrelated business tax is addressed in §511 and generally includes organizations exempt from tax under §501(a). In addition, the tax is imposed on IRAs, state and municipal colleges and universities, qualified state tuition programs under §529, ABLE accounts under §529A, medical savings accounts, and Coverdell savings accounts.
Colleges and universities that are agencies or instrumentalities of any government or any political subdivision of a government, or that are owned and operated by such, are subject to the tax on unrelated business income (UBI). Government for this purpose means any domestic government (the United States, any state, U.S. possession, the District of Columbia) and any foreign government (unless a treaty applies). Since community colleges are usually organized as agencies or instrumentalities of domestic governments, they too are subject to the UBIT.
The tax is imposed on the college themselves and on their wholly-owned or controlled tax-exempt subsidiary organizations. If the wholly-owned subsidiary is organized primarily to operate or conduct any unrelated trade or businesses, then it is not considered tax-exempt and not subject to this rule. Instead, they are typically taxed as taxable corporations.
Unrelated business income is income from:
- A trade or business.
- Regularly carried on.
- Not substantially related to the organization’s exempt purpose.
A thorough analysis of the college’s activity should be reviewed to determine if these criteria are met. However, there are several excluded trades or businesses including but not limited to, activities primarily for the convenience of members, students, patients, officers and employees, qualified sponsorship activities, and selling donated materials. In addition to these exclusions, there are several other exclusions such as dividends, interest, annuities, and other investments income, gains and losses from most dispositions of property, royalties and rental income from real property. There are also exclusions specific to colleges such as the exclusion from UBTI of income from research, whether fundamental or applied.
When a college determines that they have unrelated trade or business activity, they must file Form 990-T within 4 months and 15 days of their year-end. If a tax is due, they must pay it by that time but can request an extension of time (Form 8868) to file the form. States may also impose a tax and have filing requirements. For example, New York State requires the filing and payment of tax with Form CT-13.
It is easy to overlook the unrelated business income tax implications of a community college. However, colleges must review their activity to determine if and if so, how much income, should be reported. Our tax advisors at Bonadio can help guide community college clients with this analysis.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute an accountant-client relationship.