Even though an organization is recognized as tax exempt, it still may be liable for tax on its unrelated business taxable income. An exempt organization that has $1,000 or more gross income from an unrelated business must file Form 990-T, Exempt Organization Business Income Tax Return. For additional information, see the Form 990-T instructions. For the latest developments on filing unrelated business income tax returns, see Form 990-T Filing Developments.

The unrelated business taxable income (UBTI) of organizations described in Internal Revenue Code (IRC) sections 501(c)(7), 501(c)(9), and 501(c)(17) includes all gross income, less deductions directly connected with producing that income, but not including exempt function income. Also, the dividends received deductions for corporations are not allowed in computing UBTI, because they are not expenses incurred in producing income. Exempt function income is gross income from dues, fees, charges, or similar items paid by members for the purposes for which exempt status was granted to the organization. Exempt function income also includes income that is set aside for qualified purposes.

The investment income of these types of organizations generally is not taxed if it is set aside to be used for religious, charitable, scientific, literary, or educational purposes or for the prevention of cruelty to children or animals. In addition, for an IRC section 501(c)(9) or an IRC section 501(c)(17) organization, investment income is generally not taxed if it is set aside to provide for the payment of life, sick, accident, or other benefits. However, income on any amounts set aside that exceed the qualified asset account limit, figured under IRC section 419A, is unrelated business income. Special rules apply to the treatment of existing reserves for post-retirement medical or life insurance benefits. These rules are explained in IRC section 512(a)(3)(E). Income derived from an unrelated trade or business may not be set aside and therefore cannot be exempt function income. In addition, any income set aside and later spent for purposes other than those specified must be included in unrelated business taxable income.

Any gain on the sale of property used directly in performing an exempt function by an IRC sections 501(c)(7), 501(c)(9), or 501(c)(17) organization that is used to purchase other property that is used directly in performing an exempt function is recognized only to the extent the sales price of the old property exceeds the cost of purchasing the new property. For nonrecognition of gain to apply, the purchase of the new property must be within one year before the date of sale of the old property or within three years after the date of sale. For these purposes, the term "sale of property" includes the property's destruction in whole or in part, theft, seizure, requisition, or condemnation.

For a discussion of current developments concerning UBIT, download UBIT: Current Developments. For a discussion of the general UBIT rules, see Unrelated Business Income Tax. For more information, download Publication 598, Tax on Unrelated Business Income of Exempt Organizations.