Unrelated Business Income Tax (UBIT): Tax-exempt organizations pay regular income tax on unrelated business taxable income (UBTI). UBTI = gross income from unrelated trade or business − deductions directly connected. An activity is unrelated if: (1) trade or business, (2) regularly carried on, (3) not substantially related to exempt purpose. Exceptions: volunteer labor, donated merchandise, convenience to members, certain investment income (interest, dividends, royalties from non-debt-financed investment property), qualified convention/trade show activities.

Debt-financed property: Investment income from debt-financed property is subject to UBIT. The portion subject to tax = income × (acquisition indebtedness / average adjusted basis). Important for tax-exempt organizations investing in real estate using borrowed funds (including through LPs/LLCs).

Private foundations: Subject to excise taxes — 1.39% excise tax on net investment income; prohibited transactions (self-dealing with disqualified persons — substantial contributors, foundation managers, family); mandatory distribution (5% of net investment assets annually); excess business holdings (limited ownership in non-exempt operating businesses); jeopardizing investments (prudent investor standard); taxable expenditures (grants to individuals without IRS-approved procedures, non-charitable grants to non-public-charities without expenditure responsibility).

Donor-Advised Funds (DAFs): Account sponsored by a public charity; donor contributes, takes immediate deduction (at FMV for cash and appreciated property); fund makes grants to other charities over time. DAF sponsor has legal control; donor has advisory privilege. Recent legislation proposed addressing minimum distribution requirements for DAFs.

Key Terms:

• Private Inurement: Net earnings flowing to private benefit of insiders; automatic disqualification from 501(c)(3) status
• UBTI: Unrelated business taxable income; income from trade/business that is regularly carried on and not substantially related to exempt purpose
• Debt-Financed Property: Investment property acquired with borrowed funds; proportion of income attributable to debt is UBTI
• 5% Distribution Requirement: Private foundations must distribute at least 5% of net investment assets annually for qualifying distributions
• Self-Dealing: Transactions between a private foundation and a disqualified person (substantial contributor, manager, family); subject to excise tax
• DAF: Donor-advised fund; donor gets immediate deduction, fund makes grants over time; sponsor has legal control