CPA Exam — REG (Regulation)Federal Taxation of EntitiesHard
A client, a tax-exempt organization, operates a gift shop that sells religious merchandise and books related to its exempt purpose. The gift shop is open to the public and generates a significant profit. What is the tax treatment of the income from this gift shop?
- APartially taxable as UBI, limited to 20% of gross sales
- BTaxable as unrelated business income (UBI)
- CExempt from tax as it is substantially related to the organization's exempt purpose
- DTaxable only if total UBI exceeds $1,000,000
Show answer & explanationAnswer & explanation
Correct answer: C. Exempt from tax as it is substantially related to the organization's exempt purpose
The sale of religious merchandise and books that are related to an organization's exempt purpose is generally considered substantially related to that purpose and thus is not unrelated business income. The fact that it's open to the public and generates a profit does not automatically make it UBI if the activity itself is related to the exempt function.
Why the other options are wrong
- A. Incorrect. There is no such percentage limitation for UBI determination in this context.
- B. Incorrect. The activity is related to the organization's exempt purpose.
- D. Incorrect. The $1,000 UBI deduction applies, but not a $1,000,000 threshold for taxability.
UBI - Related Business Activity
Income from a trade or business activity conducted by an exempt organization is not UBI if the activity is substantially related to the organization's exempt purpose.
- Substantially related means it contributes importantly to the exempt purpose
- Sales of items that further the exempt purpose (e.g., museum gift shop selling art reproductions) are generally exempt
- Convenience exception for members/patients/employees
Memory trick: UBI: Trade, regularly, not related – three steps to be hated (taxed).