CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, a tax-exempt organization recognized under IRC Section 501(c)(3), operates a gift shop that sells religious books, educational materials, and small souvenirs related to its charitable mission. The gift shop is open to the public and generates significant revenue. Which of the following statements is true regarding the income generated by the gift shop?
- AOnly income exceeding $1,000 from the gift shop is subject to UBIT, regardless of the items sold.
- BIncome from the sale of religious books and educational materials is generally not subject to UBIT, but souvenir sales may be.
- CAll income from the gift shop is exempt from UBIT because it is operated by a 501(c)(3) organization.
- DAll income from the gift shop is subject to Unrelated Business Income Tax (UBIT) because it competes with commercial retailers.
Show answer & explanationAnswer & explanation
Correct answer: B. Income from the sale of religious books and educational materials is generally not subject to UBIT, but souvenir sales may be.
Sales related to the organization's exempt purpose (educational materials) are generally not UBIT. Souvenir sales, especially if not substantially related, may be. The $1,000 threshold applies to net unrelated business income, not gross income from specific items.
Why the other options are wrong
- A. The $1,000 threshold is for the total net UBI, not a determinant for individual items' UBIT status.
- C. Operating a trade or business, even by an exempt organization, can trigger UBIT if unrelated to its exempt purpose.
- D. This is too broad; some sales may be related to the exempt purpose.
UBIT - Related vs. Unrelated Activity
Unrelated Business Income Tax (UBIT) applies to income from a trade or business regularly carried on by a tax-exempt organization that is not substantially related to its exempt purpose.
- An activity is 'substantially related' if it contributes importantly to the accomplishment of the organization's exempt purpose.
- The sale of items that enhance the organization's educational or religious mission is generally related.
- Souvenir sales may be unrelated unless they have a direct educational or promotional link to the exempt purpose.
Memory trick: Unrelated Business Isn't Tax-Exempt.