Academic journal article Journal of Business and Entrepreneurship

A Further Look at the Unrelated Business Income Tax

Academic journal article Journal of Business and Entrepreneurship

A Further Look at the Unrelated Business Income Tax

Article excerpt


Small businesses appear to be increasingly concerned with competition from nonprofit organizations. They argue that because of government subsidies in general, and the Unrelated Business Income Tax in particular, nonprofits are being afforded a taxpayer supported competitive edge. This is not a new issue; it dates back to 1913, when the Sixteenth Amendment to the Constitution was ratified. However, the furor has tended to intensify as the number of nonprofit institutions grows. According to Cook (1990), there are now approximately 1.3 million nonprofits, with an estimated annual revenue of over $750 billion, or about 15% of the gross national product.


Nonprofit organizations are engaging in a growing number of activities that are increasingly being perceived by small business as unfair competition. A sampling of such ventures might well include: an apartment association for landlords offering for sale to its members preprinted lease forms and an owner's manual; a public university building its own lodging accommodations in order to expand its continuing education program; a state college changing its personnel policy so as to allow faculty members to own parts of companies started to produce and market their research developments; a bar associaiton administering an insurance program for its members; a fraternal organization offering hearing aids for sale; and a university marketing commercial software packages to the public at educational discount prices.

Specifically, there is concern that as government funding for social programs continues to decrease, nonprofit organizations (generally defined as those tax exempt charitable, educational, or other special purpose entities as delineated in sections 401(a) and 501(c) and (d) of the Internal Revenue Code) will continue to expand, using their tax-free status to give them a marketing advantage. For their part, nonprofits deny that they are doing, or plan to do, anything wrong, maintaining that such activities are truly related to their teaching and public service endeavors (Saunders, 1987).

The United States Treasury Department estimates that there are about 19 million small businesses in the United States. This represents a marked growth in the 1980s, and is especially significant as it is a result, in part, of a steady decline in the rate of business failures. This increased longevity is attributable in large measure to a number of determinants, which include relatively strong consumer spending, increases in United States exports, and a better understanding of the marketplace. The 1990s, however, might be another story. A changing work force, worldwide competition, economic slowdown, and the need for more highly skilled employees are among the factors which could result in comparatively difficult times for small business in this decade (Lilies, 1988).

Within this setting, the issue arises as to whether small business is being disadvantaged by nonprofits. Because of the tax advantage which they enjoy, it is alleged that, in a number of instances, nonprofits are pricing below for-profits and can thus accumulate earnings much faster, grow more quickly with less involved risk, and appear less vulnerable to bankruptcy. At the core of this conflict is the Unrelated Business Income Tax (UBIT), a tax on earned revenues from activities not associated with the basic mission of nonprofit organizations. It was enacted in 1950, codified as a part of the Internal Revenue statutes, and put into place as a mechanism to provide relief for what was seen as an unfair competitive advantage enjoyed by major nonprofit institutions. Because a number of organizations fell outside the scope of the original enactment, continuing criticism by small business resulted in the provisions of the tax being extended, in 1969, to include all nonprofit entities (Knight & Knight, 1987).

Four basic tests are provided for use in determining if revenue is unrelated business income, and thus subject to tax: (1) Is the organization engaged in a commercial venture? …

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