UBIT and Universities: Inside and Outside the Educational Purpose, Should Universities Face Taxation on Real Estate Holdings?

by Judith Peck

AbstractThe Unrelated Business Income Tax (UBIT) is imposed on the income of nonprofit

organizations when this income is generated by businesses unrelated to the purpose of the

organization. The Internal Revenue Service defines unrelated business income as income that:

1) is in a trade or business, 2) is regularly carried on, and 3) is not substantially related to

furthering the exempt purpose of the organization. Once a nonprofit business meets these three

conditions, the income generated by the nonprofit business is taxable.

Nonprofit organizations are generally exempt from tax under I.R.C. § 501(c)(3).

Universities qualify as nonprofit organizations. UBIT applies to universities under I.R.C. §

511(a)(2)(B). Universities are restricted by UBIT as to what type of income can retain this tax

exempt status. A regularly carried on business that is unrelated to the purpose of the university

will be taxed. However, it is not always easy to determine if a university’s activities fall within

the exemption or are subject to UBIT taxation.

When a university ventures into an unrelated business, then the income generated from

this unrelated business is taxable. Recently, universities have ventured into businesses that may

or may not be defined as related to the purposes of the universities. Examples include; alumni

condominiums, public restaurants, bookstores, and child care facilities.

The exemption under UBIT is particularly relevant when universities step into the

business of real estate because the university has the ability to deduct income and property taxes.

1

For profit businesses with the same real estate holdings would pay both income and property tax.

Real estate holdings potentially generate substantial opportunities for taxation or exemption.

A simple solution to taxation on university real estate holdings is fragmentation. Thus,

the university should be able to maximize its tax exemptions derived from our tax laws. At the

same time our government receives taxes when the UBIT requirements are met. Public policy

encourages exemptions for our educational entities, for much of our hope for the future lies in

the education of our youth. On the other hand, taxes fund our governmental services. In fact

some taxes collected find their way back to the educational system through government funds.

Should a university enter the real estate market? Yes, but only if the university can

clearly differentiate which income from the property falls inside and outside the educational

purposes of the institution.

Table of Contents

I. OUR TAX SYSTEM AND NONPROFIT ORGANIZATIONS...........................................................3A. TAXATION V. EXEMPTION.................................................................................................... 4B. NONPROFIT ORGANIZATIONS................................................................................................ 4C. UBIT.................................................................................................................................... 4

II. THE HISTORY OF UBIT......................................................................................................... 6

III. THE UBIT AND UNIVERSITIES............................................................................................. 9A. OUTSIDE THE UNIVERSITY’S PURPOSE..................................................................................9

1. It is a trade or business.................................................................................................... 102. It is regularly carried on.................................................................................................. 103. It is not substantially related to furthering the exempt purpose of the organization.........10

B. INSIDE THE UNIVERSITY’S PURPOSE...................................................................................111. It is not a trade or business.............................................................................................. 112. It is not regularly carried on............................................................................................ 113. It is substantially related to furthering the exempt purpose of the organization...............11

IV. FRAGMENTING UBIT INCOME........................................................................................ 11

V. FRAGMENTING UNIVERSITY REAL PROPERTY INCOME.....................................................14A. UNIVERSITY ALUMNI CONDOS...........................................................................................14

2

B. UNIVERSITY RESTAURANTS................................................................................................ 16C. UNIVERSITY BOOKSTORES.................................................................................................. 18D. UNIVERSITY CHILD CARE FACILITIES.................................................................................19

VI. Conclusion........................................................................................................................... 19"No government can exist without taxation. This money must necessarily be levied on the people; and the grand art consists of levying so as not to oppress.''1

Our nation was founded on ideals of justice, fairness, and equality. These principles have

guided both the creation and the application of our laws, including our tax laws. From the very

birth of our country, taxation has been at the foundation of our sense of justice. Eliminating

unfair taxation was at the heart of many of the revolutionaries who established our nation. Even

today, Americans want to believe that our system of taxation is fair. This goal of fairness

satisfies the taxpayer’s desire for justice.

I. OUR TAX SYSTEM AND NONPROFIT ORGANIZATIONS Our government is funded through tax revenues. Without taxation, our government

would not be able to provide basic community services, such as schools and roads. Thus,

taxation is necessary to our form of government. James Madison stated, "The power of taxing

people and their property is essential to the very existence of government.''2 Although our tax

system is essential, it is not always simple. Even Albert Einstein found tax difficult stating,

“This is too difficult for a mathematician. It takes a philosopher.”3 Difficulty, however, is no

excuse for failing to do our best in understanding and applying our tax system.

A. TAXATION V. EXEMPTION Fundamentally, taxes involve money. People do not want to part with money without

good cause. Our tax system need not be perfect, but it should strive to be just and fair. Taxation

1 Frederick the Great, 18th Century Prussian King, http://www.irs.gov/newsroom/article/0,,id=110483,00.html.2 James Madison, 4th U.S. President, http://www.irs.gov/newsroom/article/0,,id=110483,00.html.3 Albert Einstein, http://www.cornerstoneexchange.com/quotes.htm.

3

involves more than mere numbers, it involves philosophy through public policy. Tax only

enough to fund the government, and leave the rest of the money in the hands of the people.

Thus, a fine line is created between taxable entities and exempt organizations.

B. NONPROFIT ORGANIZATIONSNonprofit organization charities are granted an exemption from income tax through

I.R.C. § 501(c)(3).4 In order to qualify as nonprofit under this code5, an organization must:

1) Be organized and operated exclusively for a tax exempt purpose.

2) Not allow earnings to inure to shareholders.

3) Not participate in political activities.

C. UBITThe UBIT was created to help refine the line between taxation and exemption.6 In order

to understand why we have the UBIT, it is necessary to first recognize why nonprofit

organizations have a unique tax status. Nonprofits serve our communities in a variety of ways by

providing services that benefit our society. This paper specifically explores universities which

provide educational opportunities. Universities qualify as nonprofit organizations.7 Taxing these

nonprofit organizations only takes away from the benefits that they are able to provide. Thus, to

maximize these benefits to our society, nonprofits, including universities, are allowed exemption

from taxation.

Public policy is served through encouraging education. Society wants people to be

educated in many areas, including law, medicine, and science. Universities must have funds

4 I.R.C. § 501(c)(3).5 Id.6 ROBERT R. STATHAM & RICHARD W. BUEK, ASSOCIATIONS AND THE TAX LAWS 42-80 (Chamber of Commerce of the United States, 1978).7 I.R.C. § 501(c)(3).

4

available for scholarships, new technologies, and research. When universities are taxed, funds

for the educational purposes are diminished.

However, it is also important that these nonprofit organizations stay within the purposes

that serve public policy. One way a nonprofit organization may step outside the boundaries of

its purposes is by running an unrelated business. If a nonprofit organization begins an unrelated

business, this brings into question whether or not the nonprofit purpose is actually being

furthered.

Nonprofit organizations do not retain tax exempt status because the government is

generous, or even because helping others through charity makes us feel like better people.

Nonprofits are tax exempt because this exemption serves public policy. The theory is that

nonprofit organizations provide services that would otherwise go unfulfilled unless the

government became the provider. Of course, any new government service would require

funding from tax dollars. This would lead to an increase in taxes.

Another concern with nonprofit organizations entering unrelated businesses is unfair

competition. A nonprofit organization could reinvest all profits back into the organization itself.

A for profit business cannot reinvest all profits, some profits must be used to pay taxes. This

situation presents the opportunity for an unfair advantage for nonprofit organization over a for

profit business.

Societal interests are best served when nonprofit organizations are tax exempt and for

profit businesses are taxed. The UBIT was created to ensure this sense of fairness in our tax

system. However, the UBIT is open to interpretation, and sometimes the line between

exemption and taxation is blurred.

5

II. THE HISTORY OF UBITThe UBIT has not always been a part of our tax system. Until 1950, nonprofit

organizations did not have specific guidance on the taxation or exemption status of an unrelated

business. At that time, nonprofit organizations risked their entire tax exempt status when they

entered an unrelated business. Simply put, it was all taxation or all exemption. The UBIT was

enacted in response to several cases involving nonprofit organizations involved in unrelated

business.

Nonprofit organizations must obtain funds in order to operate. Many times, these funds

come from donations. However, nonprofit organizations have looked for other ways to obtain

funds.

In Trinidad v. Sagrada Orden de Predicadores,8 a religious nonprofit organization found

a way to create its own income. The religious organization sold chocolates and wine for a profit.

These profits were used to further the purposes of the organization. In that case, the Supreme

Court held that the means of obtaining the funds was inconsequential in determining tax

exemptions. The important matter was where the funds were to be used. Thus, as long as the

funds furthered the purpose of the organization, the funds were tax exempt even though they

came from an unrelated business.

A few years later in 1938, the Second Circuit reaffirmed this idea in Roche’s Beach, Inc.

v. Commissioner.9 That case involved a nonprofit organization that cared for the poor.10 To

obtain funds, the organization started a business selling umbrellas, food, and drink to

8 263 U.S. 578 (1924).9 96 F.2d 776 (2d Cir. 1938).10 Id.

6

beachgoers.11 The income from this business was used to help the poor.12 Since the funds were

used for charity, they were tax exempt. It did not matter that the funds came from an unrelated

business.

New York University School of Law ran an unrelated business to generate funds for the

law school.13 In 1947, NYU School of Law became the proud owner of a spaghetti factory.

While this might seem an odd investment, the spaghetti deal proved very lucrative.14 In fact,

much of the university law school’s success in the late 1940s can be attributed to spaghetti.15

The law school received well over six figures in profit each year, and $67 million on the sale of

the spaghetti factory.16 The law school was able to build a new academic building, new student

housing, and increase professor salaries.17 These improvements greatly contributed to NYU’s

prestige as a law school. The law school was well within the laws concerning funding the school

from an unrelated business. It was the destination of the funds from the unrelated business that

mattered, and no one questioned whether the law school was furthering its educational purposes

with the spaghetti funds. The funds were spent to enhance the educational environment, thus the

funds were tax exempt under the Sagrada theory.

Although the university had academic goals in mind when it acquired the spaghetti

factory, should that be enough? What would prevent universities across the nation from

acquiring a variety of businesses in order to fund their own academic goals? Since the only

11 Id.12 Id.13 John Brooks, The Marts of Trade: The Law School and The Noodle Factory (1977), reprinted in NICHOLAS P. CAFARDI & JACLYN FABEAN CHERRY, TAX EXEMPT ORGANIZATIONS: CASES AND MATERIALS 815-897 (2nd. ed. 2008).14 Id.15 Id.16 Id.17 Id.

7

restraint on maintaining tax exemption was that the funds from the unrelated business be used

within the purpose of the university, the universities could own any kind of business as long as

the income was funneled back to the university for educational purposes. Each business that was

acquired by a university would thus effectively be taken out of the taxpaying base.

Our government is funded through tax dollars. Universities are nonprofit organizations

that are not paying tax. Thus, income from a university spaghetti factory would not provide our

government with funding. On the other hand a private spaghetti factory would pay tax to our

government. So, the government was losing money every time a university acquired an unrelated

business, i.e. spaghetti factory.

It is not enough that the educational purposes were furthered with the funds from the

unrelated businesses. The tax exemption for nonprofit organizations was not intended to create

university spaghetti moguls. While the public policy wants our universities to succeed in their

educational purposes, this does not outweigh the societal interest in funding our government.

Congress recognized this loophole allowed by the Sagrada theory of nonprofit

exemptions. In order to prevent nonprofits from taking advantage of this loophole, the UBIT was

enacted. The Internal Revenue Code defines the requirements of the UBIT for nonprofit

organizations under three conditions; 1) is trade or business, 2) is regularly carried on, and 3) is

not substantially related to furthering the exempt purpose of the organization.18

III. THE UBIT AND UNIVERSITIES

“The tax which will be paid for education is not more than the thousand part of what will be paid if we leave the people in ignorance.” President Thomas Jefferson19

18 I.R.C. § 13; see also I.R.S. Pub. No. 598 (Nov. 2007).19 President Thomas Jefferson, http://www.taxanalysts.com/www/freefiles.nsf/Files/Yablon.pdf/$file/Yablon.pdf.

8

Universities must follow the UBIT.20 Most universities strive to adhere to the laws of our

nation.21 This does not prevent universities from seeking to maximize the benefit of their

nonprofit status. Thus, a prudent university will find ways to increase income while still

following our tax code. This has been true for many decades. Before the UBIT was enacted,

NYU legally received money from the spaghetti business. Prior to UBIT, universities bought

several different businesses in order to gain income, including gas stations, an airport, and a

cattle ranch.22 Still today universities seek to gain tax exempt income wherever possible.23

A. OUTSIDE THE UNIVERSITY’S PURPOSEThe UBIT provides a three prong test for determining the tax status of a nonprofit

organization’s unrelated business.24

1. It is a trade or business A “trade or business” is any activity carried on for the production of income from the

sale of goods or the provision of services.25 The Supreme Court examined this definition in

United States v. American College of Physicians.26 The court stated that each business must be

examined on its own.27 In that case advertising within a medical journal was found to be outside

the purpose of the nonprofit organization.28 Even though a business might appear to fit within

20 I.R.C. § 511(a)(2)(B).21 American Council On Education and Others Respond to Treasury Proposals to Ways and Means Oversight Subcommittee on UBIT Revisions, 87 Tax Analyst, Tax Notes Today, 167-36.22 Michael S. Knoll, The UBIT: Leveling an Uneven Playing Field or Tilting a Level One?, 76 FORDHAM L. REV. 857 (2007).23 Bittker and Lokken, FED. TAX'N INCOME, EST.& GIFTS ¶ 103.3(2008).24 I.R.C. § 513(a).25 I.R.C. § 513(c).26 475 U.S. 834 (1986).27 Id. at 83628 Id.

9

the broader purposes of the nonprofit, an examination of the individual business and its purpose

was necessary.

2. It is regularly carried onOregon State University Alumni Ass'n., Inc. v. C.I.R. determined that royalties from

credit card was not in competition with other business.29 In that case, the university’s minimal

involvement in the credit card solicitations was not enough involvement to meet the

requirements of the UBIT.30 There must be more than occasional business transactions in order

to be considered “regularly carried on.”

3. It is not substantially related to furthering the exempt purpose of the organization

Henry E. & Nancy Horton Bartels Trust For Ben. of University of New Haven v. U.S.

examined whether a trust fund created to benefit the university was substantially related to the

university’s purpose.31 In that case the funds used to create the trust came from borrowed money.

The court determined that the university purposes were not furthered by borrowing money to

make money.32

B. INSIDE THE UNIVERSITY’S PURPOSEFortunately, the I.R.S. has provided guidance as to what falls within university purposes

and thus remains tax exempt.33

29 T.C. Memo. 1996-34, 1996 WL 33213, U.S.Tax Ct.,1996.30 Id.31 209 F.3d 147 (2d Cir. 2000).32 Id. at 148.33 Michael A. Rosenhouse, Annotation, When Will Income of Tax-Exempt Organization Be Deemed Income from Unrelated Trade or Business Taxable Under §§ 511 to 513 of Internal Revenue Code (26 U.S.C.A. §§ 511 to 513), 199 A.L.R. Fed. 591 (2005).

10

1. It is not a trade or businessFor example, rock concerts and sporting events held at university campuses by outside

promoters are not considered a trade or business that furthers the purpose of the university.34

2. It is not regularly carried onVending machines that are maintained by an outside service company are not considered

to be “regularly carried on.”35 Thus, the UBIT requirement is not met and the university does not

have to pay tax on this form of income.

3. It is substantially related to furthering the exempt purpose of the organizationRevenue Ruling 76-33 sets out the taxation rules for nonprofit universities and the

unrelated income from the rental of dormitory facilities and provides a starting point for existing

rules as how to treat university owned housing that is rented for income.36

IV. FRAGMENTING UBIT INCOME

The complexities of the UBIT must be addressed. The UBIT focuses on our societal need

for a sense of fairness in our tax system. The tax system needs to achieve a believable sense of

fairness. Simply put, we must use our best effort in the attempt to achieve a sense of fairness.

Otherwise, nonprofits will feel that they are carrying too heavy a tax burden, while at the same

time for profits will feel that they are carrying too heavy a tax burden. The lack of fairness

creates resentment.

The UBIT debate pits for-profit organizations, primarilyrepresenting small business, against an array of tax-exemptorganizations ranging from hospitals to universities. Small businesshas taken the offensive position, arguing for a tax remedy that woulddrastically scale down, if not eliminate, the edge held by tax-exemptentities engaging in competing business activities. The tax-exempt

34 Streckfus, Paul, IRS'S Owens Briefs Universities on Tax Liabilities, 93 Tax Analyst, Tax Notes Today, 233-7.35 2001 Tax Analyst, Tax Notes Today, 192-9.36 Rev. Rul. 76-33, 1976-1 C.B. 169.

11

organizations have countered by noting the disappearance of manytraditional funding sources and the subsequent need for tax-exemptsto branch out. It is a struggle not between a David and a Goliath butbetween two Davids.37

A system of fragmentation within the UBIT is necessary. We want nonprofit

organizations to continue serving our communities with tax exempt funds. We also want for

profit enterprises to continue to fund our government through tax dollars. The nonprofit sector

and the for profit sector do not have to be mutually exclusive of one another. Fragmenting

university income from real estate holdings presents a fair solution to this problem.

So, when the question arises as to whether a university should deal in real estate holding,

the answer is yes as long as there is fragmentation. Fragmentation can be accomplished through

rather simple means. Indeed, this is not the first time that our tax system has dealt with

fragmentation.

The following text explains one author’s approach to fragmenting the sales of a nonprofit

organization’s gift shop:

Apply UBIT to income from sale of gift shop items except income from (1) on-premise sales of low-cost mementos (such as memorabilia and souvenirs); (2) sale of any article of an educational nature purchased at an on-premise gift shop which relates to the organization visited; (3) sale of guides to the organization's exhibits, events or facilities; and, (4) the sale of articles purchased from an on-premise hospital gift shop of a nature generally used by or for inpatients of the hospital. 38

Table 1 sets forth guidelines for museums that would provide for the fragmentation of

unrelated business income. In fact, the fragmentation provides a detailed example of when the

UBIT applies. If the museum has a dinosaur display about triceratops, then books on triceratops

would be exempt. However, a book that includes all dinosaurs generally would be taxed. If this

37 House Oversight Subcommittee Ubit Proposals Elicit Cautious Reaction, 88 Tax Analyst, Tax Notes Today, 78-1.38 List of Recommendations on the Unrelated Business Income Tax for the Consideration of the House Ways and Means Oversight Subcommittee, 88 Tax Analyst, Tax Notes Today, 71-7

12

level of detail is applied in the museum setting, then the same level could be applied in the

university setting. Fragmentation of university income is not only possible, it is plausible.

Table 1. Museum Unrelated Business

UBIT would not apply to: UBIT would apply to:

-income from a paperweight, key chain, or other low-cost memento of the visit to the exempt organization's facility.

-income from the sale of a bookmark, tote bag, or other item with the museum's name imprinted that indicates a visit to the museum.

-sales of museum publications about its own photography collection or Van Gogh exhibit or miniature replica of a museum's collection of furniture.

-income from the sale of all hospital gift shop items such as flowers, loungewear, greeting cards, and candy.

-income from a museum shop sale of a general art history book and sale of furniture sold by a private foundation for a historical landmark.

V. FRAGMENTING UNIVERSITY REAL PROPERTY INCOME Universities have dealt in real property for many years. Recently, the real property

holdings have developed into new ways to create income. Thus, we must decide what should be

taxed and what should remain exempt.

13

A. UNIVERSITY ALUMNI CONDOSRecently, the University of Michigan built condos for its alumni.39 Other universities are

also joining this trend.40 This calls into question whether condos for alumni further the

educational purposes of the university. Having university alumni around could enhance the

educational atmosphere because these alumni would presumably because these alumni would

bring a wealth of knowledge when interacting with the student body. However, the university’s

purpose is not to provide housing for alumni. The university has an educational purpose. The

question is whether alumni condos fit within the educational purpose. Student housing is

appropriately owned by the university because students are in the process of pursuing a degree at

the university.

Alumni living on campus could serve an education purpose. Alumni would have

knowledge and experience that could be shared with students. The interaction between alumni

and students would fall under the educational purpose of the university. However, there would

need to be limitations on qualifying alumni housing.

Universities might intend to fill alumni condos with alumni, but what happens when not

enough alumni are interested? The university will likely allow non alumni in the condos. At

what point are there too few alumni to satisfy the educational purpose? There must be a breaking

point at which the condos filled with non alumni should not qualify for an exemption under the

UBIT.

Alumni condos would need to be within a reasonable distance of the university campus

in order to facilitate alumni and student interaction. University condos built 10 miles from the 39 Associated Press, Alumni Return to College Towns for Retirement, MSNBC, March 17, 2005, http://www.msnbc.msn.com/id/7193144 .40 Lisa Belkin, Alumni Condos on Campus, N.Y. Times, March 5, 2006, available at http://www.nytimes.com/2006/03/05/magazine/305speculator.1-1.html.

14

campus would not likely induce interaction between alumni and students. The question is what

distance is reasonable to facilitate this interaction. This might be decided on a case by case basis.

A university with a sprawling campus might reasonably build condos further away than a

university with a compact campus.

Alumni would need to spend a reasonable amount of time living in the condo in order to

facilitate interaction with students. Some alumni might purchase the condo as a second home,

and thus maintain a part time residence. This could still meet the educational purpose. However,

what if alumni only stay on campus a short time each year? Does this meet the educational

purpose? Probably not, if the alumni are on campus only for a few short weekends each year.

At Texas Tech University, developers (not the university) plan to build condos alumni

and students.41 The developers expect some of the condos purchased by alumni to be used as a

place to stay on football game weekends.42 Although this example is not university owned,

university alumni condos could be purchased for this same use. Thus, in order to meet the

education purpose, alumni condos should require a minimum use time. Table 2 provides

examples of possible limitations.

41 http://www.lubbockonline.com/stories/121006/bus_121006015.shtml.42 Id.

15

Table 2. University Unrelated Business, Alumni Condos

UBIT would not apply to: UBIT would apply to:

-housing comprised of 75% or higher university alumni residents.

-housing within 3 miles of the university campus areas.

-live in the condo 6 months or more a year

-housing comprised of less than 75% university alumni residents.

-housing further than 3 miles from the university campus areas.

-live in the condo less than 6 months a year

B. UNIVERSITY RESTAURANTSAnother current issue involves a nonprofit organization going into the restaurant business

in New York City.43 This brings into question whether nonprofits in an unrelated business have

an unfair advantage over for profit entities.44 This is another example of current university

ventures into unrelated business or trade.

Restaurants operated by a nonprofit organization remain exempt from tax when

“substantially related” to the nonprofit’s purpose.45 “The operation of a dining room, cafeteria,

and snack bar by an exempt art museum for use by the museum staff, employees, and members

of the public visiting the museum does not constitute an unrelated trade or business activity.46”

Thus, a university restaurant used by university patrons should remain tax exempt. However, not

all university restaurants have only university patrons. When income is received from university

and non university patrons, some income should be exempt and some should be taxed.

43 Michael S. Knoll, The UBIT: Leveling an Uneven Playing Field or Tilting a Level One?, 76 FORDHAM L. REV. 857 (2007).44 Id.45 Rev. Rul. 74-399, 1974-2 C.B. 172.46 Id.

16

How do we fragment a nonprofit restaurant? Similar to the list above for gift shops, we

could create a list of taxable and exempt income. The location of the restaurant should be taken

into account. A location in the heart of campus would seem to serve mainly university patrons,

thus serving a university interest. A location on a busy street on the outskirts of campus would

naturally bring in patrons from outside the university.

A percentage of the profits could be attributed to the university patrons and a percentage

could be attributed to outside patrons. The income generated from these outside patrons would

be taxable. University patrons could identify themselves through a swipe of a university identity

card. Table 3 provides examples of possible limitations.

Table 3. University Unrelated Business, Restaurants

UBIT would not apply to: UBIT would apply to:

-restaurants with no storefront visible from non campus areas

-restaurants with storefront visible from non campus areas: income from percentage of university patrons (students, faculty, staff).

-restaurants with storefront visible from non campus areas: income from percentage of non university patrons

OR OR

-all income generated by the restaurant when 65 percent or more of the patrons are university patrons

-all income generated by the restaurant when less than 35 percent of the patrons are university patrons

17

C. UNIVERSITY BOOKSTORESUBIT application to university bookstores has been addressed in Tax Notes Today.47 To

determine whether the bookstore income is “substantially related” to the purpose of the

university, convenience is considered.48 If the business itself is unrelated to the nonprofit

purpose, the UBIT applies. However, there is an exception when the business is for the

convenience of the nonprofit organization.

A bookstore on the campus of the University of Oklahoma provides books and items for

the convenience of university patrons. However, not all patrons are university patrons. The

location of this bookstore is in the concourse area of the university football stadium. This

bookstore also serves non university patrons on football game days. The bookstore offers

clothing, jewelry, and gifts. Although support of the university football team is important,

selling team trinkets does not contribute to the educational purpose of the university.

Textbooks purchased by university students should be exempt. Sweatshirts purchased by

football fans should not be exempt. The income generated by this bookstore should be

fragmented. Table 4 provides examples of possible limitations.

Table 4. University Unrelated Business, Bookstores

UBIT would not apply to: UBIT would apply to:

-textbooks

-books and items provided for the convenience of university patrons

- books and items not related to the educational purpose that are not provided for the convenience of university patrons

47 Parker, Byron A., Dillon, Randy, KPMG Peat Marwick, Schools Anxious About Proposed Examination Guidelines, Says Peat Marwick, 93 Tax Analyst, Tax Notes Today, 62-32.48 Id.

18

D. UNIVERSITY CHILD CARE FACILITIESChild care facilities located on a university campus are a “convenience” for university

students, faculty, and staff. Child care is not substantially related to the educational purpose of

the university. This is a business unrelated to the educational purpose unless the facility is used

as a teaching tool for students studying early childhood education. However, since child care is a

convenience for university patrons, it should be exempt.

If the facility is not used as a teaching tool, it is subject to UBIT. The income generated

from caring for children of university student, faculty or staff should be exempt. The income

generated from caring for children of non university patrons should be taxed. Table 5 provides

examples of possible limitations.

Table 5. University Unrelated Business, Child Care Facilities

UBIT would not apply to: UBIT would apply to:

-children of university students, faculty, and staff

- children of non university patrons

VI. CONCLUSION

Determining where the UBIT applies in university real estate holdings is necessary in

order to maintain a sense of fairness in our tax system. As three authors in Tax Notes Today

state, “…Guidelines can serve as an important educational device to the tax-exempt community

if issues are clearly stated, if objective criteria can be utilized to the greatest extent possible, and

if the positions expressed comport more closely to the statutes and regulations.49”

When a nonprofit organization operates an income-producing business, it is important to

determine whether this income should be taxed. In order to increase the funds available for

49 Id.19

nonprofit organizations (to further purposes that serve the greater good), public policy approves

the tax exempt status of nonprofit organizations.50 On the other hand, the public interest is also

served by our tax-funded government. Without the collection of taxes, our government would

lack operational funds. Thus, we must balance the need to collect taxes with the need of

nonprofit organizations to retain funds for purposes that serve societal interests.

These unrelated university businesses must be considered when allowing tax exemptions

for nonprofit organizations. Taxpaying businesses could suffer a disadvantage when forced to

compete with tax exempt businesses.51 Unrelated university businesses should not be tax exempt.

If these university businesses, that are unrelated to the purposes of the university, compete with

taxed for profit businesses, then university businesses would receive an unfair economic

advantage through tax law.52

Specifically, when universities venture into real property, tax exemptions are magnified

because nonprofits are exempt from property tax. So, not only do other businesses suffer

economic disadvantages, but local governments also lose out on property tax income.

Consequently, it is imperative that each university unrelated business is evaluated under

the UBIT. A determination of what falls inside and outside the university’s purpose is essential.

Since many university businesses encompass both related and unrelated purposes, fragmenting

the taxable and tax exempt portions of the business allows fair competition and necessary

taxation.

50 Henry B. Hansmann, The Role of the Nonprofit Enterprise, 89 YALE L.J. 835, 838 (1980).51 John D. Colombo, Commercial Activity and Charitable Tax Exemption, 44 WM. & MARY L. REV. 487 (2002).52 Boris I. Bittker, The Exemption of Nonprofit Organizations from Federal Income Taxation, 85 Yale L.J. 299, 301 (1976).

20