All organizations subject to UBIT, except trusts, are taxable at corporate rates on that income. All exempt trusts that are subject to these provisions, and that, if not exempt, would be taxable as trusts, are taxable at trust rates on unrelated business taxable income. However, an exempt trust may not claim the deduction for a personal exemption that is normally allowed to a trust.

An activity is an unrelated business (and subject to UBIT) if it meets three requirements:

1. It is a trade or business,
2. It is regularly carried on, and
3. It is not substantially related to the furtherance of the exempt purpose of the organization.

There are, however, a number of exclusions and modifications to this general rule.

The term "trade or business" generally includes any activity carried on for the production of income from selling goods or performing services. It is not limited to integrated aggregates of assets, activities, and goodwill that comprise businesses for purposes of certain other provisions of the Internal Revenue Code. Activities of producing or distributing goods or performing services from which gross income is derived do not lose their identity as trades or businesses merely because they are carried on within a larger framework of other activities that may, or may not, be related to the organization's exempt purposes.

Business activities of an exempt organization ordinarily are considered "regularly carried on" if they show a frequency and continuity, and are pursued in a manner similar to, comparable commercial activities of nonexempt organizations.

To determine if a business activity is "substantially related" requires examining the relationship between the activities that generate income and the accomplishment of the organization's exempt purpose. Trade or business is related to exempt purposes, in the statutory sense, only when the conduct of the business activities has causal relationship to achieving exempt purposes (other than through the production of income). The causal relationship must be substantial. The activities that generate the income must contribute importantly to accomplishing the organization's exempt purposes to be substantially related.

The Code contains a number of modifications, exclusions, and exceptions to unrelated business income. For example, dividends, interest, certain other investment income, royalties, certain rental income, certain income from research activities, and gains or losses from the disposition of property are excluded when computing unrelated business income. In addition, the following activities are specifically excluded from the definition of unrelated trade or business:

• Volunteer Labor - Any trade or business is excluded in which substantially all the work is performed for the organization without compensation. Some fund-raising activities, such as volunteer operated bake sales, may meet this exception.
• Convenience of Members - Any trade or business is excluded that is carried on by an organization described in section 501(c)(3) or by a governmental college or university primarily for the convenience of its members, students, patients, officers, or employees. A typical example of this is a school cafeteria.
• Selling Donated Merchandise - Any trade or business is excluded that consists of selling merchandise, substantially all of which the organization received as gifts or contributions. Many thrift shop operations of exempt organizations would meet this exception.

For a discussion of the special UBIT rules for organizations described in 501(c)(7), 501(c)(9), or 501(c)(17), see Unrelated Business Income Tax. For more information, download Publication 598, Tax on Unrelated Business Income of Exempt Organizations.

Source:  http://www.irs.gov/charities/article/0,,id=96104,00.html

Isn't it illegal for a nonprofit to run a for-profit business? What are the laws and regulations regarding the creation of nonprofit enterprises?  http://www.compasspoint.org/askgenie/details.php?id=40

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