In search of profits: Measuring income from the unrelated commercial use of a tax-exempt organization's assets

Profits a tax-exempt organization earns from business activities that are n ot related to the organization's exempt purpose are subject to the unrelate d business income tax (UBIT), This paper shows that when the taxable and ta x-exempt activities are substitutes, taxable income exceeds the incremental pretax financial return from the unrelated business activity because the e xempt organization cannot deduct the opportunity cost of lost exempt functi on revenues when computing UBIT. As a result, the exempt organization may: (1) reduce or eliminate its unrelated business activity, or (2) change the way it uses its assets for unrelated business purposes by licensing the use of its assets to an unrelated taxable organization in exchange for nontaxa ble royalties, The model shows that although UBIT may distort the way in wh ich an exempt organization uses its assets, this distortion can increase so cial welfare.