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§ 3.5 UNRELATED BUSINESS RULESthat is funded from one source (usually, one individual, family, or corporation),that receives its ongoing funding from investment income (rather than a consistentflow of charitable contributions), and that makes grants for charitable purposesto other persons rather than conducting its own programs.§ 3.5 UNRELATED BUSINESS RULESThe unrelated business income rules that are applicable to charitable and othertax-exempt organizations were enacted in 1950, were significantly enhanced in1969, 443 and have been augmented by nearly every subsequent tax act. The objectiveof these rules is to prevent unfair competition between tax-exempt organizationsand for-profit, commercial enterprises. 444 The rules are intended to placethe unrelated business activities of a tax-exempt organization on the same taxbasis as the nonexempt business with which it competes.(a) IntroductionPrior to enactment of the unrelated income rules, the federal law embodied thedestination of income test. 445 Pursuant to this standard, the law merely requiredthat the net profits of organizations be used in furtherance of exempt purposes.That is, the test did not consider the source of the profits, thereby toleratingforms of unfair competition. Thus, in adopting and expanding these rules, Congresshas not prohibited commercial ventures by nonprofit organizations.Rather, it struck a balance, as the U.S. Supreme Court characterized the matter,between “its two objectives of encouraging benevolent enterprise and restrainingunfair competition.” 446Essentially, for an activity of a tax-exempt organization to be subject to tax,four tests must be satisfied. The activity must:1. Constitute a trade or business,2. Be regularly carried on,3. Not be substantially related to the tax-exempt purposes of the organization,and4. Not be specifically exempted (or have the income from the activity specificallyexempted) from taxation. 447Nearly all types of tax-exempt organizations, including charitable ones, aresubject to the unrelated income rules. 448 The unrelated income rules are also applicable“in the case of any college or university which is an agency or instrumentalityof any government or any political subdivision thereof, or which is owned oroperated by a government or any political subdivision thereof, or by any agencyor instrumentality of one or more governments or political subdivisions,” as well443 IRC §§ 511–514.444 Reg. § 1.513-1(b).445 The test is discussed in Tax-Exempt Organizations § 25.1.446 United States v. American College of Physicians, 475 U.S. 834 (1986).447 Reg. § 1.513-1(a).448 IRC § 511(a)(2)(A). 115