Nonprofit Unrelated Business Income
The question concerns nonprofits receiving income from business activities. How much income can they receive from related activities before they lose their status. Also, how much from unrelated activities before they lose their status. There are at least two scenarios, one when a nonprofit has an actual business it is running, and another where they are receiving income from the sales of related goods, and then unrelated goods.
First, the IRS defines UBIT (Unrelated Business Income which is taxable to a non-profit) as income derived from:
“(1) a trade or business, (2) regularly carried on, and (3) not substantially related to furthering the exempt purpose of the organization.”
The first two requirements are obvious, it must be an ongoing business to be taxable (a one time bake sale would not be, but opening a pie shop that is open five days a week probably would be) the last of the three is the nuanced piece of the picture. What is related to furthering the purpose of the organization? This question becomes very complex, one of my favorite examples is that of a museum with a gift shop. A good case could be made that certain items that the gift shop sells do further its purpose as a non-profit (to educate and inform the public). Perhaps an educational game, or book on history. On the other hand, the candy the shop sells is obviously not related to its primary purpose. When engaged in ongoing business activities as a non-profit it is always wise to get the opinion of a professional on the tax-ability of the income. (There are numerous exclusions to the UBIT rules as well)
Now, regarding how much income a non-profit can derive from activities classified as UBIT before the IRS revokes the 501 status. The IRS is unclear on this issue, some believe it has been intentionally unclear due to the general ambiguity of the 501 status in tax law, others believe it is simply because it makes those who run non-profits more cautious in how they run the organizations. In either case, a reasonably safe rule of thumb to follow is to not allow gross UBIT to exceed 10% of the entities income from all sources. Of course, this number doesn’t matter if the only business type transactions a non-profit has are those which are “substantially related to furthering the exempt purpose of the organization”. (Run the non-profit as it was originally setup and in the pursuit of what it originally set out to accomplish and this should never be an issue!)
Rockwell R. Carr CPA
Office Email. CarrCPAS@gmail.com
Office phone. 505.891.2277
Any US tax advice contained in the body of this article was not intended or written to be used, and cannot be used, by the reader for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.
Always consult with a tax professional, or other appropriate professional, about your specific situation before making any final decisions.