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Unrelated Business Income

  • Your nonprofit might owe it

  • Too much and you can lose tax-exemption

Nonprofits often undertake business operations that supplement fundraising and other activities that are related to the organization's mission. While this is becoming more popular, nonprofit organizations must be careful not to expand those operations to a level where they jeopardize their nonprofit status.

First, what is unrelated income? Unrelated business income is generated by a business activity not substantially related to the exempt purpose of the organization and regularly carried out by the organization. Take for example a 501 (c) (3) science center that charges admission to tour the facility and review exhibits and demonstrations. The money from admission is related and therefore not subject to federal corporate tax. The science center also operates a restaurant in the facility with the profits used to fund the mission of the center. Even though the funds are used to support the nonprofit's mission, it is unrelated and subject to the unrelated business income tax. Generally, all 501(c) (3) organizations are subject to a tax on unrelated business income.

There are some activities that the IRS has ruled will not be subject to the unrelated business income tax:

  • activities in which almost all the work is handled by volunteers.

  • activities engaged primarily for the benefit of members, students, patients, officers or employees.

  • the sale of merchandise that has been donated to the nonprofit (thrift store).

  • the rental or exchange of mailing lists of donors or members.

  • the distribution of items worth less than $5 as incentives for donating funds (stamps, pre-printed mailing labels, etc.)

If unrelated business gross income is less than $1,000, it is not necessary to file an unrelated business tax return. See the instructions for Federal Form 990T.

Nonprofits need to be careful not to engage in activities that produce unrelated business income to an extent those activities take on a significant portion of the organization's overall activity. This can lead to the nonprofit losing its tax-exempt status. As a general rule, if the level of unrelated business activity uses more of a nonprofit's resources of time and effort than do exempt activities, it can loose tax-exempt status.

There are other considerations as well but no clear and defined rule so it is better to be safe than sorry and restrict unrelated business income to a level with which you and your tax and legal advisors are comfortable. In case you missed it, consult tax and legal advisors before embarking on activities that can produce substantial unrelated business income taxes.

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