Like other nonprofits, your organization probably has searched for new sources of revenue during the recession and economic slump. Hopefully, though, you haven’t run into problems accumulating too much unrelated business income (UBI). That kind of green can subject your nonprofit to taxes — and even threaten your tax-exempt status.
Here’s what to watch out for going forward on the UBI front.
The IRS defines UBI
According to the IRS, an activity generally is an unrelated business and its income, therefore, is subject to UBI tax if the activity is a trade or business carried on regularly, and not substantially related to furthering your nonprofit’s exempt purpose. Typically, all three factors must exist for the income to be considered UBI.
Certain product sales count
The types of activities that can generate UBI often are activities that you might consider fundraising. For example, the IRS counts as UBI the sale of products that are unrelated to your purpose. Examples might include sales from a park restaurant or a museum gift shop.
To determine if the revenue is UBI, the IRS suggests that you ask: 1) Are you regularly — that is, frequently and continually — selling the goods to make a profit? and 2) would a for-profit organization want to carry on this kind of activity?
If you answer “yes” to these questions, you’ll likely need to report the income from the activity as UBI.
Ad space revenue is UBI, too
Do you sell ad space in your organization’s journal, magazine or newsletter or on its website? Language that induces the reader to buy or use a product or service typically is considered advertising — for instance, a description of the product’s or service’s quality or a favorable comparison to a similar product or service. And the income from that activity is considered UBI. On the other hand, a brief acknowledgment — listing, for instance, the supporter’s name and logo in a program — probably isn’t advertising, but rather is sponsorship and considered a donation.
Selling unrelated services also matters
Let’s say that an organization owns a parking lot and opens it regularly to the general public. The parking fee income collected from the lot is taxable. That’s because the activity — charging a fee for public parking — isn’t substantially related to the not-for-profit’s exempt purpose. But, if only members and visitors use the parking lot while participating in the organization’s activities, the parking fee income isn’t taxable.
Income from certain investments, from selling membership lists and from gaming activities (see below) also can produce UBI.
Exceptions to the rules exist
There are many exceptions to the rules — for instance, when your volunteers run the activity. According to the IRS, income from any trade or business where uncompensated volunteers perform a substantial amount of the work is exempt from UBI tax.
A transaction’s structure also can exclude the resulting income from taxation. While being paid to directly promote products compatible with your mission probably will result in UBI, receiving royalties for licensing others to use your name or logo to promote such products may avoid it.
Other situations in which your nonprofit’s income may be exempt from tax include the sale of merchandise that’s largely donated, such as in a book sale, or activities related to a convention, trade show or annual meeting. See IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations, for more exemptions.
Gaming is ticklish
The revenue from charitable gaming activities is usually considered UBI and is subject to tax — with the exception of traditional bingo. Newer forms of bingo generally don’t qualify for the tax exception, including scratch-off and pull-tab games. Also, to be eligible for the exception, the wagers must be placed, winners must be determined and prizes must be awarded while all players are present.
Report UBI carefully
All 501(c)(3) organizations should be aware of what is considered unrelated business income. UBI can be a good source of revenue as long as it doesn’t overshadow your nonprofit’s exempt activities. If you do bring in some revenue of this type, report it accurately. If your nonprofit is audited, it’s likely that the IRS will examine your records to see whether your recordkeeping mirrors reality.
For additional information on our nonprofit services, please contact Jon Moll, CPA at 302.225.0600 or click here to email Jon. In a brief consultation he can assess your situation and determine the best way to proceed.