In order to address cash flow problems, many not-for-profit organizations seek additional revenue streams in order to continue to carry out their missions. But not-for-profit organizations should be aware of whether or not their activities are related to their organization’s exempt purpose. When activities are considered unrelated to the organization’s exempt purpose, the revenue earned from these activities may be considered unrelated business income (UBI) by the IRS, and will be taxable. The organization will need to report unrelated business income as taxable to the IRS on the form 990-T.
A “facts and circumstances” test is used by the IRS in order to determine the treatment of income, judging activities upon whether or not they substantially further the exempt purpose of the organization.
The IRS gives us a three part test for unrelated business income:
- The income must be from a trade or business, which generally refers to activities that produce income (usually from the sale of goods or services).
- The trade or business must be regularly carried on. This means that the business operates continuously or frequently. An infrequent activity such as an annual fundraiser is not considered regularly carried on.
- The trade or business is not substantially related to the organization’s exempt purpose. This means that the activity does not contribute in a significant way to the organization’s exempt purpose.
There are some exceptions to unrelated business income which will be non-taxable. These include situations such as activities conducted by uncompensated volunteers or the sale of merchandise donated to the organization.
If an activity results in UBI and may result in taxes payable to the IRS, this does not necessarily mean that the organization needs to discontinue the activity – unrelated activities will generally only put an organization’s tax-exempt status at risk when they are significant in comparison to all of the exempt activities conducted by the organization. Organizations should give careful consideration to their activities however, as it is important to be aware of what activities may be considered UBI and can result in a tax liability. Otherwise, an organization may come to the end of the year and realize that they have unintentionally conducted unrelated taxable activities and have accumulated a tax liability for which they are unprepared.
The IRS provides guidance and requirements regarding UBI for not-for-profit organizations via their website at www.irs.gov/Charities-&-Non-Profits/ as well as providing additional resources regarding obtaining and maintaining tax-exempt status at www.stayexempt.irs.gov.
By Paul Biggs