You already know that nonprofits can make money from earned revenue and that earned revenue can take hundreds of different forms. A few examples include:
Sales from nonprofit swag such as t-shirt, bumper stickers, tote bags
Charging for services, such as ticket sales for a theater, or charging tuition at a school
Entrance fees to a museum
A thrift shop that sells donated items
A gala or other fundraising event
Registration fees for a walk-a-thon or other event
But did you know your earned revenue could be subject to Unrelated Business Income tax (UBI tax)? Understanding UBI tax is very important because it can determine not only if you owe a tax bill, but if you could lose your nonprofit status.
Like most laws, the rules may seem clear, but the application can get a bit murky. The rule according to Internal Revenue Code Section 511-514 puts forward the following:
A nonprofit is subject to UBIT if all three of the following are met:
1.) it earns income from a “trade or business,”
2.) that trade or business is “regularly carried on,” and
3.) that trade or business is “unrelated” to the exempt purpose as stated in your 501(c)3 determination letter.
So, let’s look at each of these.
1) Reg. 1.513-1(b) defines “trade or business” as “any activity carried on for the production of income from the sale of goods or the provision of services.” So, yes – your t-shirt sales with your nonprofit logo does meet the definition of trade or business.
2) Reg. 1.513-1(c) defines “regularly carried on” as “manifest a frequency and continuity, and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations.” So, yes, if your nonprofit swag is always available for sale, it may meet these criteria.
3) The activity is “unrelated” to mission. So, yes, if you are a humane society, then clothing people (in shirts with your logo) is unrelated to your mission.
Importantly, the courts have made it clear that simply using the money earned from an unrelated activity (like t-shirt sales) to further the organization’s mission is not enough to consider something as related to mission.
Seems simple enough, right? But let’s look at a few examples of how this has played out.
A nonprofit that performs a once-a-year gala is not subject to UBI tax because the gala does not meet the requirement of number 2 (regularly carried on). But, if your organization sells items at each of the year’s football games, then that activity is considered “regularly carried on.”
Now, it is possible for the IRS to claim something should be subject to UBI tax and lose in court. One example of this is the NCAA Final Four basketball tournament. The IRS determined that the NCAA owed UBI tax on income from the sale of ads because they spent several months selling ads and creating the booklets that would be handed out at the tournament. But the court said that the programs were only distributed three weekends a year and thus did not meet the definition of “regularly carried on” (NCAA v. Commissioner, 914 F.2n 1417, 1990).
Let’s look at a few other examples of how this law has been applied.
1973 – Greeting cards sold in a museum’s gift shop were not subject to UBI tax because they were reproductions of select artworks and that “contributed significantly” to the museum’s educational function (Rev. Rul 73-194).
1973 – Scientific books sold in a folk-art museum were deemed subject to UBI tax because scientific books had no relationship to the mission of a folk-art museum (Rev. Rul 73-105).
1980 – Items in an aquarium gift shop were scrutinized and it was found that the sale of ashtrays and other souvenirs with the aquarium logo were subject to UBI tax but the sale of actual seashells was not subject to UBI tax because they were related to the mission.
1986 – The American College of Physicians sold advertisement space for medical devices in their annual program (Annals of Internal Medicine). Even though the advertised items were related to medicine, the ad revenue was deemed subject to UBI tax because the courts found it was no different from commercial advertising (U.S. v. American College of Physicians, 475 U.S. 834, 1986).
Now, there are some exceptions that we must be aware of:
If the activity is conducted for the “convenience” of those that are served by the nonprofit or its employees, then the activity is not subject to UBI tax. Thus, the lunchroom at your local nonprofit zoo is not subject to UBI tax
At least 85% of the activity is conducted by volunteers. Thus, a volunteer-run gift shop in a hospital is not subject to UBI tax.
Where all of the merchandise that is sold is received as a donation. Thus, a local thrift shop that is benefiting a local nonprofit may not be subject to UBI tax.
For 501(c)3s, passive income is not subject to UBI tax. Thus, dividends and interest on traditional investments (such as stocks, mutual funds, savings accounts) is not subject to UBI tax.
Rental income from renting land or a building for unrelated activities is generally not subject to UBI tax.
Also, it is important to note that too much unrelated business income can result in losing your nonprofit status. The Orange County Agricultural Association lost their tax-exempt status because more than 30% of their gross income came from activities unrelated to their expressed nonprofit purpose.
So, you have determined that some of your revenue is subject to UBI tax. Now, what? If you make more than $1,000 a year in UBI income, then you need to file a form 990-T and pay regular corporate taxes on the profit that is subject to UBI tax (not all your funds).
Need more information on this topic? See the IRS Guide: https://www.irs.gov/publications/p598
댓글