Does your not-for-profit earn unrelated income?
Profitable
activities may trigger unrelated business income tax
Tax-exempt
organizations must be operated primarily for their stated exempt purpose,
but the IRS allows them to carry on certain unrelated business activities
without jeopardizing their exempt status. If these ventures are not
related to a nonprofit's core mission, however, the organization may
have to pay unrelated business income tax (OBIT) on the net income.
Even organizations exempt from filing Form 990, such
as churches, could still be subject to UBIT if an income-generating
activity is deemed to be unrelated to their purpose.
Some not-for-profits
have opted to simply steer clear of activities that might be considered
unrelated out of appearance concerns or fear they might endanger
their exempt status. Others have taken the stance that because they
may incur tax liability, it's best to avoid having unrelated business
income altogether.
But when carried out properly, unrelated activities
pose little risk for not-for-profits. Even if UBIT is owed - and
often it isn't because taxes are paid only on the net income after
expenses - your organization still has the potential to retain substantial
income for your effort.
Rather than routinely avoiding ventures that
might incur income tax, raise your awareness of the rules in this
area so you can effectively comply if you conduct an incomegenerating
activity.
Take
the "unrelated" test
According
to the IRS, an activity is unrelated and potentially subject to tax
if it's:
- A trade or business,
- Regularly carried on, and
- Not "substantially
related" to an organization's exempt purpose.
A trade or business is
defined as selling goods or performing services to produce income.
It's considered to be regularly carried on if it's frequent, continuous
and pursued in a manner comparable to the commercial activities of
a nonexempt organization.
For instance, an annual money-making event
wouldn't meet the definition, but an activity that takes place
one or two days a week during the year probably would.
To determine
if an activity is substantially related, the IRS looks at whether
there is a clear relationship between the activity and the organization's
ability to achieve its exempt purpose.
Understand unrelated activities,
exclusions
Many types of income-producing activities may be
unrelated, depending on the circumstances. For example, income derived
from the rental or sale of most debt-financed property, rental income
from parking lots, and regular revenue from advertising are usually
considered unrelated income.
Sponsorships aren't included in
advertising because they are treated as contributions rather
than income. The IRS has loosened the rules on sponsorships to
allow qualitative or comparative descriptions if they are part
of that organization's slogan or corporate message - for instance, "the
region's best."
In addition to the general rules for unrelated
activities, there are numerous activities and situations that
are excluded from UBIT, including:
- Activities substantially
performed by uncompensated volunteers,
- Most passive income such as
royalties, dividends and interest,
- Gains from the sale of property
(unless it's debt-financed),
- The sale of donated merchandise (for
example, goods given to a thrift shop),
- Real property rental
income (unless it's debtfinanced),
- Income from bingo in states
where it isn't carried on by for-profits,
- Income from the rental
or exchange of mailing lists with other exempt
organizations or with for-profits, as long as no other services are
provided,
- Income from trade shows and conventions,
- Activities
carried on primarily for the convenience or benefit
of members, students, patients or employees (such as a school cafeteria),
and
- Qualified sponsorship payments.
Organizations with annual
gross income of less than $1,000 from unrelated business activities
are excluded from UBIT.
Follow the tax rules
As is
the case with most tax matters, the rules pertaining to unrelated
business income contain numerous exceptions and stipulations. For
instance, if you expect to owe $500 or more in UBIT, your organization
must make quarterly estimated tax payments.
Unrelated activities,
whether excluded from UBIT or not, may consume too many
resources. When this occurs, the IRS may see the unrelated business
activities as your organization's primary focus and revoke your
exempt status.
In complex financial situations such as these,
you should seek professional advice before starting a for-profit
venture or filing Form 990-T, the income tax return for exempt organizations.
Assess your objectives
It's not inherently bad for your
not-for-profit to conduct unrelated business activities. You can
develop a muchneeded income source, which can also complement and further
your mission. But, as with any business matter, your decision
to engage in profit-making should be carefully evaluated in the
context of your organization's needs and goals.
Being green may yield a tax break
A little-noticed provision
of the American Jobs Creation Act of 2004 offers exempt organizations
an opportunity to generate tax-free income for being a good
steward of the environment.
The law specifically excludes from
unrelated business income tax any gain or loss resulting from
the remediation of brownfield properties and their subsequent
sale or exchange by not-for-profits.
Several requirements are
associated with the tax break, including:
The acquisition
date and brownfield status. You must acquire the property
before 2010 and it must be a qualifying brownfield - that is,
one that has been certified as possibly having hazardous substances,
pollutants or contaminants.
Remediation expenses. Your not-for-profit
must spend a certain amount on remediation: the greater
of $550,000 or 12% of the property's fair market value at the
time you acquired it.
Lack of involvement. You can't have
caused the property's environmental damage or have ties to
anyone who could be held liable.
This provision could pave the
way for not-for-profits that are receptive to new income-producing
activities and that have the resources to carry them out
to do a good deed for the environment. |
These publications are distributed with the understanding
that the author, publisher and distributor are not rendering legal,
accounting or other professional advice or opinions on specific facts
or matters, and, accordingly, assume no liability whatsoever in connection
to its use.
