While nonprofit organizations are generally exempt from income tax, they are required to pay taxes at normal corporate rates on their unrelated business income. According to the Internal Revenue Service (IRS), “unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption.” This kind of income can come from ticket sales, bake sales, gift shop income, and other activities that generate income not directly relevant to the mission of the organization.
Many nonprofits – which are typically “tax-exempt” entities – try to avoid paying income taxes, as their goals are not in earning revenue, but in serving another purpose. Depending on the type of organization and the activities that are generating unrelated business income, there are ways for nonprofit organizations to remain tax-exempt.
Updated unrelated business income tax (UBIT) rules were put into place to prevent nonprofit organizations from unfairly earning income and competing with businesses whose earnings are taxed. If any unrelated business income is considered these three things, it is likely subject to UBIT: 1) the activity is a trade or business, 2) it is regularly carried out and 3) its result is not “substantially related” to the nonprofit’s goals and mission.
However, UBIT rules do allow nonprofits to generate income in certain situations, especially what is referred to as “passive income.” Passive income includes rental income from real estate and other property, royalties received from licensing arrangements, and dividends.
Royalties are payments to owners of certain property for use of that property. For example, if your business or organization allowed another entity (i.e. publication, manufacturer, religious group, etc.) to use your logo, imagery or copyrighted material elsewhere, they may send your organization the profits, or percentage of the profits, in form of a royalty payment. In most cases, these types of payments will be considered royalties and passive income.
If you or your organization can license your intellectual or physical property, you may be able to avoid paying unrelated business taxes on the income generated for these activities. In general, if another party is using the owner’s property to generate income, then the percentage of the income received by the owner does not follow UBIT rules and should be exempt.
When nonprofits license their logo, instead of advertising it themselves or using it for sales, then those royalties are most likely not taxable. For clarification on what type of royalties are taxable and what types are not, contact a knowledgeable and experienced tax lawyer.
Unrelated Business Income & Taxes
The bottom line is this: there are lots of grey areas for nonprofits and income tax. If you have concerns about unrelated business income or royalties, James C. Provenza & Associates in Glenview, Illinois, can answer your questions and help you with any of your tax-related concerns.
For more than 20 years, James C. Provenza has devoted his legal practice to helping people in the area set up and manage their taxes, estates, and organizations, to serve their best intentions. With reasonable rates, reliable quotes and ethical and honest assistance, the team at Provenza Law will be happy to help any entity with their legal or tax planning needs.
For help forming and growing your nonprofit, or for planning advice from an experienced legal and tax planning professional, contact James C. Provenza & Associates, PC, today at (847) 729-3939 or fill out the contact form here. We look forward to speaking with you.