A nonprofit organization is just that—one that doesn’t produce a profit by general business standards. Any earned “profits” go back into the organization’s coffers to pay for general business needs and to continue the work they intend to do for the betterment of the community.
But if a nonprofit decides to branch out into other revenue streams to bring in more money, there is a possibility of running into what’s called Unrelated Business Taxable Income (UBTI.)
How It Works
A 501(c)(3) nonprofit does have a tax-exempt status as long as the income is used for the organization’s stated purpose and daily operating expenses.
Sometimes a nonprofit finds itself in a position to increase their income by doing something else that brings in additional monies. It could be in the form of selling branded merchandise (T-shirts, coffee mugs, bags, etc.) or some other revenue stream that isn’t directly related to the nonprofit mission.
The organization will have to begin paying taxes on everything after the first $1,000 of gross unrelated income from these UBIT income sources using IRS Form 990-T and State form IL-99-T.
Determining UBTI
There are three parts to the equation to determine if a nonprofit’s revenue stream:
1. If the activity could be considered a trade or a business (such as a coffee shop)
2. If the activity is “regularly carried on” (such as one that creates a daily or weekly income) that could compete with commercial businesses. This could include things like yearly sales at the holidays that compete with other local businesses as well as something done daily or weekly, like a childcare facility.
3. If the activity is “not substantially related” to the nonprofit’s mission. This is a more complicated factor, one which may be open to interpretation, since the focus is on the actual business activity, and not where the money will be used. The activity needs to be examined in the context promulgated in the organization’s bylaws, articles of incorporation and other documentation
Congress’ basic idea is to keep a “level playing field” and not give a nonprofit an advantage over commercial business when it comes to taxes.
Caveat: Don’t Make Too Much UBTI
It’s a Catch-22—a nonprofit needs income to continue its work. Additional income can increase the nonprofit’s reach, and help them do more for the community.
But if the nonprofit makes more income from the UBTI than it does with it regular fundraising, the IRS may see the nonprofit as a for-profit business. This could result in a loss of the organization’s 501(c)(3) (nonprofit) status.
Get Help In Chicago For Your Nonprofit’s UBTI
Unrelated Business Income Tax is both straightforward and significantly broad. With the many exceptions and modifications designed for specific charitable and for-profit activities, it is important to be well-versed in these tax laws.
With decades of experience helping many nonprofits throughout Chicago, James C. Provenza & Associates, PC can help your tax-exempt nonprofit operate within IRS tax laws and properly differentiate tax-exempt income and unrelated business income. When preparing your annual reports to the IRS, contact our Chicago law office for a consultation with James Provenza. Call us today at (847) 729-3939.
