Many people assume that all non-profit organizations operate in a federal tax-free environment. After all, that is the entire point of section 501(c)(3) of the Internal Revenue Code. But, it isn’t always the case that all money made by non-profits is tax-free; so that they can raise additional funds, many organizations sell items or services that aren’t inherently related to the causes that they support. Here is where Illinois nonprofits can run into the often misunderstood unrelated business income tax (UBIT).
What is unrelated business income? The answer to that question requires a bit of unpacking. John C. Provenza & Associates, P.C. has been one of the Chicago area’s leading non-profit law firms for more than 20 years. John C. Provenza is not just an attorney—he is also a certified public accountant. This unique mix of expertise gives our firm the ability to advise non-profits not only on legal issues but financial governance and complex tax situations as well.
The money that a non-profit raises to support their activities is generally not taxed by the federal government. Where things become more complicated is when a tax-exempt organization conducts an income generating activity that is not primarily related to their tax-exempt purpose. That revenue is called unrelated business income, and it is often subject to the business income tax.
The IRS defines an unrelated business like this:
1. The activity is a trade or business, meaning that the activity produces goods for services in exchange for money.
2. The activity is regularly carried on, which means that there is an element of frequency and continuity to the activity. Once per year fundraising dinners or bake sales are generally not subject to the UBIT. However, seasonal events of a similar type that occur at different time throughout the year may be subject to the UBIT.
3. The activity is not substantially related to the tax-exempt purpose of the non-profit organization.
It is that last statement, “not substantially related to the tax-exempt purpose,” that can unwittingly get non-profits into trouble with the IRS. Determining whether or not the activity generating money for your organization is substantially related to your purpose can be confusing, so getting the advice of an experienced Illinois non-profit attorney is essential.
Here are some examples of unrelated business activities that might be subject to the UBIT:
· A church notices that their building is close to a new sports stadium. To make extra money, church leaders decide to sell parking during events. Since selling parking spaces is unrelated to the church’s primary mission of being a faith institution, these funds would be subject to the UBIT.
· Your non-profit provides books and educational materials to area children. You’ve become quite popular in your community, so you decide to sell t-shirts and other apparel with your logo. Selling clothing is not substantially related to the mission of providing educational materials, so your apparel sales income would be considered unrelated business income.
· Your non-profit organization is paying down a mortgage on the building that you’ve purchased. To defray some costs, your board of directors has decided to rent half of the space to a local artist. The income generated from this rental is considered to be unrelated business income.
· Your non-profit supplies food to the homeless and underprivileged and employs a young local chef who is quite talented. To create buzz in your community, you decide to open your doors to paying patrons. The income generated from these food sales is considered to be unrelated business income since the food is being sold to people other than non-profit employees and the disadvantaged community you serve.
These are just a few examples of what could be considered unrelated business income that is subject to the federal UBIT. There are some exceptions to the general UBIT rules; volunteer labor, products and services intended for the convenience of non-profit members, selling donated merchandise, and some bingo games are exempt from federal business income taxes. There is also a substantial amount of nuance involved—the evaluation of whether or not a product or service is unrelated may require that you look at your offerings on an item by item basis. For instance, an art museum that sells prints of the artwork they display may find that those sales are not subject to the UBIT, but gift shop sales of sweatshirts with the museum logo are.
So that they can avoid an embarrassing and expensive negative interaction with the IRS, it is critical that each non-profit has experienced legal advice to help them navigate these tricky unrelated business income issues. If you have questions regarding the UBIT and your organization, call the law offices of John C. Provenza & Associates, P.C. Our legal knowledge, accounting experience, and passion for serving those that serve others make our firm the perfect choice for all of your non-profit law needs. Contact our office at (847) 729-3939 or via our website.