Question: What Is Unrelated Business Activity?
What do you need to know about nonprofit "profits"? How do you distinguish between taxable business activities and those that are not taxable? What is all the fuss about "unrelated" business activities?
Answer: Even though nonprofit organizations are not created to pursue a profit, sometimes they have them. Profit is not denied to the nonprofit as long as the organization is pursuing the mission for which it was founded.
However, some profit is taxable and some profit is not. Many nonprofits engage in "related" business activities to help sustain their primary mission. Any profit from such an activity is tax-exempt.
What is a related business activity? Let's use an example of a museum that offers summer courses to high school students on art appreciation for a fee. Since the museum's mission involves the education of the public about art, the proceeds from such courses is tax-exempt.
Profit from an "unrelated business activity" may be taxable. An example could be if the museum publishes a magazine that carries advertising that has nothing to do with its mission of art education and preservation.
However, since there is a fine line sometimes between "related" and "unrelated" business activity, the IRS will not tax certain activities even if they don't seem related to the nonprofit's mission. Some of those activities include:
- those where nearly all the work is done by volunteers.
- those that are carried on primarily for the benefit of members, students, patients, officers, or employees. An example might be a gift shop at a hospital that serves patients or employees.
- the sale of merchandise that has been donated to the organization, as in a thrift store.
- the rental of mailing lists of donors or members.
- distributing incentives that are worth less than $5. Examples are stamps or pre-printed mailing labels given as incentives for donating money.
Although, a nonprofit can engage in unrelated business activities and pay taxes on the profit, it pays to be careful. Too much unrelated business activity may prompt the IRS to take a second look at your 501(c)(3) tax-exempt status. Make sure that your unrelated business activity doesn't absorb too many resources from staff or volunteers and don't let the income become too large a percentage of your total annual income.
Be sure to consult your legal counsel and your tax expert before you begin any "business" activity. The IRS provides details on unrelated business income tax on its website.