As a nonprofit, your tax-exempt status with the IRS is based on how your organization is organized and operated. Your tax-exempt status exempts your organization from federal income tax on income related to your organization’s exempt operations. However, in the process of actually operating your nonprofit, there are times you’ll engage in a certain amount of activity unrelated to your exempt operations that produces income. This income is called unrelated business income and it may be taxable.
Is my nonprofit subject to Unrelated Business Income Taxation?
Almost all charitable tax-exempt organizations are subject to unrelated business income taxation (UBTI). Organizations subject to UBIT include:
- Social welfare
- Advocacy groups
- Veterans’ organizations
- Trade and professional associations
- Labor organizations
- Employee benefit funds
- Fraternal organizations
There are a handful of tax-exempt organization who are not generally subject to unrelated business income taxation. These groups include:
- Corporations organized under Act of Congress and that are instrumentalities of the United States
- Certain charitable trusts not subject to the tax on private foundations
What is Unrelated Business Income Taxation?
If your nonprofit regularly generates certain types of income from business activities that aren’t related to the tax-exempt purpose of your organization, this income is likely taxable as unrelated business income. It doesn’t matter if your nonprofit uses that income for its tax exempt purpose, it’s how the income is earned that makes it taxable.
The key parts of determining if income is from an unrelated business are:
- Is the activity a trade or business? Meaning, does the activity produce goods or services in exchange for money?
- Does your nonprofit carry on the activity on a regular basis? Regular basis usually means more than once a year.
- Is the activity unrelated to the tax-exempt purpose of your nonprofit?
If you can answer yes to all three questions, the income from the activity in question is likely subject to UBTI.
Examples of Unrelated Business Income
Here are a couple examples to help illustrate unrelated business income:
Example 1: Your church is next to a sports arena. To raise additional funds, you sell parking during games. Since parking is not related to your mission as a religious organization, any funds raised through the sale of parking spots would be considered unrelated business income.
Example 2: Your nonprofit bought a building and is working to pay off the mortgage. The building has space you’re not using, so you rent the space to a local retailer. The money you collect in rent is considered unrelated business income.
How much Unrelated Business Income can I have as a nonprofit?
The IRS expects tax-exempt nonprofits to have some unrelated business income, but if the IRS determines the percentage of unrelated income your nonprofit generates is too high, you may risk losing your tax-exempt status. There is no specific threshold nonprofits must stay under to avoid losing their tax-exempt status, as the IRS considers the unique circumstances surrounding each organizations’ unrelated business incomes.
Corrigan Krause can help
The Corrigan Krause Nonprofit team can help your nonprofit properly document income, including unrelated business income. You can connect with any of the Nonprofit team members here or email firstname.lastname@example.org.