Federal State Unrelated business Income tax

Introduction

A nonprofit organization that has received tax exempt recognition under Section 501(c)(3) of the IRS code is exempt from taxes on Income from any activity which is substantially related to its tax exempt purpose. Income derived from the normal purpose for which the organization has been established is called as the “Exempt function income”. Exempt function income is exempt from Income taxes even though it may be a regular trade or business income for the Non profit organization.

Alternatively, if the nonprofit organization indulges in certain activities that are not substantially related to its exempt purpose, the organization is liable to pay taxes on Income from such “Unrelated business”.

The purpose behind the enactment of the Unrelated Business income provision was to prevent tax exempt organizations from unfairly competing with businesses that pay regular taxes, thereby aiming to restrict individuals who try to evade taxes under the garb of a tax exempt nonprofit organization.

As per IRS guidelines, all tax exempt Nonprofit organizations their unrelated business Income on form 990 T, if the organization’s gross Income from Unrelated trade or business income is $1000 or more.

Definition of Unrelated Business Income

For an income to be considered as unrelated business Income, it must fit these three criteria –

1) The Activity must be a trade or business. ( i.e. the activity must be conducted for income or profit)

2) The trade or business must be carried on regularly – (i.e. the frequency of activity could be similar to the frequency of a commercial entity operating in the same business.)

3) The business must not be related substantially to the organization’s tax exempt purposes.

Exceptions which are not considered Unrelated Business or Trade

Trade or Business performed by unpaid volunteers
Trade carried on for the convenience of the organization’s students
Some qualified sponsorship payments
Selling of donated merchandise
Selling of Low cost Articles (low-cost article, for organizations eligible to receive charitable contributions, was increased to $9.50 for 2009)
Exchanges Involving donors
Qualified trade show activity.

How is Unrelated Business income Tax Calculated?

Unrelated Business Income is taxed at the normal corporate rates and in the same manner as it is applied to other commercial entities.

Summary of Unrelated Business Income section

Conclusion – Can a nonprofit organization sell goods or render services for profits?

Selling goods or services does not risk an organization’s tax-exempt status with the IRS, provided the revenue out of the sales is used to promote the organization’s tax – exempt purpose and the organization duly files and pays the applicable taxes on its unrelated business income.

However if a Nonprofit organization has a substantial unrelated business Income which is out of proportion to its spending on its tax exempt purpose, it may risk loosing its tax exempt status.