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Earning income from activities that are outside a nonprofit’s primary mission, such as by renting unused space, selling merchandise, or offering paid services, is not necessarily a problem.

However, tax-exempt status does not automatically make every source of revenue tax-free. If a nonprofit regularly carries on a business activity that is not substantially related to its exempt purpose, the income may be subject to unrelated business income tax.

The Main Question Is Whether the Activity Supports the Mission

The IRS looks at how closely a revenue-producing activity relates to the nonprofit’s exempt purpose when determining whether the income is generally covered by the organization’s tax exemption or may be subject to unrelated business income tax.

Simply using the profits to support the mission is not enough by itself to make the income tax-exempt. The activity generating the income generally needs to contribute importantly to accomplishing the nonprofit’s exempt purpose.

For example, income from a program that directly advances an organization’s educational or charitable work may be treated differently from income generated by a separate commercial activity that primarily exists to raise money.

Some Revenue Sources Are Treated Differently

Not every activity outside a nonprofit’s central programs creates unrelated business income.

The tax code includes several exceptions and exclusions. For example, certain activities performed substantially by volunteers and sales of donated merchandise may fall outside the definition of an unrelated trade or business. Certain rental income and investment income may also be excluded, depending on the circumstances.

That means two nonprofits earning money in similar ways may not receive the same tax treatment.

Occasional Fundraising Is Different From Operating a Regular Business

Frequency also matters.

The IRS generally considers whether an activity is carried on with a frequency and continuity similar to comparable commercial businesses. A recurring operation may raise different issues than an occasional fundraiser or one-time event.

A nonprofit that occasionally sells merchandise at a fundraising event, for example, may be in a different position from an organization operating a year-round retail business unrelated to its charitable purpose.

Too Much Unrelated Activity Can Raise Broader Questions

Paying tax on unrelated business income does not necessarily threaten a nonprofit’s tax-exempt status.

However, leadership should pay closer attention if unrelated commercial activities begin taking up a significant portion of the organization’s time, resources, or operations. A nonprofit still needs to be organized and operated primarily for its exempt purposes.

The larger and more permanent a new revenue activity becomes, the more important it may be to evaluate its relationship to the nonprofit’s mission and whether a different structure should be considered.

Review New Revenue Activities Before They Become a Major Operation

A nonprofit attorney can help leadership evaluate a proposed revenue stream before substantial money, staff time, or resources are committed to it.

That review may include determining whether the activity is substantially related to the organization’s exempt purpose, whether unrelated business income tax may apply, and whether contracts, leases, or a separate business structure create additional legal considerations.

Addressing those questions early can help nonprofit leaders pursue new sources of revenue without overlooking the tax and governance issues that may come with them.

Get Legal Guidance Before Expanding Nonprofit Revenue

If your nonprofit is considering a new business activity, rental arrangement, paid service, or other revenue source outside its traditional programs, our Atlanta nonprofit attorneys can help evaluate the potential tax and governance issues before you move forward.

Call the Law Office of Cameron Hawkins at (678) 921-4225 to discuss the proposed activity and whether additional planning may be appropriate.