As a not-for-profit (NFP) organization, you were founded with a benevolent purpose to pursue a mission to aid your community through charitable, education, and other types of endeavors. To help achieve this mission, your organization engages in fundraising and other income-generating activities in order to support the organization’s purpose. The tax law typically provides NFP entities with a tax-exempt status, meaning that they do not ordinarily have to pay taxes on the funds they earn.
This does not, however, apply to all of the earnings that a NFP can make. Depending on the type of income a NFP organization earns, they may be subject to taxation, known as unrelated business income. In this article, we will explore potential taxable income for NFP entities and the implications that has for your organization.
Income for a not-for-profit organization is divided into two categories: related income activities and unrelated income activities. Organizations that maintain a 501(c)(3) status will not pay income tax on income-generating activity that is considered to be related to the mission of the business.
The Internal Revenue Service (IRS) provides guidelines for what types of activities are considered to support the mission of the organization.
For example, for organizations such as an animal shelter that may sell sponsorships for the animals, this income would be considered related to the mission of the NFP and exempt for federal tax purposes as this income directly supports the purpose of the organization.
Unrelated business income is considered to be generated separately from the mission of the NFP. NFP organizations should be especially careful when engaging in activities that generate unrelated business income as that can jeopardize that tax-exempt status of the organization. While some unrelated business income is okay, significant earnings can be troublesome.
For example, if the animal shelter opened an animal café next door to the animal shelter, this income would be considered unrelated taxable income and subject to taxation (after the initial $1,000 in earnings).
Income from investing activities such as dividends, interest, and capital gains are also generally not considered to be unrelated taxable business income.
Income directly related to the activities of the NFP are exempt for tax purposes. Money generated from donations, memberships, fundraising events, and other similar activities would be included.
Certain activities will be considered tax-exempt even if they do not necessarily relate to the core mission of the NFP organization. These activities can include:
The IRS provides guidance for activities which will be considered unrelated to the mission of the organization and subject to taxation. Three requirements are used to determine unrelated business income:
The income earned from unrelated business activity should not overshadow the activities for the NFP’s core purpose.
If your business generates unrelated business income in any given tax year, the income must be reported on the organization’s tax return (Form 990—Return for Organization Exempt from Income Tax). For those activities that are considered to be taxable, a NFP organization can pay up to 37% of the earnings over $12,750. This tax can have a significant impact on the bottom line of the organization.
Determining whether the income being generated by your tax-exempt organization is taxable is a crucial part of your NFP’s strategy. Generating excessive unrelated business income can put your organization’s tax-exempt status in jeopardy. You should review these activities each year as a part of your NFP’s financial strategy to ensure compliance.
If you have any questions about unrelated taxable income for NFPs and how it may impact your organization
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