It may come as a surprise to many, but nonprofits can have taxable income, known as Unrelated Business Taxable Income (UBTI). Even if they get a tax exemption from the IRS.
If an organization has UBTI of $1,000, it must submit 990-T Unrelated Business. You can check out his form at the IRS website –https://www.irs.gov/pub/irs-pdf/f990t.pdf
The government defines taxable income as income not substantially related to the organization’s tax-exempt purposes or activities. The idea is to prevent nonprofit organizations from competing with for-profit firms unfairly. The tax due is known as Unrelated Business Income Tax (UBIT), and it conforms to the corporate tax rate. Often, an activity generates unrelated business income if it meets three requirements:
- It’s a trade or business
- It’s regularly carried on, and
- It’s not substantially related to furthering the exempt purpose of the organization.
For example, an organization runs a pizza parlor selling pizza to the public. The nonprofit’s mission and programs don’t relate to the parlor’s business. The nonprofit pays employees to run the pizza place. All this information points to the pizza parlor generating unrelated business income that’s taxable.
On the other hand, a humanitarian-service organization holds a bake sale. While the sale is unrelated to the mission, It’s likely to be tax-exempt if not “regularly carried on.” Nonprofit’s activities are considered regularly carried on if they show a frequency, continuity, similarity to comparable commercial activities of for-profit businesses.
Some unrelated business activities may not be taxed. For instance, if an organization sells donated items, or if volunteers perform all the labor involved in the business, proceeds are exempt from taxes.
Note that if the IRS notices too much UBTI, it may revoke the tax-exempt status, which can spell disaster for a nonprofit. To avoid this potential risk, organizations should consider the following:
- Resources and volunteers must spend most of the time on the mission, not business activities
- Most of the revenue must come from the public and mission-related programs. The percentage of business income should be minimal
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