One of the big traps that can tangle up an organization is engaging in some sort of fundraising activity that generates what the government calls “unrelated business income,” which can cause an organization to have to pay taxes or, in extreme cases, even forfeit the 501(c)(3) tax exemption altogether.
Some sources of income are automatically excluded from UBI (and I’ll give you some other exceptions near the end), like dividends and interest, some types of investment income, royalties, some types of rental income, and some capital gains.
If you do have unrelated business income of $1,000 or more, you must file Form 990-T for the tax year involved. If you expect to have more than $500 in UBI during a particular year, your organization must pay estimated tax.
What is Unrelated Business Income?
Unrelated business income is money earned by an organization that meets three requirements:
- It’s earned from activities that constitute a “trade or business.”
- The activity is “regularly carried on.”
- The activity does not further the organization’s exempt purpose.
For something to count as UBI, it must meet all these requirements; if one is missing, it’s not UBI. Let’s talk about each of these requirements in more detail.
What is a “trade or business?”
Here’s how I think about this requirement: is the money-making activity something that a for-profit business would engage in to make money? If you’re exchanging a good or service for money, you’re probably engaging in a trade or business. Car washes, bake sales, and selling advertising in programs, for instance, have obvious for-profit equivalents: the commercial car wash, the local bakery, and newspapers and magazines that sell ad space do the same thing. Each of those would qualify as a trade or business.
Of course, not every activity that raises funds is a trade or business. Receiving donations is not a trade or business–there’s no exchange taking place. Likewise, applying for grants from other organizations or charitable trusts isn’t a trade or business; it’s a donation.
What does it mean to be “regularly carried on?”
Generally, an activity is “regularly carried on” if it occurs roughly as often as it would for a for-profit business engaged in the activity. If a for-profit business does the activity year-round, and you’re only doing the activity every now and then, it probably won’t be considered regularly carried on.
For example, imagine that your organization operates a sandwich stand for a couple of weeks out of a year. Most for-profit sandwich sellers operate year-round, and a couple of weeks isn’t going to be frequent enough to be regularly carried on (that example is from Treasury Regulation 1.513–1(c)(2)(i), if you want to see it for yourself). On the other hand, the regulations also say that if you were to run that same sandwich stand one day each week throughout the year, that would be sufficient for the activity to be regularly carried on. Also, if a for-profit business would operate the activity on a seasonal basis, a couple of weeks of that activity within the same season might be enough.
The closer your activity is to a comparable for-profit business in terms of how frequently you’re open for business, the more likely your activity will be “regularly carried on” for UBI purposes.
What do you mean, the activity doesn’t further an exempt purpose?
This criterion often surprises people. To be “substantially related to an exempt purpose,” the activity itself has to help achieve the exempt purpose. The classic example is tuition for an educational institution. Education is one of the 501(c)(3) exempt purposes, so students enrolling and taking classes directly furthers the school’s purpose.
Here’s what gets people: fundraising activities do not “further an exempt purpose” even if all the money you raise is going to an exempt purpose. Let’s go back to the car wash example. Washing cars is not an exempt purpose. So, if you have a car wash fundraiser, that doesn’t “further an exempt purpose” even if every cent you raise goes to fund your organization’s exempt purposes.
Again, don’t forget that for the organization’s income to count as unrelated business income, it must meet all 3 of these requirements. And even then, there are exceptions.
Exceptions to Unrelated Business Income
So, let’s say that your organization does engage in some sort of money-making activity that meets all three requirements for unrelated business income. We’re not done yet! There might be an exception available. There are four big exceptions:
- Volunteer labor: Your activity is run entirely by unpaid volunteers
- Convenience of members: Your activity is carried on primarily for your members, students, patients, or employees–(examples from the regulations: leasing dormitory apartments to students of a college, school or hospital cafeterias, or hospital parking lot all fall under this exception)
- Selling donated merchandise: Your activity involves selling merchandise which was donated or gifted to your organization
- Bingo: Bingo should probably get its own post, but the exception applies in bingo games where you complete a pre-selected pattern on a card (5 in a row is most common) to determine a winner, and wagers are made, winners are determined, and prizes are awarded simultaneously.
One more thing about bingo: don’t forget that bingo games may be regulated by your state or local government! You may need to apply for permits or register–or you might not be able to do it at all.
In addition to those exceptions,
Unrelated business income is an easy issue to miss–every time you consider a new fundraising activity, you should always take a moment to consider if this activity will create UBI for your organization.