At times the line between related exempt income and unrelated income can be narrow and gray. Because exempt organizations are not required to pay income taxes on “exempt earnings”, there are perceived advantages for developing diverse revenue streams that support the operations of the entity. However because these activities are competing with for-profit (tax paying) organizations, the IRS attempts to impose equality by assessing a tax on unrelated activities.

What is program related and what is unrelated? Here’s an example – A substance abuse center offers educational and counseling services to individuals based on need and income levels, helping them understand the signs of addiction. Because the center’s exempt purpose is rehabilitating individuals with addictions, this revenue stream is directly related to the exempt purpose. However, suppose the center operates a donut shop selling baked goods to the public. Is the donut shop related to the center’s exempt purpose? Probably not.

In order to qualify as unrelated income, the activity must meet all of the following characteristics:
1. Performance of a trade or business (profit motive in the selling of goods or services).
2. Regular activity (based on frequency and continuity, compared to commercial enterprises).
3. Not related to exempt purpose (does not significantly advance the exempt purpose of the organization).

If the activity meets all three requirements, there may be exceptions that eliminate the potential tax. Read the rest of this entry »

In this down-turned economy, all business entities are looking to enhance or supplement their current revenue sources, and not-for-profit organizations (NPO’s) are no exception.  Because a number of charitable organizations are exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code, the revenue generated by these organizations must be in accordance with its stated mission in order to be tax-exempt. Go back and review the organization’s Form 1023 and the IRS determination letter and verify “why” your organization is exempt from taxation. 

So what if an opportunity presents itself to increase your bottom line that may not fit your mission? Does that mean as a NPO you can not take advantage of this opportunity?  Not necessarily.  The income can be earned, but depending on its source, it may be considered unrelated business income. If the revenue is unrelated, then net income in excess of $1,000 is subject to the excise tax.

What types of property or transactions are specifically exempt or subject to being taxed? Continue reading…

Read the rest of this entry »

Over the last few years, the IRS has become very concerned that tax-exempt organizations are using their nonprofit status to avoid paying taxes on certain transactions, investments or business activities that are unrelated to their tax-exempt purpose.

In October 2008, the IRS sent 400 letters to colleges and universities requesting detailed information about executive compensation and business activities. Now the IRS is considering expanding its investigation to include endowment investments.

Although schools are not required to respond to the inquiries, not doing so could invite further scrutiny by the IRS, or even an audit.

As quoted in a recent New York Times article, IRS commissioner Douglas H. Shulman said, “Universities are really part of a rapidly evolving sector, and as sectors evolve and the economy evolves, we’re going to periodically take a hard look.”

If the IRS finds that certain colleges and universities have avoided paying taxes on unrelated business income, my guess is that it won’t take the IRS long to expand the scope of its investigation to include private schools.  How will your institution respond?

If you’ve got questions about unrelated business income, take a look at this post.

An exempt organization that regularly carries on a trade or business not substantially related to its exempt purpose has unrelated business income. The concept of “unrelated” is defined by the business activity and not how the funds are used by the organization. Just because an exempt organization needs funding does not allow the activity to be “exempt” from taxation.

Under the Internal Revenue Code, 1.513-1(a) describe three criteria that must be met for an activity to be considered “unrelated” and thus taxable:
• The activity must be a “trade or business”
• The trade or business must be regularly carried on; and
• The trade or business is not substantially related to the organization’s exempt purpose.

If an organization has more than $1,000 in gross receipts (total sales less cost of goods sold, plus any income from investments and from incidental or outside operations or sources) from unrelated business income, Form 990-T should be filed. The tax form is due on the 15th of the fifth month following year-end and should be filed with the Department of the Treasury, Internal Revenue Service Center, Ogden, UT 84201.

Certain employees’ trusts defined under section 401(a), and IRA (SEPs and SIMPLEs), a Roth IRA, an Educational IRA and an MSA may have unrelated business income and must file the form by the 15th of the fourth month following year-end.

Need help in understanding unrelated income? Contact us.