history of technology timeline: Can a non-profit produce business income?

Wednesday, September 5, 2012

Can a non-profit produce business income? :: COMAR LAW

Because they are often tied to funding-sources (such as private or institutional donors), non-profits often wonder if they can engage in business activities and retain their non-profit status.

Generally, a non-profit can engage in business activities so long as those activities do not qualify as ?unrelated business income.? Unrelated business income may be taxed by the IRS, and if substantial, can also threaten the non-profit?s tax exempt status.

The IRS defines ?unrelated business income? as income that comes from (1) trade or business, that is (2) regularly carried on, and (3) not substantially related to furthering the exempt purpose of the organization.

There are clear-cut exemptions to unrelated business income, including activities which depend on volunteer labor, activities designed primarily for the convenience of its members, and selling donated merchandise.

Other than those exemptions, however, whether or not a business activity counts as ?unrelated business income? is subject to the three-pronged test described above, and the case law is hardly clear.

What does it mean to be ?regularly carried on? (prong two) for example? In general, the IRS will look at the frequency of the activity as compared with similar activities of a non-exempt organization. Case law here is inconsistent and highly dependent on specific facts and circumstances.

What does it mean for an activity to be ?not substantially related? to the purpose of the exempt organization (prong three)? Again, case law here is inconsistent and hinges on fine distinctions.

The general test is that the trade or business must make an important contribution to an organization?s exempt purpose other than through the production of money. The IRS gives the example of an ?experimental dairy herd maintained for scientific purposes by a research organization.? Sales of the milk and cream produced in the ordinary course of operation would be substantially related, but sales of further manufactured goods (such as ice cream, pastries, etc.) might be unrelated trade or business.

In sum, a non-profit hoping to engage in business activities will want to, among other things, (1) distinguish its activities as much as possible from analogue activities carried on by for-profit enterprises, and (2) try and relate the business activities as much as possible to the non-profit?s purpose. This is a highly fact-intensive process that should be documented through due diligence and ultimately approved by the non-profit?s board.