Producing Income as a Nonprofit
Nonprofit corporations, by IRS definition, are given that designation because they do not exist for the purpose of making money for any person or persons but to fulfill one of the defined purposes recognized by federal law: charitable, educational, scientific or literary. (IRS Publication 557)
As long as a nonprofit corporation is organized and operated for a recognized non-profit tax exempt purpose and has secured their proper tax exemptions in writing under state and federal tax laws, however, it can take in more money than it spends to conduct its activities. (IRS Publication 598)
In other words, IRS recognized non-profit entities can make a profit. The question then becomes whether a nonprofit’s income is taxable or tax exempt and that depends on whether the activities are related to the nonprofit’s purpose.
There are two categories of earned income to be considered in answering this question. They are: related business income and unrelated business income which are defined in a special IRS publication 1828 produced to specifically provide guidance in this area for non-profit organizations.
Earning Income from “related” activities
Tax-exempt nonprofits often make money as a result of their activities and use it to cover expenses to fulfill its purposes. In fact, this income can be essential to an organization’s survival. As long as a nonprofit’s activities are associated with the nonprofit’s purpose, any profit made from them isn’t taxable.
Let’s take as an example of a group called Friends of the Church. It’s a 501(c)(3) nonprofit (which means it has a federal tax exemption), organized to encourage and advance the spread of the Gospel by raising money to help save souls.
It makes a profit from the sale of a lecture series featuring its famous pastor and from an annual sale of books, tracts and other digital materials.
Because these activities are educational and religious in nature, they do not jeopardize the group’s tax-exempt status, and the proceeds from them are not taxable.
The organization may use the income for its operating expenses for the benefit of its charitable purpose (including salaries for officers and staff). What it cannot do is directly distribute any of the income to the nonprofit’s officers, directors or others connected with the church outside of their work in and for the church.
Earning From Unrelated Business Activities
Sometimes nonprofits make money in ways that aren’t related to their nonprofit purposes. While nonprofits can usually earn unrelated business income without jeopardizing their nonprofit status, they may have to pay corporate income taxes on this income, under both state and federal corporate tax rules. Generally, according to the IRS, the first $1,000 of unrelated income is not taxed, but the remainder may be. (See IRS Publication 598)
Let’s go back to the Friends of the church nonprofit corporation for an example of unrelated business income. The Pastor and staff write books, produce video and audio and donates the proceeds from the sale of thousands of books and DVDs to the church during its annual book sale, one of its major fund raising events. Although the sale is always successful, one year they produced over one thousands more books than before and the nonprofit decides to sell the more valuable of these books by advertising in sources for DVDs and books.
The response was overwhelming, and before long the nonprofit has six employees cataloging books for sale. Soon, Friends of the church finds itself in the business of buying and selling books and DVDs from other pastors and reselling them to the public. When this occurs the nonprofit will have to report these earnings to the IRS, which will tax them as income from unrelated business activities. Within certain limits, (which we will discuss next), with can be done without jeopardizing the churches non profit status
However, there are some unique situations where excessive unrelated business activities can prompt the IRS to reconsider a nonprofit’s 501(c)(3) tax-exempt status. To avoid this, a nonprofit should never let its unrelated business activities reach the point where it starts to look like a regular commercial business more than it looks like a church. For instance, unrelated business activities shouldn’t absorb a substantial amount of staff time, require more paid staff or volunteers than regular church activities, or produce much more income than that generated by the organization’s exempt activities.
Non-profit organization like churches can earn income without jeopardizing its non profit status. The question then becomes whether the income earned by the church r non profit is related or unrelated business income. If the income is related to the primary purpose of non nonprofit’s the income is non generally taxable. The tax status depends on whether the activities are related to the nonprofit’s purpose. To insure there are no risk of the IRS raising questions the Church simply needs to monitor the amount of income earned in relation to the public support it generates not related to the business activity. However, in the income exceeds the public support that income may become taxable and the non profits will need to file an addition form with its tax return called a 990-T along with its regular 990 reporting requirement all non profit organizations are required to file annually.