Can a Nonprofit Earn Business Income?

A nonprofit organization can earn revenue from business activities, but how that income is generated matters for tax purposes. Tax-exempt status does not necessarily mean every dollar a nonprofit earns is exempt from federal income tax.

When a nonprofit regularly conducts a trade or business that is not substantially related to its exempt purpose, the resulting income may be treated as unrelated business taxable income (UBTI).

Can Nonprofits Make Money?

Yes. Nonprofit organizations are allowed to generate revenue and can even produce a financial surplus.

The key distinction is that a nonprofit generally does not operate to distribute profits to private owners or shareholders. Instead, its resources are used to support the organization's mission and activities.

Revenue can come from sources such as:

• Donations and contributions

• Grants

• Membership dues

• Program fees

• Fundraising activities

• Investment income

• Sales of goods or services

• Business activities

Different types of revenue can receive different tax treatment.

What Is Unrelated Business Income?

An activity can potentially generate unrelated business income when it generally meets three characteristics:

It is a trade or business. The organization is conducting an activity involving the sale of goods or services.

It is regularly carried on. The activity occurs with a frequency or continuity similar to comparable commercial activities.

It is not substantially related to the nonprofit's exempt purpose. The activity does not meaningfully contribute to accomplishing the organization's tax-exempt mission beyond simply generating money.

The facts and circumstances surrounding the activity are important when applying these rules.

What Is an Example of Unrelated Business Income?

Imagine an educational nonprofit that operates a commercial activity unrelated to its educational programs throughout the year.

Even if the organization uses the resulting profit to fund its mission, the activity itself may potentially generate UBTI because using the money for an exempt purpose does not necessarily make the underlying business activity related to that purpose.

By contrast, revenue generated directly through activities that accomplish the organization's exempt mission may receive different treatment.

What Is Form 990-T?

When a tax-exempt organization has sufficient gross income from an unrelated trade or business, it may be required to file Form 990-T, Exempt Organization Business Income Tax Return.

Form 990-T is separate from the organization's regular Form 990-series information return.

A nonprofit could therefore potentially have both a Form 990 filing requirement and a Form 990-T filing requirement.

Are Fundraising Activities Unrelated Business Income?

Not automatically.

Fundraising is common among nonprofit organizations, but the tax treatment depends on the nature of the activity.

Certain activities may qualify for specific exceptions or exclusions from UBTI. Activities involving donated merchandise or substantial volunteer participation, for example, can receive different treatment under applicable rules.

Each activity should be evaluated individually rather than assuming all fundraising revenue receives the same treatment.

What About Advertising and Sponsorships?

This distinction can be particularly important for nonprofits.

Certain qualified sponsorship payments may receive different tax treatment from traditional advertising revenue.

If a payment primarily provides acknowledgment of a sponsor rather than substantial advertising benefits, the treatment may differ from a commercial advertising arrangement.

The details of the agreement and benefits provided to the sponsor matter.

Is Investment Income Considered UBTI?

Certain passive income—including some dividends, interest, royalties, and rents—may generally be excluded when calculating unrelated business taxable income.

However, exceptions can apply, particularly with certain debt-financed property or other specialized arrangements.

Nonprofits with substantial investment or rental activity should therefore evaluate the specific circumstances.

Can Too Much Business Activity Affect Tax-Exempt Status?

Potentially.

Generating some unrelated business income does not automatically cause an organization to lose its tax-exempt status.

However, if unrelated commercial activities become substantial compared with the organization's exempt activities, broader questions about the organization's tax-exempt purpose can arise.

Organizations should monitor both the financial and operational significance of commercial activities.

Keep Business Activities Properly Tracked

Accurate accounting can help nonprofits distinguish between revenue related to their exempt mission and revenue generated from unrelated activities.

Organizations should maintain records showing:

• Revenue by activity

• Direct business expenses

• Program-related revenue

• Fundraising revenue

• Sponsorship arrangements

• Investment income

• Allocation of shared expenses

• Supporting contracts and documentation

Separating these activities within the accounting system can make annual tax preparation significantly easier.

Evaluate New Revenue Sources Before Launching Them

New business activities can provide valuable funding for a nonprofit, but their tax consequences should be considered before they become a significant source of revenue.

James Ridout CPA provides nonprofit tax planning, Form 990 preparation, Form 990-T assistance, UBTI guidance, nonprofit accounting, and ongoing compliance support.

Considering a new revenue-generating activity for your nonprofit? Schedule a consultation with our team to understand the potential tax implications before moving forward.