“It doesn’t matter how I get the money in the door as long as I spend it on charitable activities.”
The source of the revenue will determine whether it’s taxable income to the tax-exempt organization.
A 1950s cry for ending a macaroni monopoly at NYU created the basis for the unrelated business income tax (UBIT) as we know it today. Crazy but true! Prior to congress approval of the law change, there was a “destination of income test” which meant that revenues could be earned tax-free by a tax-exempt entity no matter the source, so long as the destination of the income furthered the tax exempt’s purpose. In 1947, some wealthy alumni donated the Mueller Pasta Co. to the NYU School of Law, the former being a for-profit and the latter being a nonprofit. The controversy arose when for-profit competitors cried foul since NYU was earning tax-free income on the pasta maker’s income. The response from the lawmakers was the undoing of the destination test and resulted in the unrelated business income tax. This change was widely viewed as creating parity or “leveling the playing field” between for-profits and nonprofits regarding business activities unrelated to the exempt purpose of the nonprofit.
Tax-exempt organizations should review all revenue streams and document taxation implications for purposes of documentation under ASC 740 Uncertain Income Tax positions (the old FIN 48 that is still referenced on the Form 990 Part IV Line 11f).
- The standard here, as described in the typical financial statement footnote, is a greater than 50% standard, or more-likely-than-not, that the position taken for income tax will be upheld should it be put to the test of an IRS examination.
- Pro Tip: Be sure to analyze your organization’s miscellaneous revenue as well.
Revenues for nonprofits will fall into one of these 4 categories:
- Revenues from programs or other sources related to exempt purpose Examples:
a. Membership dues
b. Conference and meeting revenues
c. Publications or Research Journals
d. Tuition payments
e. Education and training
- Revenues excluded from income tax – examples:
a. Interest income
b. Rental income (from unrelated parties with no services performed)
c. Capital gains on sale of securities
d. Royalties (no substantial services performed)
e. Trade show income
- Revenues from unrelated trades or business – examples:
a. Sale of advertising space (online or print)
b. Online job placement service
c. Passthrough income from partnership investment
d. Debt financed rental income
The good news
The first three categories are tax-free to a tax-exempt organization.
The other news
The fourth category are types of income generally subject to tax. As is always true in the grey and complex world of tax, there are many rules even within each of these examples, and there are always exclusions and exceptions to each rule – so the facts and circumstances in your organization’s particular scenario are important to review and understand with your tax preparer or CPA.
Show Me How
Here is a simple example that addresses an organization’s revenue streams for the applicable tax year:
Compliant Charity, Inc.
Revenue Stream Documentation for purposes of ASC 740
Tax year ending December 31, 2020
|REVENUE||DESCRIPTION||TYPE & TAXATION||COMMENTS|
|Contributions||Amounts received from individual, corporate, foundation and other donors||Not subject to tax||N/A|
|Conferences and Meetings||Participant fees for attendance at annual meeting and several conferences throughout the year||Related or Exempt Function Income – Not subject to Tax||N/A|
|Membership||Fees paid by members to have access to high level information applicable and relevant to their careers and the ability to engage with fellow members on issues in the industry||Related or Exempt Function Income – Not subject to Tax||N/A|
|Publication income||Advertising space in journal sold to various vendors||Unrelated business revenue – Subject to Tax||N/A|
|Publication Advertising income||Advertising space in journal sold to various vendors||Unrelated business revenue – Subject to Tax||Need to capture gross receipts from sale of advertising space and report on Form 990-T with directly connected expenses|
|Rental income||Amounts received from various local businesses who use the building for events on the evenings and weekends||Revenue excluded from tax – under IRC 512(b)(3)||No services are provided with the rental of space|
|Sale of securities||Investment sales creating gains or losses during the tax year||Revenue excluded from tax – under IRC 512(b)(5)||N/A|
Pro Tip: Amounts subject to tax are considered on a gross receipts’ basis. This means even if you believe the taxable activity is being run at a loss considering all revenues and directly connected expenses, the nonprofit organization may still have a filing requirement.