Unrelated business income is the income from a trade or business that is regularly carried on by an exempt organization and that is not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from its activity.
Certain trade or business activities are not treated as an unrelated trade or business.
By its nature, selling a product is typically seen as a commercial or for-profit business venture. Though revenues received from selling products may be supporting charitable initiatives, it does not make the act of selling a product a charitable activity.
There are several methods in which a tax exempt organization can sell products on an ongoing basis to provide revenue for program activities.
If done correctly, 501(c)(3) organizations can sell products for fundraising:
- To have items available for sale ongoing, they must directly promote the organization and educate the purchaser to the mission of the organization. Examples would be t-shirts with the organization’s name on them. An informational card or tag which explained how the purchase supports the exempt program would be sufficiently educational to not be considered a retail activity. This is a recent shift over the last few years from the IRS. Bracelets, water bottles, and other similar products could be sold, again, as long as they directly promote the organization and educate the recipient of what the mission and purpose of the organization is, and how the purchase can support reaching that objective.
- Though not specific to “fundraising” selling products which result from the conduct of an exempt activity is an acceptable sale in a 501(c)(3). This may also include products created through the exempt qualifying program conducted by the organization. Per IRS Publication 598:
For example, if an exempt organization maintains an experimental dairy herd for the scientific purposes, the sale of milk and cream produced in the ordinary course of operation of the project is not an unrelated trade or business. But if the organization uses the milk and cream in the further manufacture of food items such as ice cream, pastries, etc. the sale of these products is an unrelated trade or business unless the manufacturing activities themselves contribute importantly to the accomplishment of an exempt activity.
This could also include products and services created through a job training program.
- To sell items that do not directly promote the organization, these need to be sold on short term fundraising campaigns. The best example of this would be the annual Girls Scouts cookie fundraiser. The cookies themselves do not promote the Girl Scouts, so can not be sold ongoing throughout the year, as that would make the sell of the cookies a retail activity. But since this is limited to a few weeks in the spring, as a fundraising campaign, it is compliant for them to sell the cookies.There are several key components of unrelated activities which will exclude an organization from being an unrelated trade or business, and thus exempt from taxes on such income raised.The first criteria for an otherwise unrelated activity is conducting the activity with an all volunteer workforce. The IRS gives two examples in this regard.
- The first is a retail store established by an orphanage to support the orphanage. The operation of a retail store, would typically be an unrelated business activity, not qualifying for exemption, but as the retail store is operated with volunteers, it is exempt from UBI.
- The second example is that of a volunteer fire department which conducts weekly dances to raise funds. Again, conducting weekly dances where admission would be charged would typically be considered an unrelated business activity, but as volunteers conduct the dances, this is exempt from UBI.
A second criterion for being exempt from UBI, is that an activity be done for the convenience of the members.
An example of this is an eating facility at a museum or a zoo. Typically, the operation of a restaurant would be commercial in nature, and income would be taxable, but in the case of a museum or zoo, the eating facility makes it more convenient for patrons to experience the museum or zoo, allowing them to have a meal, while remaining on site, and being able to continue see the site once they have had their meal. This also allows staff to eat on site. In this way, the eatery is for the convenience of the members, and supports the exempt qualifying activity and is exempt from consideration of UBI.