How Unrelated Business Income Could Jeopardize Your Nonprofit’s Tax-Exempt Status

What happens when a good idea for revenue starts pulling you away from your mission?

You’ve poured your heart into building a nonprofit that’s making a real difference. The mission drives you, and the impact keeps you going. But as your organization grows, so does the need for funding. You consider diversifying revenue streams, maybe even venturing into business-like activities. After all, sustainable revenue sounds like the perfect solution, right?

Here’s the catch: not all revenue is created equal. Steering too far off course can jeopardize everything you’ve built. Running a nonprofit isn’t just about passion. It’s a balancing act. While funding is essential to keep operations running, the source of that funding truly matters.

That’s why understanding Unrelated Business Income (UBI) is so critical. Many organizations unintentionally cross IRS boundaries when pursuing revenue that seems harmless, such as selling merchandise, offering services, or monetizing content. But if that income isn’t directly tied to your mission, it could cost you your tax-exempt status.

At its core, your nonprofit exists for two primary reasons: to fulfill a charitable purpose and to maintain tax-exempt status. These aren’t just legal checkboxes. They’re the foundation of your work. Your donors rely on that IRS determination. So do your partners. And more than anything, tax exemption allows your dollars to stretch farther in service of your community.

As nonprofits grow and evolve, the line between impact and income can blur. The IRS allows some entrepreneurial activity, but it must stay in the background. If unrelated revenue becomes central to your operations or displaces your primary mission, that’s when the IRS steps in. And when they do, the consequences can be steep. That includes financial penalties, audits, and even revocation of your exempt status.

Being mission-first doesn’t mean thinking small. It means being strategic. It means protecting the very structure that allows you to do this work.

UBI is revenue generated by a trade or business that is both regularly carried on and not substantially related to your nonprofit’s exempt purpose. Even if that income helps fund your programs, the IRS won’t consider it exempt unless it supports your mission directly.

For example, charging admission to an educational event that’s part of your core programming? Not UBI. But running a gift shop full of unrelated consumer goods? That’s a red flag.

To clarify, UBI:

• Must be reported separately on Form 990-T
• May be subject to Unrelated Business Income Tax (UBIT)
• Should remain limited within your overall revenue strategy

While the IRS doesn’t set a hard limit, most advisors recommend keeping UBI well below 20 percent of your organization’s total revenue. The higher that percentage climbs, the more scrutiny you invite.

It’s not just about numbers. It’s about alignment. When unrelated income becomes central, it shifts how your organization is perceived. The IRS may decide you’re no longer operating like a nonprofit at all.

Let’s say you operate a youth arts nonprofit. You start selling branded apparel to raise funds. The shirts are a hit. You double down, launch more designs, buy Facebook ads, hire part-time help to fulfill orders. Slowly, what began as a side effort becomes a core operation. You’re spending more time selling shirts than delivering art programming.

That’s when trouble starts.

From the IRS’s point of view, you’ve lost the plot. The sales may be legal, but they’re now unrelated in both spirit and scale. We’ve seen nonprofits trigger audits after earning tens of thousands in sponsorships and merchandise sales without any corresponding programming to justify it. It’s not about intent. It’s about how the balance of activity is perceived.

Mission drift happens gradually. And by the time you notice, you may already be exposed.

Your nonprofit wasn’t built to act like a business. It was built to solve problems, serve people, and meet needs. That’s why mission alignment is more than a buzzword. It’s the backbone of your IRS recognition.

Mission-driven revenue includes things like program fees for services you already offer, sales of products created through your programs, or fundraising events that put your mission front and center. These income streams serve your exempt purpose directly.

By contrast, unrelated business income tends to come from commercial activities that operate independently of your mission. Think online stores full of generic products, stand-alone cafés or venues, or corporate sponsorships that cross the line into advertising.

Here’s a simple test: if it walks, talks, and behaves like a business, the IRS will likely treat it like one.

You don’t have to stop raising money. You just need to raise it with intention. Here’s how to stay on track without stunting your growth:

• Ask the right question. Does this revenue idea clearly support your charitable purpose? If not, can it be restructured so that it does?
• Track unrelated income carefully. Monitor its frequency, scale, and percentage of overall revenue.
• Use the volunteer labor exception. Activities run by volunteers or based on donated merchandise often avoid UBIT.
• Structure sponsorships with care. Stick to name acknowledgment. Avoid perks, exclusivity, or anything that resembles advertising.
• Spin off substantial business activity. If needed, set up a separate taxable subsidiary to protect your exempt status.

Smart fundraising doesn’t have to be risky fundraising. Clarity is your best defense.

Unrelated Business Income Tax (UBIT) exists to level the playing field. It ensures nonprofits don’t use their tax-exempt advantage to compete unfairly in the commercial space.

UBIT applies when income-generating activities are:

• Ongoing
• Commercial in nature
• Not substantially related to your mission

Common sources of UBIT include:

• Advertising revenue
• Sponsorships that include promotional value
• Rental income from debt-financed properties
• Royalties tied to services or active involvement

Common exceptions include:

• Activities powered entirely by volunteers
• Sale of donated goods
• Passive income like interest, dividends, or certain types of rent

Even if you owe UBIT, it doesn’t mean you’re in trouble. It just means you need to report and manage it with care.

At the end of the day, UBI is about more than taxes. It’s about trust.

Your financial reporting tells a story. When funders, donors, or regulators look at your Form 990, they’re not just scanning the numbers. They’re gauging your priorities. Are you mission-led? Are you managing risk? Are you being transparent?

Filing Form 990-T, if needed, isn’t just about checking a box. It’s about showing that you take compliance seriously. Disclose any goods or services exchanged for donations. Record board conversations in your minutes. Make your alignment visible.

Because when your community sees that your finances are clean and your focus is clear, they’re more likely to support your mission.

Revenue is important. But it should never replace purpose.

Don’t let clever ideas about fundraising overshadow the cause that brought you here. Compliance might sound like red tape, but it’s really a safeguard. It’s the structure that protects your nonprofit’s right to exist and thrive.

At Foundation Group, we’ve spent decades guiding nonprofits through formation, IRS compliance, and nonprofit bookkeeping. Whether you’re questioning your current revenue streams, concerned about unrelated business income, or just looking for peace of mind, we’re here to help.

Feeling unsure about what counts as ‘too much’ business income? That’s exactly the kind of clarity we help nonprofits find every day. Reach out to Foundation Group and speak with someone who understands the terrain and how to keep your mission protected.

Because when your mission stays at the center, everything else falls into place.