The tax code requires that tax-exempt organizations be taxed on income derived from trade or business that was both regularly carried on and not substantially related to the organization’s exempt purpose(s). As an example, a nonprofit that was chartered to help protect African wildlife and which regularly traded in precious metals would be taxed on the income derived from the metals trading. Such income in known as unrelated business taxable income (UBTI). Historically, not all instances of income that the IRS considered unrelated were so obvious as this example.
Then, in a private letter ruling recently issued, the IRS determined that a foundation established to improve the lives of low-income children and their families could charge fees for collecting and analyzing data that would support their charter without the fees being treated as UBTI.
It is important to note that the services at issue furthered the foundation’s charitable purpose, were provided to other exempt organizations that shared that purpose, and the fees were determined based on each customer’s ability to pay.
Profits Are Irrelevant
It is also interesting to note that profitability is not a consideration when determining whether income is taxable. In a 1972 case, the IRS held that an organization formed to provide managerial and consulting services at cost to unrelated exempt organizations was itself not exempt under the code because providing those services on a regular basis for a fee is a trade or business ordinarily carried on for profit, and the fact that the services were provided at cost and solely for exempt organizations was not sufficient to characterize the activity as charitable.
Take-Away
When determining whether to take on another project, it is prudent to ensure that the project will advance your organization’s mission. This is true regardless of whether you charge a fee for providing services.
The nonprofit foundation that prompted the IRS letter previously absorbed all costs of providing technical assistance to other exempt organizations, which limited the number of projects it could take on. Now it charges a “reasonable fee” for technical assistance requests that require more than four hours of staff time. They can now expand the reach of these services due to generating new revenues.