Public charities can generate income in two primary ways: through activities directly related to their mission (tax-exempt income) or unrelated business activities (subject to tax). Understanding the difference can help a charity make informed decisions, maximize tax benefits, and support its mission effectively.
Income in Furtherance of Exempt Purposes (Related Income)
When a public charity earns income directly related to its core mission or exempt purpose, this income is tax-exempt and supports the organization’s mission without affecting its tax-exempt status.
Examples of Related Income
- Educational Charity Selling Educational Materials
- Example: A public charity focused on environmental education publishes and sells books, guides, and online courses on conservation.
- Impact: Since these sales are educational and support the charity’s mission, this income is tax-exempt.
- Healthcare Charity Providing Medical Services
- Example: A charity hospital charges a nominal fee for medical services to underserved communities to cover some operating costs.
- Impact: This fee income is tax-exempt because it directly supports the healthcare mission.
- Animal Shelter Offering Adoption Fees
- Example: An animal shelter charges adoption fees to cover the costs of care, vaccinations, and placement for animals.
- Impact: These fees are tax-exempt as they align with the charity’s purpose of finding homes for animals.
- Museum Charging Admission Fees
- Example: A nonprofit art museum charges admission to fund exhibitions and art education programs.
- Impact: Admission fees are considered related income and are tax-exempt as they support the museum’s mission of public education in the arts.
Recommendation: Private Foundations and Required Distributions: A Guide to I.R.C. Section 4942 Compliance
Unrelated Business Income (UBI)
If a charity engages in income-generating activities that do not directly relate to its exempt purpose, that income is usually considered Unrelated Business Income (UBI) and may be subject to the Unrelated Business Income Tax (UBIT). UBIT applies to income from activities that are a trade or business, regularly carried out, and unrelated to the charity’s exempt purpose.
Examples of Unrelated Business Income
- Charity Selling Merchandise Unrelated to Its Mission
- Example: An environmental charity sells general merchandise, such as clothing or mugs with popular slogans, without an educational or advocacy purpose.
- Impact: This income may be subject to UBIT because it is unrelated to the charity’s environmental mission.
- Nonprofit Renting Space for Unrelated Events
- Example: A charity rents out its extra building space for weddings or corporate events that are unrelated to its mission.
- Impact: This rental income is considered UBI and may be taxable, as it doesn’t support the charity’s purpose.
- Nonprofit Running a Café with No Educational Component
- Example: A museum operates a café that functions solely as a regular restaurant, without educational displays or programming.
- Impact: The income from the café could be taxable because it doesn’t directly contribute to the museum’s mission.
Key Takeaways
- Related Income: Income that directly supports a charity’s mission is typically tax-exempt.
- Unrelated Income: Income that doesn’t support the mission may be subject to UBIT.
Carefully structuring income-generating activities to align with their exempt purpose allows charities to maximize tax benefits while fulfilling their mission.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. Consult a qualified attorney or tax advisor for guidance specific to your organization’s circumstances.
