Posted by Abundant Wealth Planning LLC

Tax Concerns When a Nonprofit Organization Earns Money

Tax Concerns When a Nonprofit Organization Earns Money

The sole essence of a nonprofit organization is not to make money; instead, they fulfill other purposes as stated by the law: charities, scientific, educational, or literary. Considering the federal and state tax laws, if a nonprofit organization is set up for a distinct and recognized purpose, and they have the right tax exemptions, such a corporation can collect more money than they earn to direct its activities. 

This means that you can make a profit even as a nonprofit organization. However, the issue of tax is a factor of the activities if it is a nonprofit purpose. 


Profit coming from “Related” Activities

Nonprofits that are tax-exempt will likely make money from their activities and use the activities for expenses. This income, most time, is primal to the survival of the firm. If nonprofit activities are solely for the nonprofit purpose, the profit from such activity cannot be taxed as income. 

We will consider an example of a group known as Sons of Art, Inc. This group is nonprofit since there is a federal tax exemption. The idea behind Sons of Art is to drive people's interest in art and raise funds to support the renovation and further upgrade of the local museum. There is an exhibition which brought some profit. 

Since these activities are educational, it did not endanger the tax-exempt status of the group. As a result, the corporation can use the income to cater for its expenses or other benefits of the museum. It can also pay the salaries of staff with the funds. However, it cannot give any of the proceeds to nonprofit officers, organizers, or others linked to the museum. 


Profit Coming from Business Activity that is “Unrelated”

There are times a nonprofit could make money from activities that are not related to its sole purpose. Even though nonprofits have a provision for earning business income from unrelated sources, it will not hurt their normal nonprofit status. They, however, will be required to pay both federal and state corporate tax.

Still using Sons of Art's example, let us assume people donated many old arts for its recent gallery opening, which was one of the main fundraising events. Even though the sale was successful, there was a year they had a series of arts and photos leftover, and the team decided they would advertise to get buyers. They got a successful and overwhelming response that they had to hire three employees to assist with the workload. 

Soon, Sons of Art started buying art from dealers and artists and selling it back to the public. Such a nonprofit will need to report the earnings to Uncle Sam, which will be taxed as income from business activities that are not related. 

In a couple of situations when business activities that are not related to a business get excessive, it can make Uncle Sam query the tax-exempt status of an organization. For a firm to avoid this, a nonprofit should avoid making unrelated business activities get so much that it starts looking like a usual business activity. 

For example, you should not have an unrelated business activity get so much that the staff will have to devote excessive time, hire extra staff or volunteer, and bring in excessive gain than those generated by the organization's exempt activities. 


Activities Not Taxed

There are times the difference between the "unrelated" and "related" activities of a nonprofit firm can be confusing. As a result, the IRS has specified that some activities will not be taxed even if such actions have no relation to the firm's purpose.

A quick recap of such activities are:

  • Activities that have almost every part of the work done by volunteers

  • Activities with the sole aim of benefiting the members, students, officers, workers, etc. 

  • Sale of any item donated to the nonprofit 

  • An exchange of the donor mailing list

  • Distribution of insubstantial items as an encouragement for donation

The IRS has many more details about rules for nonprofit organizations. You can check to ensure you are not breaking any law.


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