Tax-Exempt Organizations may earn income that is used to fulfill a public purpose. For example, a charity that is organized to provide food for the homeless may receive donations, grants and other funds. Provided the organization meets Internal Revenue Service requirements and uses the funds to purchase and distribute food, the organization will not be assessed taxes on the money received. Tax-Exempt Organizations need to ensure that they use any income for appropriate purposes only in order to keep exempt status.
Tax-Exempt Organizations must identify their purpose, which must provide some type of public benefit or charitable service. Under some circumstances, however, a Tax-Exempt Organization may engage in activities that generate a profit and that are outside of the normal scope of operations. For example, a Tax-Exempt free clinic may begin a side operation selling non-prescription pharmaceutical medications at an on-site pharmacy. The free clinic is earning business income that may not be considered Tax-Exempt. This money is called Unrelated Trade or Business Income (UTBI).
When a Nonprofit or Charity earns Unrelated Trade or Business Income, the Tax-Exempt Organization may be charged tax on this specific limited income only while still retaining Nonprofit status. It is important to understand the circumstances in which an organization will be taxed on Unrelated Trade or Business Income in order for an organization to comply with IRS obligations. An experienced Scottsdale Arizona nonprofit business lawyer at Lotzar Law Firm, P.C. can assist with understanding whether your organization is earning Unrelated Trade or Business Income.
Earning Unrelated Trade or Business Income (UTBI)
Unrelated Trade or Business Income is money that a Nonprofit Organization is taxed on. There is a very specific set of requirements that must be met for money that a charitable organization makes to be classified us UTBI. The IRS specifies that the key criteria include:
- The income is earned through a business or trade.
- The activities resulting in the income being earned are regularly carried out by the exempt organization.
- The activities resulting in the income are not substantially related to furthering the purposes of the organization.
According to the IRS, Trade or Business “generally includes any activity conducted for the production of income from selling goods or performing services.” The fact that a particular activity is similar to the activities conducted for the purpose of a nonprofit does not necessarily mean it is not a trade or a business. For example, as the IRS explains, the fact that a pharmacy provides medication and supplies to a nonprofit hospital does not change the fact that its provision of supplies to the general public is a business or trade.
The question of whether an activity is regularly performed or not is also important. For example, if a Charitable Organization has a one-time bake sale, the income would not be taxed even if the production of baked goods was not related to its organizational mission. If the Charitable Organization begins operating a bakery and routinely sells its products, then the earnings from the bakery may be considered Unrelated Trade or Business Income and will be subject to taxation.
Finally, the IRS indicates that: “A business activity is not substantially related to an organization’s exempt purpose if it does not contribute importantly to accomplishing that purpose (other than through the production of funds).” This question must be answered by considering the facts in a particular case.
It is imperative your charitable organization follows the rules regarding taxation of unrelated trade or business income. A Scottsdale Arizona business law attorney at Lotzar Law Firm, P.C. can provide assistance in understanding your obligations and complying with tax requirements. Call today to schedule a consultation and learn more.
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