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What is Related Business Activity?

When a nonprofit charges a fee for service, or even sells product(s) as an ongoing activity directly related to its founding mission, it is considered a related business activity because it furthers the nonprofits mission. For example, if a nonprofit animal shelter charges a fee to allow a family to adopt a new puppy, it would be a related business activity.

The fee furthers the shelters mission to provide loving homes for animals in its care.

But not all business activities—or profits for that matter—are protected by a nonprofit’s tax-exempt status. So where does the line get crossed? And how can a nonprofit keep from accidentally conducting taxable business?

What is “Unrelated Business Activity”?

The simplest definition of unrelated business activity is that it is taxable profit a nonprofit earns through actions not directly related to its founding mission. But that doesn’t really mean much in the scope of things, so let’s back up and delve a little deeper.

If a business activity is not related to the organization’s tax-exempt purpose, then any profits would be considered “unrelated” and subject to the Unrelated Business Income Tax (UBIT), as applied when gross income from the unrelated business is $1,000 or more.

So, if a nonprofit animal clinic were to also run an exclusive dog breeding program—where the work is not only not performed by volunteers, but also doesn’t coincide with the founding mission of the shelter—then it’s possible that the gross income from this business venture could be considered unrelated.

In fact, it’s highly probable it would be considered unrelated.

Under IRS regulations, a nonprofit can risk losing its tax-exemption if a “substantial” portion of the organizations total activities are unrelated to its mission. When applied by the IRS, the word “substantial” is interpreted to be in effect when the unrelated business activity grows to 25% or more of the nonprofit organization’s activity.

And although the IRS does make certain standard exceptions, an activity is almost also considered to be unrelated if all three of the following are present:

– It is a trade or business

– It is regularly carried on

– It is not substantially related to furthering the exempt purpose of the organization

Although a nonprofit can engage in some unrelated business activity and pay taxes on the profit, it’s always best to be careful. If you think it may be possible that your nonprofit could be gaining 25% or more of your profits through an unrelated business venture, a lawyer well-versed in UBIT and other nonprofit tax/legal implications can help you determine how to keep your 501(c)(3) status and avoid the pitfalls of losing your tax-exempt status.

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03/27/12 3:18 AM

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