Earned Income Strategies (Part 1 of 5): How For-Profit Strategies Can Help Nonprofit Corporations

It’s no secret that charitable resources are limited and hard to come by for small nonprofit organizations. Many foundations and grant making entities, in fact, advise nonprofits to develop long term funding plans that utilize the for-profit sector and investment strategies to counteract this issue. Therefore, it is advisable, if not economically necessary, for nonprofits to understand what we refer to as “earned income strategies.”

Earned income strategies, for the most part, “involve setting up a business spin-off that complements an organization’s work[1].” Income generated by a nonprofit that is unrelated to its charitable purposes will be taxed at a standard rate as unrelated business income (“UBIT“), so long as it is insubstantial (otherwise a nonprofit’s tax-exempt status could be in jeopardy). As with most tax rules, there are exceptions, and these exceptions can be tricky. This blog series will help you understand the different earned income strategies that nonprofits can-and often should-engage in. Below is a brief outline of what each post in this series will discuss.

Related Business Activity: A nonprofit can earn income by conducting business that is related to its charitable purposes. Nonprofits like FareStart and Haiti Babi all offer products and services akin to what a for-profit restaurant or retail outfit would offer. But unlike for-profits, FareStart and Haiti Babi do not have to pay taxes on the sale of their services or products. Why? Because their services and products are directly related to their exempt purpose. The Farestart restaurant works to train people in jobs who would normally be extremely difficult to hire in the average job market. Haiti Babi’s handmade products are specifically made by people in Haiti in order to help with economic development in that area.

Passive Income Activity: A nonprofit can receive funds in the form of passive income, even if such income is completely unrelated to its exempt purposes, without being taxed. Classic examples of this include dividends from a for-profit business, royalties from the licensing of intellectual property, and rental income from owned real property. Income must be truly passive to fall into the passive income exception to UBIT. The nonprofit must not have control of the income flow or operations resulting in income. As an example of dividends, a nonprofit can wholly own an LLC and receive all profits from the LLC in the form of dividends so long as the nonprofit does not managerially control the LLC. An example of royalties would be licensing the nonprofit’s trademark to use as a co-venture for for-profit branding, like having a university’s logo on your VISA card.

Unrelated Business Activity: Finally, a nonprofit can simply engage in unrelated business and pay the standard tax. Be warned: this course of business will only be advisable if the unrelated business is an “insubstantial” amount of what the nonprofit does. This can be a tricky and dangerous exception, but fruitful when done correctly.

Moving forward, we will discuss each of these strategies in greater and depth and how they can be used in conjunction in order to advance your nonprofit into financial health.

The above article is for general information purposes only and should not be relied upon as specific legal advice. This article, or using the contactapex@apexlg.com form, does not in any way form an attorney-client relationship. If you have any questions or would like to learn more, please contact Jacob Ferrari at jacob@apexlg.com.

[1] https://www.ncrp.org/publication/responsive-philanthropy-fall-2014/earned-income-strategies

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