For the final blog post in this series, we will run through a case study of a hypothetical nonprofit to see how each one of these strategies can be used and how each can interact with the other.
The Doing Good Foundation is a Washington nonprofit 501(c)(3) organization. The Doing Good Foundation’s mission is to promote the production of literature in poor and distressed communities. Its primary activity is to help fund local authors in
poorer impoverished regions of the United States to help them have the necessary materials to write and publish their own literature. Most of the Foundation’s funding comes from donations and contributions from the public. The Foundation would like to figure out a way to earn income through the published works of the authors in order to continue to fund its activities in seasons when public donations and contributions slow down.
The Foundation can use all three of the strategies that we have talked about in this series, and in some cases, even combine some of the strategies.
The Foundation may be able to sell the authored works without paying any taxes on their sale if the authored works educate the public and spread awareness about the Foundation’s exempt purpose. Furthermore, the Foundation can always make the argument that the authors’ writing, publishing, and selling the books help directly further its exempt purpose of promoting the production of literature in poor and distressed communities. If this activity was directly related to its exempt purpose, the Foundation would realize no unrelated business income and would not even have to rely on an exception to UBIT (Unrelated Business Income Tax).
The Foundation can also use the passive income exception to UBIT either through dividends or through royalty payments. Through the dividend option, the Foundation would actually create a for-profit LLC and become the sole member of the LLC. The LLC could publish the books on its own, having an active role in the publishing and selling of the books. All profits of the LLC could be channeled through to the Foundation as tax free dividends. The disadvantage with this model is that the Foundation would have less control of the LLC since the LLC would need to follow all corporate formalities and operate separately from the Foundation. However, under this option, the Foundation need not worry about the sale of the books, building relationships with publishers, or the like. The for-profit LLC will do the grunt work. It will establish a contract with a publisher in exchange for a royalty payment. The royalty payment will be exempt from UBIT in its own right. The royalty payment will pass through the LLC to the Foundation as a tax free dividend. Neither entity will recognize income by this method.
As a second option, the Foundation could work with a publishing company, help the authors sell the rights to that publishing company, and receive a percentage of the royalty payment from the sale of the books. As passive income, these payments would be exempt from UBIT.
Finally, depending on how much funding the Foundation needs to have adequate reserves, the Foundation could simply take the sales as unrelated business income by taking on the publishing of the books themselves and selling them for a percentage of the revenue. The Foundation could only sell the books to the extent the revenue represents an insubstantial amount: the magic number is somewhere between 15% and 20% of its entire revenue. As should be clear by this series, not only can nonprofit and charitable organizations engage in what one might consider for-profit activity, but the health and good stewardship of the organization might actually demand such strategies in an economic climate that is becoming more and more unpredictable.