Fox Business recently ran an article on a creative way non-for-profit universities have been raising funds. (See the article here). As a basic summary, universities have started renting out dorm rooms to people in order to raise additional funds to support the university. These creative ways to raise additional revenues come as enrollment numbers and state financing have been declining. With these creative fund raising ideas, non-for-profits need to be aware of unrelated business income and what effects these rules could have on their non-for-profit.
Typically, non-for-profits are not taxed on any income that the non-for-profit makes. The one main exception to this policy falls under Internal Revenue Code Section 513. This section states that any trade or business carried on by a non-for-profit will be taxed if the trade or business is not substantially related to the non-for-profit’s exempt purpose.
The first issue is whether or not the activity is a trade or business. When considering if an activity is a trade or business, the IRS looks to see if the activity has some sort of profit motive. If the activity does not have a profit motive, then it will not fall under the unrelated business income rules.
The next issue is the activity needs to be related to the non-for-profit’s exempt purpose. This just means the activity needs to relate to whatever purpose the non-for-profit was created for. The relationship cannot be that the activity provides funds for the non-for-profit to carry out its activities.
For example, in a university bookstore, the university sells books and sells branded apparel. Selling books to students helps educate the students which align to the exempt purpose of the university. Selling apparel does not really contribute to the exempt purpose, so it is not related to the exempt purpose and would therefore be subject to the unrelated business income rules.
As a small caveat to this rule, the activity must be regularly carried on. So, if the activity is only once a year, it will not be subject to unrelated business income rules. The major case in this area dealt with the ad revenue from programs sold at the NCAA Basketball Tournament, where the court held the tournament was not regularly carried on so ad revenue from the tournament would not be subject to unrelated business income rules.
From the Fox Business article, it would appear that the universities will be subject to the unrelated business income rules since renting dorm rooms is a trade or business and it is not related to the exempt purpose of providing education. However, Internal Revenue Code Section 513 does exempt some income from these rules. This income includes, but is not limited to interest, dividends, royalties, and rental income from real property (not personal property). So, even though the income is unrelated business income for these universities, it is statutorily exempt from these rules.
As funds start declining for non-for-profits, coming up with creative ways to generate revenue can be a great way to help serve your non-for-profit. When coming up with these types of plans, it is always best to consult with a tax adviser to see if your non-for-profit’s creative ideas will be subject to unrelated business income.
