Charitable 501(c)(3) organizations receive tax-exempt status because their missions are to benefit society, and the majority of their revenue goes toward achieving their tax-exempt purpose. Yet, many such organizations also operate retail ventures such as a museum gift shop or a hospital-run thrift shop. Proceed cautiously, however, because although commercial-like activities can help generate after-tax income, straying too far into commercial territory can cause revocation of your exempt status.

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haritable 501(c)(3) organizations receive tax-exempt
status because their missions are to benefit society,
and the majority of their revenue goes toward achiev-
ing their tax-exempt purpose. Yet, many such organizations
also operate retail ventures such as a museum gift shop or
a hospital-run thrift shop. Organizations should be aware that
doing so has pitfalls from a tax perspective.
While nonprofit organizations may receive an unlimited
amount of income that is “substantially related to the pursuit
of its exempt purpose” (generally not subject to income tax),
charities that regularly engage in business activities unrelated
to their exempt functions may be subject to tax on the net
income from these activities. If this unrelated business activ-
ity becomes “substantial,” the charity risks losing its exempt
status. Therefore, it is vital that the organization not only
demonstrate that its income-generating business activity is
an appropriate method of achieving the organization’s exempt
purposes but also show that there is no substantial non-
exempt commercial purpose.
How much Unrelated Business Taxable Income (UBTI) can
a nonprofit receive without jeopardizing its tax-exempt
status?
The IRS may consider proceeds from nonprofits’ retail ven-
tures UBTI if the income is considered a “trade or business,”
is regularly carried on and is not substantially related to the
nonprofit’s exempt purpose.
For nonprofits, exclusions to UBTI include income substan-
tially generated by unpaid volunteers; retail income donated to
the nonprofit; dividend, interest and royalty income and gains
from sale of property; and retail income from real property
(provided the property is not debt financed).
Because the IRS does not provide iron-clad guidelines for
organizations to follow regarding UBTI, organizations instead
must use their own judgment to interpret IRS rulings made in
cases similar to their own.
IRS regulations provide that a trade or business is “re-
lated” to an organization’s exempt purposes only where the
conduct of the business activities has a causal relationship
to the achievement of exempt purposes and the activity from
which the gross income is derived contributes importantly to
the accomplishment of those purposes.
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Do Your Nonprofit’s Retail Activities Venture into Commercial Territory?
Article reprinted from Spring 2014GROWTHBIZS T R A T E G I E S
A connection between the items sold in a gift shop and
accomplishing the organization’s exempt purpose must be
established before sales of the items can be considered
substantially related within the meaning of section 513(a) of
the Code.
In general, when the IRS determines whether UBTI is
substantial it considers the reasonableness of the commercial
venture’s pricing, the extent of the commercial venture and the
size and extent of the commercial venture relative to the size
of the exempt function it is said to serve.
Proceed with caution.
Expanding into new activities is a great way to grow your
nonprofit organization, support its mission and take advantage
of new opportunities. Proceed cautiously, however, because
although commercial-like activities can help generate after-tax
income, straying too far into commercial territory can cause
revocation of your exempt status.
BRENDA BOOTH
CBIZ MHM, LLC • Boston, MA
617.761.0729 • bbooth@cbiztofias.com