Nonprofit corporations exist to fulfill recognized purposes, such as charity, education, science, or literature. As long as a nonprofit is organized and operates for a recognized purpose, and has the necessary tax exemptions, it can generate more money than it spends. This means it can make a profit. Whether this profit is taxable depends on the relation to the nonprofit’s purpose.
Tax-exempt nonprofits often make money from their activities to cover expenses. This income is crucial for an organization’s survival. As long as the activities are related to the nonprofit’s purpose, any profit made from them is not taxable.
For example, the Friends of the Library, Inc. is a nonprofit organization that encourages literature appreciation and raises money for the local library. It profits from a lecture series featuring famous authors and an annual sale of donated books. Since these activities are educational and literary, they do not jeopardize the organization’s tax-exempt status.
Nonprofits sometimes make money from activities unrelated to their purposes. In these cases, they have to pay corporate income taxes on the unrelated income, as per state and federal tax rules. (The first $1,000 of unrelated income is generally exempt from tax.)
Returning to the example of Friends of the Library, they receive many donations for their annual book sale and decide to sell the more valuable books by advertising to book collectors. This leads them to buy books from other dealers and resell them, qualifying as unrelated business activities that are taxable.
Excessive unrelated business activities can lead to reconsideration of a nonprofit’s tax-exempt status. To avoid this, nonprofits should not let unrelated activities resemble regular commercial businesses. They should not take up a significant amount of staff time, require additional paid staff or volunteers, or generate much more income than exempt activities.
The IRS has provided guidelines on activities that are not taxed, even if they are unrelated to the nonprofit’s purpose. These include activities carried out primarily by volunteers, activities benefiting members, students, patients, officers, or employees, sales of predominantly donated merchandise (e.g., thrift stores), rental or exchange of mailing lists, and the distribution of items worth less than $5 as incentives for donations.
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