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A carefully considered mix of earned and contributed revenue can help you thrive in any economic conditions.

Tax strategies

Nonprofits: Don’t Fear Earned Revenue — Respect It and Grow With It

  • Bruce Braunewell
  • 5/12/2017

Don’t get tripped up by your “nonprofit” moniker and operate under the belief that your revenue-generating abilities are limited. This is simply not true. Your exempt organization is a business and it should be run like a business or it will suffer the same fate as any poorly run for-profit entity. A healthy mix of revenue sources — even those with tax consequences — can be the key to sustainability.

In a recent interview with Gail Bower, a nonprofit revenue strategist and founder of Bower & Co. Consulting LLC, I talked about how earned revenue ― that is, revenue from the sale of goods and services ― can be a two-edged sword for nonprofit organizations. On one hand, it can help diversify revenue streams and build reserves for tough times. On the other hand, there are legal and tax issues that can arise from unrelated business income (UBI). In many cases, earned revenue is more predictable than donated funds and grants. While CEOs and finance committees should give the potential tax liability the respect it deserves, they should not automatically exclude earned revenue from a diverse revenue mix.

Most organizations know that an over-reliance on a single revenue source, whether it be donations, grants, or government funds, can be unsustainable. We have seen organizations that are 80 to 100 percent dependent on government funding. When state budgets are slashed and those resources are no longer there, these organizations may find their future in jeopardy.

A mix of earned and contributed revenue is generally the way to go. Earned revenue may include things like the sale of tickets and admission fees for museums and performing arts organizations, merchandise, products, and thrift store sales. The other main revenue stream for nonprofits generally includes individual donations, corporate funding, bequests and endowments, and government and private grants.

Why pursue earned revenue?

As an organization, you should think critically about why new revenue streams are being considered. Some of the reasons will relate directly to your current mission (to expand services, for example), some may branch into new mission areas (addressing a different area of need with the same constituents), and others may be purely to generate much-needed reserves (a smart goal). Understanding these distinctions will be an important part of reporting the activity and potentially limiting your tax liability.

Earned revenue is not the answer for every organization, but for many, it offers a number of solid benefits:

  • Use these funds as you wish, there are no strings attached
  • Become more self-sufficient
  • Develop stronger, more diverse, better-funded programs
  • Improve your image and visibility in the community
  • Create a customer service mentality that can improve how you serve your clients

The reputation and reality of UBI

Exempt organizations that generate earned revenue from a trade or business that is carried out on a regular basis and is not related to their mission (and exempt purpose) may have to classify all or part of those dollars as UBI and remit unrelated business income tax (UBIT). Some common examples of revenue that can trigger UBIT include:

  • Rental of debt-financed property
  • Advertising revenue generating from a program book
  • Fitness center or day care fees generated from the general public
  • Gift shop sales to the general public

Just mentioning UBIT can cause trepidation for some nonprofit leaders. However, earning UBI is not prohibited and is not necessarily a bad thing. If your organization identifies a business activity that is going to help diversify revenue streams and could potentially lead to an increase in much-needed reserves, it may be well worth it to pay UBIT on the funds generated by that activity. For a limited number of nonprofit entity types, such as a social club, too much UBI will cause termination of the tax-exempt status.

The threshold for reporting UBI to the IRS is extremely low; gross UBI of at least $1,000 must be reported on Form 990-T. There are also limits on how much UBI a nonprofit can generate. It’s not a set dollar amount or percentage of revenue. Instead, every organization has to look at its specific facts and circumstance. A red flag should pop up if you are spending the same amount of time (or more) on UBI activities as you are on exempt function activities. When this happens, there may be a reason for some evaluation and restructuring.

IRS regulations related to UBIT are complex and can be interpreted differently based on the facts and circumstances of each case, so it’s not recommended (or even possible) for your CFO and finance committee members to try to memorize every scenario. However, you should be able to recognize the types of revenue streams that could create a UBIT liability so they can be addressed early in the planning stage.

How we can help

Any potential new revenue streams, whether earned or philanthropic, should be discussed with outside advisors (an accountant, auditor, and attorney) early in the planning process. These professionals will be able to help you with guidance on structure, tracking, and the potential tax impact of certain revenue sources before you get too far down the road. There are no one-size-fits-all solutions; every situation has its own specific facts and circumstances that will need to be taken into consideration.

CLA’s experienced nonprofit professionals can provide a quick, comprehensive report on your organization’s expenses, revenue sources, profitability, liquidity, and more with the Financial SCAN benchmarking tool. The report lets you explore your options and develop a revenue mix that helps keep your organization thriving in every economy.