In general, income generated by a 501(c)(3) organization from an online store could be considered unrelated business income (UBI) and subject to taxation. It depends on whether the activity is substantially related to the organization’s exempt purpose.
Under the Internal Revenue Code (IRC), UBI is addressed by Section 511-514.
1. Unrelated Business Income
- IRC § 513 defines unrelated business income as income from a trade or business that is regularly carried on and is not substantially related to the exempt purpose of the organization.
- For an activity to be substantially related, it must contribute importantly to accomplishing the exempt purpose of the organization (IRC § 513(a)).
2. Key Factors for Determining UBI
- Regularity of the Business: If the activity (such as the gift shop) is conducted regularly, it is more likely to be considered UBI. This is clarified in IRC § 513(b), which states that an activity is “regularly carried on” if it is conducted with a frequency and continuity similar to those of commercial businesses.
- Substantial Relation to Exempt Purpose: Under IRC § 513(a), for an activity to not be considered unrelated, it must be substantially related to the exempt purpose of the organization.
3. Examples
- Not UBI: A gift shop at a museum that sells books, educational materials, or other items directly tied to the museum’s mission is often not considered unrelated business income. The sales help to further the museum’s educational purpose.
- UBI: If the gift shop sells general merchandise (like souvenirs) that are not related to the organization’s mission (e.g., generic gifts or trinkets), the income may qualify as UBI and could be subject to taxation.
4. Exclusions
Certain activities may be excluded from UBI, even if they are commercial in nature. For example, IRC § 513(d) excludes from UBI the sale of donated items. So, if the gift shop operates primarily by selling donated items, it may not generate UBI.
5. Unrelated Business Income Tax (UBIT)
If a 501(c)(3) organization generates UBI, it is subject to the Unrelated Business Income Tax (UBIT) under IRC § 511. The organization must report this income on Form 990-T.
Important Internal Revenue Code Sections
- IRC § 513 – Definitions and exceptions for unrelated business income.
- IRC § 511 – Imposition of the unrelated business income tax.
- IRC § 513(b) – Defines “regularly carried on.”
- IRC § 513(d) – Exclusion of certain sales from UBI, such as sales of donated items.
In summary, it might be best to keep the online store in the nonprofit if it is deemed to be unrelated business income. The Form 990 T can be used to pay the tax on this income rather than having a separate entity.
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