According to the IRS, an unrelated business income is an activity that is unrelated to the organization’s goal, according to these three requirements:
1. It is a trade or business. These terms generally include activities involving the making of income from selling goods or performing services. It’s important to remember that even if you’re producing or distributing goods or performing services for the benefit of your organization (and still making money from it), those activities don’t lose their identity as trades or businesses. These activities that exist within a larger framework of other activities aren’t necessarily related to the organization’s exempt purposes.
2. It is regularly carried on. This rule applies if your organization is selling something that is producing revenue, and this selling has a frequency and continuity. This frequency/continuity can be comparable to commercial activities of businesses and other nonexempt organizations.
3. It is not substantially related to furthering the goals of your organization that helped determine it as exempt in the first place. But keep in mind that an activity has to be substantially related, which involves comparing the activity generating income and the organization’s goals. The activities that generate the income must contribute importantly to accomplishing the organization’s exempt purposes to be substantially related, and have a causal relationship to achieving exempt purposes (other than through the production of income).
This video provides a good example of what an unrelated business expense might be for a nonprofit or church: Say you’re selling shirts to raise money for a fundraiser. This wouldn’t be unrelated business income because it’s a one-off event. You may have additional fundraisers in the future, and that’s fine, but as long as you’re not selling the same good or performing the same service regularly (refer to rules 1 and 2), then it’s acceptable. In the scenario where you were selling a good or service on a regular basis to support your organization, then the act itself of selling these goods and services is unrelated to the mission of your organization, even if the mission of your organization will someday benefit from this revenue.
Hopefully you found some of this information useful, and if you need any clarifications or have questions, feel free to leave a comment and we’ll be happy to answer them.