New Revenue Idea? Watch Out for the Commerciality Doctrine
February 10, 2021

If your nonprofit has lost financial support during the pandemic, you may be looking for ways to raise new revenue. But if your proposed solution is a side business, be careful. Even when business ventures are related to a nonprofit’s exempt purpose, they can run afoul of the commerciality doctrine — and jeopardize an organization’s tax status.

Countering an Unfair Tax Advantage

The commerciality doctrine was created along with the operational test to address concerns over nonprofits competing at an unfair tax advantage with for-profit businesses. In general, the operational test requires that a nonprofit be both organized and operating exclusively to accomplish its exempt purpose. The test also requires that no more than an “insubstantial part” of an organization’s activities further a nonexempt purpose. This means that your organization can operate a business as a substantial part of its activities as long as the business furthers your exempt purpose.

Here’s the catch: Under the commerciality doctrine, courts have ruled that the otherwise exempt activities of some organizations are substantially the same as those of commercial entities. Courts and the IRS consider several factors when evaluating commerciality. No single factor is decisive, but asking the following questions about your nonprofit and its business activities can help you evaluate risk:

  • Have you set prices to maximize profits?
  • To what degree do you provide below-cost services?
  • Do you accumulate unreasonable reserves?
  • Do you use commercial promotional methods such as advertising?
  • Is the business staffed by volunteers or paid employees?
  • Do you sell to the general public?

Also consider the extent to which your organization relies on charitable donations. They should be a significant percentage of total support.

Avoiding UBIT

There’s another risk for nonprofits operating a business. You could pass muster under the commerciality doctrine but end up liable for unrelated business income tax (UBIT).

Revenue that a nonprofit generates from a regularly conducted trade or business that isn’t substantially related to furthering the organization’s tax-exempt purpose may be subject to UBIT. Much depends on how significant the business activities are to your organization as a whole. There are also several exceptions, so be sure to check with us.

Reducing Risk

If you’re thinking about launching a new business venture to raise revenue, talk to us first. We can review your proposed idea and help you reduce the risk that the commerciality doctrine or UBIT will trip it up.

© 2021

You might also like

Build a Better Nonprofit Board with Term Limits

Build a Better Nonprofit Board with Term Limits

Are your nonprofit’s board members subject to term limits? If not, you might want to consider implementing what’s widely considered a best practice. Some board members lose enthusiasm for the job over time or might even become ineffective or disruptive. Negative...

read more
Why Nonprofits Should Be Transparent about Compensation

Why Nonprofits Should Be Transparent about Compensation

More and more U.S. workers are calling for “pay transparency,” and nonprofit employers need to listen — and act. Pay transparency is the idea that employers should openly share their compensation policies and practices with job candidates, current employees and the...

read more
Cut Taxes by Reimbursing Expenses with an Accountable Plan

Cut Taxes by Reimbursing Expenses with an Accountable Plan

If you’re looking for another way to attract and retain staffers that won’t bust your nonprofit’s budget, consider offering an accountable plan. It’s an easy and low-cost way to reimburse employees for out-of-pocket expenses free from income and employment taxes....

read more