Program Service Revenue

Can my nonprofit charge for services or products? | Program service revenue, rent, and other ways to earn money

a person counting money they made from Program Service Revenue

There’s an understandably common misconception that nonprofit organizations are not permitted to make money. The truth is, nonprofits can and should bring in revenue. No money = no mission, and you’ll even want to make enough to have an emergency fund.

Donations and grants are an obvious source of funding for most nonprofits, but there are other, often overlooked ways to earn money. And if you’re looking for a nonprofit attorney to advise on your organization’s efforts to legally bring in revenue, let us know and we’d be happy to help. 

Program Service Revenue 

Program service revenue is when a nonprofit charges for a service directly related to its mission. It’s the second most common way nonprofits make an income after charitable gifts. Below are some examples of how nonprofits leverage program service revenue:

  • An animal shelter charging an adoption fee 
  • A private school charging tuition 
  • A community choir charging for admission to shows

In each of the above examples, the organizations are carrying out their exempt purposes: finding forever homes for pets, providing an education to children, or bringing musical arts to a community. The revenue generated from these activities is exempt from income tax—which can make a huge difference over time. 

Since tax-exempt organizations are so highly regulated, it’s important to make sure that you go about charging program service revenue the right way to avoid penalties from the IRS or investigations from your state attorney general. If you’d like to retain a nonprofit attorney to assist with program service revenue compliance concerns, reach out to us here. 

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Charging Rent

Many nonprofits own property and earn additional income by renting out the space. It’s not uncommon for a church to rent out its sanctuary for weddings, or a youth mentorship club to rent out its gym for community events.  

There are three ways that nonprofits can can generally earn rental income:

  1. As program service revenue. Remember, in this case, the fees need to be directly related to your nonprofit’s charitable purpose. Some prime examples of this would be charities that provide low-cost housing to low-income families or housing for the elderly. 
  2. As passive investment income. In this instance, the rent is not related to the charitable purpose of the organization, and instead this income results from cash flow received on a regular basis. This requires minimal effort for the organization to maintain, but may be subject to Unrelated Business Income (UBI) rules, which render this revenue taxable. You can learn more about rent in this context here. 
  3. As an insubstantial part of the organization’s activity. If a nonprofit rents out space infrequently, it may not be subject to UBI, but in practice the IRS may view limited rent as a violation of their regulations. When in doubt, reach out to us, or read this article for further considerations when charging rent. 

Of course, one final consideration when charging rent as a nonprofit is to ensure that the amount charged is reasonable! You can determine this by comparing your rate with the fair market value for similar spaces or properties in your area. And whatever that amount may be, you can’t count those payments as donations. Rent is rent. If you’d like assistance creating a rental agreement, we can help. 

Selling Products to Support your Mission

It may come as no surprise to you that nonprofits can sell items to bring in additional revenue. You’ve probably seen nonprofits sell T-shirts for 5k fundraisers, baked goods to support a new program, or jewelry made by participants in their programs. No matter the product, it’s important to remember the distinction between program service revenue and unrelated business activity. 

Let’s say a nonprofit is formed to serve young, unemployed adults with special needs. These teens and young adults participate in a job training program where they learn agricultural and entrepreneurial skills by selling produce in the nonprofit’s marketplace. The proceeds go toward the nonprofit’s programs, and the revenue directly correlates with the nonprofit’s mission—job training for people with special needs. 

However, say this nonprofit also has a store where they sell T-shirts, mugs and baked goods year-round, not just as a one-time fundraiser. This revenue may be subject to Unrelated Business Income Tax since the gift shop is not related to the actual programs of the nonprofit, which was specifically formed for job training purposes. But there are several additional variables that the IRS may view as possible exceptions: for example, if the items sold at the store were donated goods, or if the store clerks were volunteers, not employees. These variables alone do not determine whether or not UBIT comes into play, but these examples demonstrate the many exceptions the IRS makes to their UBIT determinations. 

What this nonprofit could do to bolster these business activities is create a blocker corporation. They could open a subsidiary “owned” by the charity, usually an LLC or other business corporation, which has the purpose of protecting the nonprofit from liability and avoiding UBIT. This entity could also transfer income to the charity in the form of passive, non-taxable income. You can learn more about these blocker corporations, details for triggering UBIT, and considerations for this model here, as this topic can get quite complex. Plus, creating the blocker corporation is something we can help with. 

One important takeaway to remember is that UBIT ought to be avoided when possible—not only because it diminishes funds, but also because too many unrelated business activities can lead to the IRS revoking your organization’s tax-exempt status. The IRS does not specify an exact percentage of activity that would be considered “too much” as this varies from organization to organization. We’d be happy to give our advice for your particular situation if you’re looking to avoid this risk. 

Yes, there are a lot of tricky areas to navigate when it comes to nonprofits pursuing business activities and selling items, but don’t let this stop you from helping your organization earn money. Let us help you structure your organization so that you can enjoy extra revenue streams to further your mission.

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