Starting and Managing a Nonprofit Organization: A Legal Guide

By Bruce R. Hopkins | Go to book overview

CHAPTER THIRTEEN
Related or Unrelated?

Chapters 5 and 17 show how the tax law imposes penalties on the persons involved in law violations concerning public charities, social welfare organizations, and private foundations. This chapter deals with the taxation of income generated by activities that are unrelated to the tax-exempt functions of nonprofit organizations. The following three chapters cover taxes imposed on lobbying, political campaign activities, donor-advised funds and tax shelter activities, and more. In each situation, an organization must tread carefully. The taxes are long-established and they can be heavy.


TAXES

For more than 60 years, the law has divided the activities of tax-exempt organizations into two categories: those that are related to the performance of exempt functions and those that are not. The revenue occasioned by the latter activities, unrelated activities,is subject to tax. Gross revenues gained from unrelated activities are potentially taxable; however, in computing unrelated business taxable income, the organization is entitled to deduct only expenses incurred that are directly related to the conduct of the unrelated business.

For organizations that are incorporated, the net revenue from unrelated activities is subject to the regular federal corporate income tax. The federal tax on individuals applies to the unrelated activities of organizations that are not corporations (e.g., trusts). Unlike the intermediate sanctions and private foundation rules, the law on related and unrelated activities does not impose any taxes on the directors and officers of tax-exempt entities.

To decide whether any of its activities are taxable, an otherwise tax-exempt organization must first ascertain which activities are related to exempt functions and which are not. The judgments that go into assigning activities into these two categories are at the heart of one of the greatest controversies facing nonprofit organizations today. The existing legal structure is complex, intricate, and dynamic. Although the rules were enacted in 1950, it was not until the early 1970s that this body of tax law became of primary importance to nonprofit organizations.


UNRELATED INCOME RULES

The unrelated income rules were significantly rewritten by Congress in 1969. The original concept underlying these rules was that of an outside business owned and perhaps operated by a tax-exempt organization. In 1969, however, Congress

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