Not-for-profit organizations may be able to avoid paying unrelated business income tax (UBIT) by applying a safe-harbor exception. However, your nonprofit's use of technology could invalidate this option. For example, it's not clear whether today's hybrid or virtual convention and trade show activities meet safe-harbor standards established by the IRS nearly 20 years ago. Here's what you need to know to limit your nonprofit's tax liability.
Unrelated business income is defined as "gross income derived by any organization from any unrelated trade or business regularly carried on by it, less the deductions allowed." In other words, any profit your organization receives from conducting a regular business activity that isn't substantially related to your tax-exempt purpose is subject to UBIT.
In general, the IRS relies on a three-part test to determine whether a nonprofit is liable for UBIT:
1. Production of income. The IRS asks if the organization is carrying on a trade or business to produce income from the sale of goods or performance of services. This question is used to establish a profit motive.
2. Regular activities. Are the activities carried on regularly? The IRS examines the exempt organization's operations and compares them to similar activities by for-profit businesses.
Annual fundraising events may be excluded because they're considered "occasional" not "regular."
3. Relation to tax-exempt purpose. The IRS determines if the activities are substantially related to the organization's tax-exempt purpose. It analyzes particular activities that can be difficult to assess. In the process, the IRS may divide activities into "related" and "unrelated" buckets. Even if a nonprofit appears to answer "yes" to test one and two and "no" to test three, it may not be liable for UBIT. The tax code recognizes UBIT exceptions, including:
Income received from qualified convention and trade show activities typically is treated as exempt from UBIT. But to qualify under this safe harbor, nonprofits must demonstrate that the conference and trade show activities stimulate interest in, and demand for, products of a particular industry (or segment of an industry).
The safe harbor also covers income if the show educates attendees about new developments or about products and services relating to the organization's charitable function. This exception applies to most tax-exempt organizations, including 501(c)(3) and 501(c)(6) organizations.
What about convention and trade shows held and viewed online? In 2004, the IRS addressed the topic in its Ruling 2004-12. The ruling discussed two scenarios involving a 501(c)(6) organization that held semiannual virtual trade shows in conjunction with in-person trade shows.
In the first scenario, the key factor was whether the virtual trade shows were "ancillary" to the live shows. The organization provided a separate virtual trade show section on its website available for viewing during the in-person shows, plus three days before and after the live shows. The in-person shows included members of the nonprofit and suppliers to the industry. Exhibitors were charged a fee to participate. The website contained information and visual displays as well as links to the websites of exhibitors represented at the in-person trade show. According to the IRS, the virtual activities described in this scenario met the safe harbor for qualified convention and trade show activities — mainly because the online events were ancillary to the in-person events.
The second hypothetical scenario was comparable to the first except that the organization's virtual trade shows spanned two weeks without any connection to in-person events. In such circumstances, the virtual activity didn't qualify for the safe-harbor exception, because the website lacked a "face-to-face" component.
Much has changed since 2004. In the past two decades, virtual trade shows have become interactive, so that participants can meet face-to-face. The COVID-19 pandemic only accelerated use of the internet for interactive hybrid and virtual trade shows. Yet the IRS hasn't released any meaningful guidance on the subject since its original ruling. And without any definitive guidance from the IRS, it's impossible to say whether virtual shows now qualify for the safe harbor or whether they must be connected to an in-person show as "ancillary" events.
The IRS hasn't indicated that it plans to revisit these complex issues anytime soon. Without definitive pronouncements, your nonprofit should exercise caution and discuss any conference or trade show plans with your tax advisor.
Get in touch today and find out how we can help you meet your objectives.