The 990 filing deadline for calendar year organizations is almost here! In the third article of our UBI series, we’re going to tackle if (and when) the sale of merchandise or other goods is subject to unrelated business income tax.

Q: Selling merchandise is one thing that does seem like it should be considered an unrelated business. When isn’t it?

A: Just like any other income stream, if the sale of merchandise is substantially related to your exempt purpose it isn’t considered unrelated, so it wouldn’t be subject to unrelated business income tax. It can be a little tricky to make that connection, though, when you’re talking about selling merchandise. There are a few specific exceptions that allow the sale of merchandise while avoiding UBI treatment:

  • The “thrift shop” exemption
  • Sale for the convenience of members, students, patients, officers or employees
  • Low cost items sold in conjunction with a charitable solicitation
  • Substantially all the work is performed for the organization without compensation

Q: OK. I see thrift shops everywhere so I can relate to this. How does this exception apply?

A: If substantially all of the things being sold have been received as gifts or contributions, then the activity of selling them isn’t considered an unrelated trade or business, so income from that type of activity wouldn’t be subject to income tax.

Q: What about those other exceptions? How do those apply?

A: If you’re selling something primarily for the convenience of members, students, patients, officers or employees, that activity isn’t considered an unrelated trade or business. Common examples include nonprofit museum cafeterias and nonprofit hospital parking lots. Remember, though, that the primary benefit can’t be for the general public.

You can also “sell” low cost items in conjunction with a charitable solicitation without it being subject to UBI if you follow certain guidelines. If you are eligible to receive charitable income tax deductible contributions (usually 501(c)(3) organizations) and the distribution of the items is incidental to soliciting charitable contributions and the items are considered “low cost”, any income received would be excluded from UBI. To qualify for the exception all of the following criteria have to be met:

  • The item must be considered “low cost”, that is its cost to the organization (not the recipient) has to be less than $5 in 1987 dollars as indexed for inflation. The 2019 equivalent is $11.10, which will usually cover your standard t-shirts and coffee mugs.
  • The recipient must not have requested the item. For example, it couldn’t have been ordered specifically by them from your website.
  • The item is sent to the recipient without their express consent, i.e. it is unsolicited.
  • The item is sent with a request for a charitable contribution and a statement is included that the recipient may keep the item whether or not a contribution is made.
Last but certainly not least, if substantially all the work related to selling the items is performed by volunteers who don’t receive any compensation, then the activity will qualify for an exception. There is a fine line here, though. The IRS has ruled that an art museum that used two full time employees and 15 volunteers to sell and rent artwork didn’t qualify for the exception, but that an organization that used 95% volunteer labor did qualify for it.
There are a number of other specific exceptions as well as some specific guidance from the outcome of court cases and the like, but that’s a bit too much to cover here. If you want to take a deeper dive, please feel free to contact us. We’d be glad to help.