Can a Nonprofit Make Money? Understanding Revenue Rules and Limitations

A common misconception about nonprofits is that they can’t make money. People assume that because these organizations focus on a mission rather than profit, they aren’t allowed to generate revenue. But that’s not true. Nonprofits can earn money, and in many cases, they need to in order to operate effectively.

However, they must follow strict IRS rules to maintain their tax-exempt status. If they don’t, they could face serious penalties or even lose their exemption. This article will break down how nonprofits can legally make money, what’s allowed, and the limitations they must follow to stay compliant.

Types of Revenue a Nonprofit Can Earn

Nonprofits can earn money in several ways, but not all income is treated the same by the IRS. Here’s a breakdown of the most common types of nonprofit revenue:

1. Donations and Grants

For most nonprofits, donations and grants are the primary sources of funding. These are generally tax-free as long as they directly support the nonprofit’s mission. Examples include:

  • Individual donations from supporters
  • Grants from government agencies or private foundations
  • Corporate sponsorships tied to nonprofit programs

2. Program Service Revenue

Nonprofits can charge fees for services directly related to their mission. As long as these activities align with their purpose, the income is tax-exempt. Examples include:

  • A museum charging admission fees
  • A school offering paid educational programs
  • A charity selling tickets to a fundraising event

3. Fundraising Events

Nonprofits can hold fundraising events like auctions, galas, and charity walks to raise money. Revenue from these events is generally tax-free, as long as the proceeds support the nonprofit’s mission.

4. Investment Income

Some nonprofits invest their funds and earn money from interest, dividends, or rental income. While this isn’t always taxable, it depends on the type of investment and how the earnings are used.

How Nonprofits Qualify for Tax-Exempt Status

Nonprofits don’t automatically receive tax-exempt status just because they serve a good cause. They must apply for it through the IRS by submitting Form 1023.

Well, what is form 1023? It’s the application nonprofits use to request 501(c)(3) status, which grants them exemption from federal income taxes. Once approved, organizations don’t have to pay taxes on income related to their mission, and donors can make tax-deductible contributions to support their work.

To qualify for tax-exempt status, a nonprofit must:

  • Operate exclusively for a recognized charitable, religious, educational, or similar purpose.
  • Ensure that no individual or shareholder personally benefits from its profits.
  • Avoid excessive political activities and lobbying that could compromise its mission.
  • Properly manage its revenue to ensure funds are used to advance its nonprofit purpose.

Even after obtaining tax-exempt status, nonprofits must follow IRS compliance rules to maintain it. That includes strict revenue guidelines, which we’ll explore next.

Understanding Unrelated Business Income (UBI)

Nonprofits must be careful when engaging in money-making activities that aren’t tied to their mission. If the IRS considers an activity unrelated business income (UBI), the nonprofit may have to pay taxes on it.

The IRS uses three key tests to determine if revenue qualifies as UBI:

  1. Is it a trade or business? – If the activity involves selling goods or services for profit, it likely qualifies.
  2. Is it regularly carried on? – If the nonprofit engages in the activity consistently (rather than as a one-time fundraiser), it might be taxable.
  3. Is it related to the nonprofit’s purpose? – If the income-generating activity has nothing to do with the nonprofit’s mission, it could be subject to taxation.

Example:

  • A nonprofit animal shelter selling pet adoption services would be tax-exempt, since it supports their mission.
  • If the same shelter starts selling pet accessories for profit, that could be considered UBI and subject to taxes.

Nonprofits that earn UBI must file Form 990-T and pay Unrelated Business Income Tax (UBIT) on those earnings.

How Nonprofits Can Earn Money Without Losing Their Tax-Exempt Status

Nonprofits can still generate revenue while keeping their 501(c)(3) status, but they need to follow the rules. Here’s how:

1. Focus on Mission-Related Income

The easiest way to avoid tax issues is by earning income directly related to the nonprofit’s purpose. For example:

  • A health nonprofit charging for wellness programs (Allowed)
  • A health nonprofit selling unrelated products for profit (Taxable UBI)

2. Limit Unrelated Business Activities

If a nonprofit does engage in unrelated business activities, they should keep it small. If too much revenue comes from taxable activities, the IRS may question whether the nonprofit is still operating for charitable purposes.

3. Use a For-Profit Subsidiary

Some nonprofits set up separate for-profit companies to handle taxable activities. The for-profit business pays taxes on its earnings, but the nonprofit can receive profits as a donation without violating tax laws.

4. Follow IRS Reporting Rules

To stay compliant, nonprofits must file Form 990 each year, detailing how they earn and spend money. If they have UBI, they must also file Form 990-T to report taxable earnings.

What Happens If a Nonprofit Violates Revenue Rules?

If a nonprofit violates IRS rules on revenue, it can face serious consequences, including:

  • Losing tax-exempt status – The nonprofit will start paying federal income taxes on all earnings.
  • Losing donor incentives – Donations will no longer be tax-deductible, which could hurt fundraising efforts.
  • Facing penalties and back taxes – The IRS may require the nonprofit to pay taxes on past earnings.

Sometimes, the IRS gives nonprofits a chance to correct mistakes, but repeated violations could result in permanent revocation of tax-exempt status.

Nonprofits can make money, but they must follow strict rules to keep their tax-exempt status. The IRS allows organizations to generate revenue as long as it supports their mission. However, earning too much from unrelated business activities could lead to taxes, penalties, or even the loss of nonprofit status.

To stay compliant, nonprofits should focus on mission-driven income, limit unrelated business activities, and ensure they report everything correctly to the IRS. By following these guidelines, nonprofits can grow financially while staying within the law.