When Mission-Driven Work Creates Unrelated Business Income
A nonprofit food bank runs a thrift store to fund its programs. A church rents its fellowship hall for weddings. A museum operates a gift shop. A youth sports league sells advertising space in its tournament program. In each case, the organization is pursuing its mission—but it may also be generating unrelated business income (UBI) that triggers tax obligations, filing requirements, and potential scrutiny from the IRS.
The concept of unrelated business income is one of the most misunderstood areas of nonprofit tax law. Many nonprofit leaders assume that because their organization is tax-exempt, all of its income is exempt. This is not true. The IRS requires tax-exempt organizations to pay tax on income from activities that are not substantially related to their exempt purpose—even if the profits from those activities are used to support the mission.
For nonprofits across Virginia and Washington DC, understanding UBI is not optional. It is essential for compliance, for protecting tax-exempt status, and for making informed decisions about revenue-generating activities.
What Is Unrelated Business Income?
The IRS defines unrelated business income as income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis for the organization’s exemption. Three elements must be present for income to be considered UBI:
1. It is a trade or business. The activity must be conducted with the intent to generate income, similar to how a for-profit business operates. Selling goods or services, advertising, and renting property are common examples.
2. It is regularly carried on. Occasional or infrequent activities—such as an annual fundraiser—are generally not considered UBI. The IRS looks at the frequency and continuity of the activity, comparing it to how a for-profit business in the same field would operate.
3. It is not substantially related to the exempt purpose. The activity must not contribute importantly to the organization’s mission. The key question is whether the activity serves a charitable purpose beyond generating revenue.
Common Sources of UBI for Nonprofits
Many activities that nonprofits engage in can generate UBI. Common examples include:
Advertising revenue. If a nonprofit sells advertising space in its newsletter, website, or event program, the income may be taxable. The IRS distinguishes between advertising (which is UBI) and sponsorship acknowledgments (which are not).
Rental income. Renting out space to other organizations can generate UBI, though there are exceptions. Rental income from real property is generally excluded from UBI if the property is not debt-financed and is not rented to a related party.
Thrift stores and gift shops. While these operations are often mission-related (providing low-cost goods or promoting the organization’s work), they can generate UBI if the merchandise is not substantially related to the exempt purpose.
Gaming and fundraising events. Bingo, raffles, and casino nights can generate UBI if conducted regularly. However, there are specific exclusions for certain types of gaming activities.
Parking lots. Operating a parking lot can generate UBI, though there are exceptions for parking provided to employees or for charitable purposes.
The UBI Exclusion for Volunteer Labor
One important exception is the volunteer labor exclusion. Income from an activity is not UBI if substantially all the work is performed by unpaid volunteers. This exclusion allows many small nonprofits to operate thrift stores, bake sales, and other revenue-generating activities without incurring tax liability. For example, a food bank that sells donated goods in a thrift store staffed entirely by volunteers would not have UBI from that activity.
Filing Requirements: Form 990-T
Organizations with gross UBI of $1,000 or more must file Form 990-T, Exempt Organization Business Income Tax Return. The form is due by the 15th day of the 5th month after the end of the organization’s tax year—the same deadline as Form 990. A six-month extension is available.
Form 990-T is a separate return from the annual information return (Form 990, 990-EZ, or 990-N). It requires the organization to report UBI, calculate allowable deductions, and determine any tax owed. The tax is calculated using corporate rates, and estimated tax payments may be required.
Virginia and DC Considerations
Virginia: Virginia follows federal rules for UBI. Organizations with UBI that are required to file Form 990-T must also file a Virginia income tax return (Form 500 for corporations) to report the UBI and pay any applicable Virginia tax. Virginia’s corporate income tax rate is 6.0%.
Washington DC: The District also conforms to federal UBI rules. Organizations with unrelated business income subject to tax under IRC Section 511 must pay DC franchise taxes on that income. DC requires organizations to file the appropriate franchise tax return and pay tax on UBI.
The Consequences of Non-Compliance
Failure to report and pay tax on UBI can result in penalties, interest, and—in severe cases—jeopardy to tax-exempt status. The IRS has identified UBI compliance as an enforcement priority, and organizations with substantial unrelated business activities are more likely to face scrutiny.
The IRS’s FY 2026 compliance strategies for exempt organizations specifically address UBI issues, including gaming income, credit union income, and hospital UBI reporting. Organizations that ignore UBI obligations risk costly assessments and reputational damage.
How Nova Tax & Accounting Services Can Help
At Nova Tax & Accounting Services, we help nonprofit organizations identify potential UBI, prepare accurate Form 990-T filings, and develop strategies to minimize tax liability while maintaining compliance. Our team understands the unique challenges facing mission-driven organizations and works with you to structure activities in a way that supports your mission while protecting your tax-exempt status. For more information about our nonprofit services, visit https://novataxservices.com/ or schedule a consultation.
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