Unrelated Business Income
One of the concerns of religious and secular charities is whether the profit obtained from a commercial venture constitutes too great a percentage of its revenues. The income from a commercial venture is designated as “Unrelated Business Income” or “UBI”. If the income from this venture exceeds even five (5%) percent of the total revenues, the tax exempt status of the charity may be put into jeopardy. However, the IRS recently broadened the scope of permissible UBI in certain cases. In one case in particular, which is memorialized in Technical Advice Memorandum #200021056, dated February 8, 2000, the IRS ruled that in this instance the tax exempt status would not be revoked even though the organization earned 62% of its gross income from taxable UBI.
In times past, churches opened small book stores or gift shops within its walls to hawk tapes and a few books of particular relevance with the genuine concern that although income tax is paid on the revenue, the status of the non-profit may be placed in jeopardy if the private, for-profit enterprise is “too successful.”
This ruling opens the door for religious and other non-profit organizations to broaden the scope of their ministries to incorporate commercial enterprise, increase their income, better serve their constituencies, reduce the burden of dependence upon charitable giving, raise their status and visibility in the communities they serve and bolster their bottom line. It also serves to endorse and encourage creative solutions to the age-old question of producing sustainable economic viability by small organizations.
The ABC Charity (the IRS withheld the actual name for its own protection) had been recognized as a 501(c)(3) organization. Its purpose, as stated in the Articles of Incorporation was “to establish and maintain. ..a place for the reception, exhibition and sale of articles, the product and manufacture of industrious and meritorious women” and “generally to assist the needy and deserving women in their efforts to earn an honest livelihood by their own industry”. (Technical Adv. Memo. #200021056 at Page 259.)
ABC claimed that its sole purpose was to aid such women to earn their own living by providing a place for them to sell their own handiwork and foods.
ABC operates three contiguous shop on site — a consignment shop, tea room and gift shop. The consignment store is operated by volunteers as well as paid employees and displays the handiwork of the women they serve. The gift shop is also managed by volunteers and paid employees purchasing decorative items from for-profit vendors for retail sales to the general public. The tea room, also managed by both volunteers and paid employees, is a luncheon facility which is open to the general public and consists of a dining room and kitchen.
The consignment shop is the portion of the enterprise which works most closely with the needy women in the community. ABC selects women as consignors who produce handcrafted toys and clothes for purchase by the general public. Each crafted benefits financially from the sale of the item on a consignment basis. According to ABC,
the consignors have heard about the program by word of mouth and ABC publicity campaigns. Volunteers from ABC’s membership evaluate the work of the proposed consignor for suitability. Once accepted, the members educate her on how to make goods that people will buy and for which they will pay high prices. They train the ladies thoroughly on fashion, fit, style, fabric, color, sewing and type of products. All work is supervised by ABC which sells its fabrics and other raw materials to the consignors at cost. The goods are sold in the shop to the general public.
ABC found that the consignment shop in and of itself would not bring in the prospective customers in sufficient numbers. It would be perceived as a “craft fair” with a few hand-made goods of secondary quality. As a result, the volunteers of ABC purchase decorative items from regular for-profit wholesale vendors for placement in the gift shop which is adjacent to the consignment shop. ABC stated that in order to attract quality clientele, it must 1) provide a reason for people to come to the shop which exposes them to the consignment items, 2) possess a showroom with the quality and ambiance that repeatedly attracts high end customers, and 3) provide attractive merchandising that suggests quality. ABC asserted that the gift shop goods were “sophisticated, tastefiil and fashionable” and because they appear in the same shop as the consignment goods, they enhance the consignment items.
In order to enhance the prices of the consignment items, ABC developed a pricing strategy: 1) gift shop items cover a broader price range than consignment items with a greater number of goods in the low and high end. The low end items give the customers a sense of “bargain and comfort,” while the high end items steer the clientele to the mid- range prices where the consignment items are situated. The price for the consignment items covers a range between $4.50 and $250.00, while the gift shop prices range from
$1.50 to $1,500. After setting aside the highest end items, ABC stated that the representative sales from consignment items range from $4.40 to $95.00, while the range for the gift shop covers from $1.50 to $150.
The tea room is adjacent to the consignment and gift shops and serves lunches to the general public. All of the food consumed is purchased from regular for-profit vendors. ABC intentionally placed the tea room in such a way that in order to use it, customers would have to meander through the gift shop. It serves only light lunches which is deemed ideal for shoppers and the menu, decor, room arrangement and tableware is designed to be tasteful and sophisticated. ABC intended the tea room to enhance the shopping experience and to create a social activity. Three paid employees and three volunteers staff the facility.
It is important to note that ABC contends that its only purpose for the gift shop and the tea room is to further its clearly stated primary purpose of assisting people who have faced adversity to help themselves out of their difficult situation, and that the gift shop and tea room merely exists to support the handicrafts by attracting customers and help by generating funds to support its exempt purposes.