Exempt Function Income refers to income earned by a tax-exempt organization that is directly related to and supports its non-profit purposes, as defined by the Internal Revenue Service (IRS) or comparable authorities in other countries. This type of income is crucial for these organizations as it ensures they can operate without incurring tax liabilities on their primary revenue sources.
Core Definition
According to the IRS, exempt function income is revenue generated through activities that are “substantially related” to the organization’s tax-exempt purposes. For instance, income from donations, grants, or membership fees specifically designated to fund the entity’s non-profit activities would fall under this category.
Types of Exempt Function Income
Donations
Donations received from individuals, businesses, or other entities, specifically intended to fund the charitable activities of the organization.
Grants
Funds received from governmental or private institutions aimed at supporting the entity’s specific tax-exempt functions.
Membership Fees
Fees collected from members of the organization that are used directly to support its tax-exempt activities.
Fundraising Events
Revenue generated from events that directly promote the organization’s non-profit purpose, such as charity balls or galas.
Special Considerations
Unrelated Business Income Tax (UBIT)
Not all income received by a non-profit organization is exempt. The IRS imposes the Unrelated Business Income Tax (UBIT) on income that is not derived from the entity’s tax-exempt activities, such as sales from unrelated business ventures.
1UBIT = \text{Taxable Income from Unrelated Business Activities} \times \text{Applicable Tax Rate}
Record Keeping
Non-profit entities must maintain precise records to distinguish between exempt function income and taxable income. Failure to do so can result in penalties and loss of tax-exempt status.
Examples
Example 1: A Charitable Organization
A charitable organization that provides free meals to homeless individuals receives a $100,000 grant from the government. This grant is considered exempt function income as it supports the organization’s mission.
Example 2: A Non-Profit Publishing House
A non-profit publishing house sells educational books related to its mission. The income generated from these sales is exempt function income, assuming funds are used to promote the organization’s educational purposes.
Historical Context
The concept of exempt function income arose from the need to distinguish between the commercial and charitable activities of non-profit organizations. U.S. tax law in this area was solidified with the passage of the Revenue Act of 1950, which introduced UBIT to ensure fair competition between non-profit and for-profit entities.
Applicability
Exempt function income is applicable to various entities, including:
- Charitable Organizations (e.g., Red Cross)
- Educational Institutions (e.g., universities)
- Religious Organizations (e.g., churches)
- Social Clubs (e.g., country clubs, fraternities)
- Employee Benefit Associations
Related Terms
- UBIT (Unrelated Business Income Tax): A tax imposed on income unrelated to a non-profit organization’s tax-exempt purposes.
- Non-Profit Organization: An entity organized for purposes other than generating profit, with its earnings reinvested in its mission.
- Tax-Exempt Status: Legal designation that allows an organization to avoid federal income tax on its exempt function income.
- IRS Form 990: Annual information return required to be filed with the IRS by most tax-exempt organizations.
- Private Inurement: The act of a tax-exempt organization’s income or assets being used for the personal benefit of individuals with significant influence over the organization.
FAQs
What qualifies as exempt function income?
Is all income of a tax-exempt organization exempt from taxes?
How should non-profits report exempt function income?
Can a non-profit lose its tax-exempt status?
References
- Internal Revenue Service (IRS). “Tax on Unrelated Business Income of Exempt Organizations.” www.irs.gov.
- Revenue Act of 1950. Public Law 81-814, 64 Stat. 906.
- “Nonprofit Organizations and Income Tax Exemption.” The Nonprofit Quarterly.
Summary
Exempt function income is an essential concept for tax-exempt organizations, helping them fulfill their charitable, educational, religious, and other non-profit purposes without incurring tax liabilities. Understanding the distinction between exempt function income and unrelated business income is crucial for maintaining tax-exempt status and ensuring compliance with IRS regulations.
