The Nonprofit FAQ

What is earned income?

By Putnam Barber, editor of The Nonprofit FAQ The opposite of "earned" is (obviously) "unearned" income. As might be expected, though, both of these terms are technically defined, and important, in several different contexts. With respect to the United States tax code, the important question about earned income is whether or not it is derived from activities that are related to the organization's exempt purposes. Income earned by recognized nonprofit corporations from performing exempt purposes is not subject to corporate tax; income from other activities is. The tax is called "Unrelated Business Income Tax" — UBIT (for more about UBIT see http://www.idealist.org/if/i/en/faq/190-37/20-4.) "Related" income is usually called "program service revenue," i.e., the money received for performing the services defined by the organization's charter documents. Examples of program service revenue include the tuition fees at schools and universities; ticket sales at theaters and dance companies; admissions to galleries and museums; fees paid to nonprofit hospitals by patients, insurance companies, and the government; payments for services rendered under contracts with local, state and federal government agencies; etc. etc. etc. According to the National Center for Charitable Statistics, about two-thirds of the total revenue received by operating nonprofits in 2007 — $1 trillion — was program service revenue. "Unearned" income includes interest and other earnings from investments; foundation and government grants; donations and dues; proceeds from special events; and many other forms of revenue that can be critically important to the survival of an organization. It may seem odd to label it as "unearned" because there is often a lot of work involved in making sure these forms of support continue, and grow. Since taxes may be due on unrelated business income, bookkeepers and accountants pay careful attention to the various income-generating activities of nonprofit organizations. Before launching any new projects that promise to return significant income to an organization, it is important to look at how the new activities will relate to its exempt purposes and to the tax code. Having a small amount of UBIT to pay is nothing to worry about (though the calculations may be a burden). The tax code provides, though, that if too large a proportion of an organization's revenues are unrelated to its exempt purposes, it may be necessary to re-incorporate as a for-profit enterprise. The advice of experienced lawyers and accountants is necessary to figure out the best course of action if that possibility is on the horizon.