Q&A #123 – Are merchandise sales considered a related activity for unrelated business income tax (UBIT) purposes?
Question: I lead a 501(c)(3) advocacy organization that educates and influences the public about certain important social issues. The organization receives some revenue from selling t-shirts, posters, mugs, and other merchandise in our online store. Some of these items show our logo while others display words and phrases that express solidarity with our cause. Can we avoid unrelated business income tax on these sales because it is related to our mission?
Answer: The sale of t-shirts and other merchandise can, under some circumstances, be considered “related” to an organization’s tax-exempt purpose and therefore avoid unrelated business income tax (UBIT). However, it is necessary to show that the merchandise sales directly further the organization’s mission without regard to how the revenue is used. Only certain types of items will satisfy this standard.
An activity generally triggers UBIT if it is: (1) “unrelated” to the organization’s tax-exempt purposes; (2) a “trade or business”; and (3) “regularly carried on.” While some merchandise sales activities may avoid UBIT because they lack the characteristics of a “trade or business” or are not “regularly carried on,” the first step in the analysis is to determine whether the activity is “related.”
As discussed in Q&A #68, an activity is related if it has a substantial causal relationship to the achievement of the organization’s tax-exempt purposes, other than through the production of income. Some merchandise sales may satisfy this standard, although these circumstances are limited and each category of items must be analyzed separately.
The IRS guidance on this issue developed largely from its analysis of museum gift shops. In Rev. Rul. 73-104, the IRS held that an art museum’s sale of greeting cards displaying printed reproductions of art works exhibited at the museum was “related” because it “stimulat[ed] and enhance[ed] public awareness, interest, and appreciation of art.” In contrast, the IRS held in Rev. Rul. 73-105 that an art museum’s sale of “scientific books and souvenir items relating to the city where the museum is located have no causal relationship to art or to artistic endeavor.”
Subsequent IRS rulings followed a similar framework. Addressing the sale of items displaying an educational organization’s logo, the IRS stated in Priv. Ltr. Rul. 8145029 that “[w]hile we acknowledge that there is some publicity value resulting from the dissemination of these items, they are essentially souvenirs with little or no connection with the facility's educational thrust.” Similarly, in Priv. Ltr. Rul. 8252011, the IRS held that a zoo’s sale of animal puzzles, stuffed animals, and other items depicting animals was a related activity, while the sale of inexpensive mementos, souvenirs, zoo shirts, caps and jewelry items was not a related activity. More recently, in Tech. Adv. Mem. 201633032, the IRS denied “related” activity treatment to an environmental organization’s sale of merchandise where the merchandise at issue imparted little or no information connected to the organization’s tax-exempt purposes (although the specific facts in this ruling are unclear).
In your case, the sale of items displaying only your organization’s name and/or logo is probably not sufficiently connected to the organization’s mission to be considered a “related” activity. However, there may be a strong argument that the sale of items displaying words and phrases that express solidarity with the organization’s mission is “related” because it is part of an effort to directly sway public opinion and raise awareness.
Planning Tip – To properly manage and plan for unrelated business income tax (UBIT) it is important to keep detailed contemporaneous records. With respect to merchandise sales, for example, these records should show the revenue and inventory cost of each item sold, the amount of time spent by volunteers and staff members on the activity, and other expenses and details. These records will help support deductions against unrelated business taxable income as well as allocation between “taxable” and “non-taxable” sales.
Be aware that not all “unrelated” activities trigger UBIT, as there are other possible exceptions and UBIT modifications and potential deductions to explore with your organization’s tax advisor.
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