Q&A #124 – Can the volunteer exception to the unrelated business income tax (UBIT) apply if the business is partially run by paid staff?
Question: I am the Executive Director for a small-staffed nonprofit organization that has a retail gift shop run mainly by volunteers. We are aware that there is an unrelated business income tax (UBIT) exception for volunteer labor. As Executive Director, I handle some aspects of the store, but most of the work is done by volunteers. Are we eligible to use the volunteer exception if we have a paid staff member involved?
Answer: Under section 513(a)(1) of the Internal Revenue Code, an activity that otherwise meets the definition of an “unrelated trade or business” does not trigger unrelated business income tax (UBIT) if “substantially all the work in carrying on such trade or business is performed for the organization without compensation.” Having paid staff does not disqualify an organization from using the volunteer exception if paid staff’s role in the activity is sufficiently minimal that the “substantially all” standard is still satisfied.
Determining whether the volunteer exception (sometimes called the “volunteer labor exclusion”) applies generally requires assessing the total amount of time expended for the business activity by volunteers and compensated workers (employees and independent contractors). While there is not one specific percentage that satisfies “substantially all” standard in all cases, a good rule of thumb is that at least 85% of the total hours worked on the activity must be volunteer hours. See, e.g. Tech. Adv. Mem. 8433010.
See also Waco Lodge No. 166, Benevolent & Protective Order of Elks v. Commissioner, 696 F.2d 372 (5th Cir. 1983) (the volunteer exception did not apply where less than 77% of the work was provided by volunteers) and St. Joseph Farms of Ind. Bros. of Congregation of Holy Cross, Sw. Province, Inc. v. Commissioner, 85 T.C. 9 (1985) (the volunteer exception applied where volunteers provided approximately 91 percent of the full-time labor and approximately 94 percent of the total hours worked).
In this helpful guide to the volunteer exception on the IRS website, the IRS is careful to clarify the percentage of hours is not the “sole determinative factor” and that “all the facts and circumstances of each case must be taken into account.” However, in most cases the percentage of volunteer hours will be far and away the most significant factor.
Planning Tip – Nonprofits should be keeping track of volunteer hours regardless of whether the activity is an unrelated trade or business that could otherwise trigger unrelated business income tax (UBIT) if not for the volunteer labor exception. As explained in Q&A #26, tracking volunteer hours is critical to the proper planning and management of this valuable resource.
Before relying on the volunteer exception, be aware that there are some circumstances in which it may not apply. For example, if an otherwise unpaid volunteer receives tips when performing the services, that is usually considered a form of compensation that would render the person no longer a volunteer for UBIT purposes. And the IRS has held that the volunteer exception cannot be used if the performance of services is not a “material income-producing factor” in the business. This should not be the case with a retail store, but might apply to other activities such as, for example, the leasing of equipment. See IRS Rev. Rul. 78-144.
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