Q: With the economy being what it is, our organization is reconsidering the way we do business. One of the options we’re exploring is to charge for some of our services. What are the IRS rules for nonprofit organizations that want to charge fees for their services?

A:  Fee for service programs are not new within the nonprofit community. On a large scale, nonprofit schools and hospitals have long charged. The IRS has no problem with the concept. In fact, Reg. § 1.501(c)(3)-1(e) states:

An organization may meet the requirements of section 501(c)(3) although it operates a trade or business as a substantial part of its activities, if the operation of such trade or business is in furtherance of the organization’s exempt purpose or purposes and if the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business, as defined in section 513.

I assume what you are really concerned about are three things: ensuring that the fees you collect will not be construed as unrelated business income; any tax implications if it is considered unrelated business income; and, correctly reporting this activity. While I will present some of the issues to be considered, this situation is complex, I am not – as I’ve said many times in this column – an attorney or CPA and my space is limited. I suggest you review your particular circumstances with a nonprofit tax specialist who can help you consider everything you should.The IRS considers an activity “unrelated business” and subject to taxation if you are regularly conducting business that is substantially unrelated to your exempt purpose. As long as you are looking to charge for services that fulfill your mission, rather than merely provide cash flow to allow you to pursue your mission, you should not incur a tax obligation. Even if the services or products you offer are unrelated to your exempt purpose you may still not be liable for unrelated business income tax (UBIT) because the IRS excludes certain activities from the tax obligation. One such exclusion is if you use volunteers to provide the services.

If the services you provide are considered an unrelated business enterprise there are several other considerations. If you gross $1,000 or more from those services you must file Form 990-T and make it and all addenda available to the public. You would then pay taxes on this income. An important note: if your income from the provision of these services ends up being a substantial portion of your revenue you could lose your exempt status.

Finally, as you undoubtedly know, public charities – as opposed to foundations – must maintain a defined level of funding from the general public. Public charities are sub-divided into two categories – 509(a)(1) and 509(a)(2). Organizations that raise the bulk of their money through contributions or grants are designated as 509(a)(1). Organizations that rely on fees for service or the sale of tickets for the majority of their support are designated as 509(a)(2). Depending on your original classification, if you decide to seriously pursue fee for service you might have to file an addendum to your incorporation papers with the IRS in order to be reclassified as 509(a)(2). Be forewarned that it more difficult to meet the support test for 509(a)(2) organizations. Here, again, your tax advisor can provide both critical information and substantial help.