Charitable organizations play a vital role in society, and they generally work hard to solicit contributions from whatever sources they can find. Increasingly, though, donations have become only one element of how successful charities make money. In particular, many people don't realize that some entities that have extensive budgets and charge users for their services, including hospitals, educational institutions, and fitness centers, are organized as nonprofit organizations. Charities have to account for these different funding sources separately, and charities that make too much of their money from certain types of earned revenue can face questions about whether their nonprofit status is legitimate.
Earned revenue vs. contributions
The difference between earned revenue and contributions is quite simple. Earned revenue is money that a charity earns for providing goods or services. For example, sales of tickets and admission fees are common items of earned revenue for museums and nonprofit performing arts organizations, while items like sales in a gift shop or thrift store also generate earned revenue.
Contributions, on the other hand, are gifts made freely without receiving anything in exchange. Monetary contributions are most common, but many charities also accept gifts of items like clothing or food.
For the donor, the difference between contributions and earned revenue is that only contributions are eligible for a tax deduction. Payments for goods or services don't qualify because what you receive is equal in value to what you pay, taking away any charitable intent.
Controversy about charities and earned revenue
In some cases, charities have run into difficulty because of their attempts to generate earned revenue. For instance, you'll often see a charitable fitness center like the YMCA operating in the same community as a for-profit fitness center. The charity gets the benefit of tax-exempt status, which can save on operating costs as well as providing additional funding sources, and so for-profit businesses have argued that charitable status is inappropriate in some cases. An even bigger example is in the hospital world, where for-profit and tax-exempt entities compete for patients to serve and medical professionals to hire.
The tax law has no prohibition on earned revenue generally but rather focuses on whether that revenue is related to the nonprofit's charitable mission. If the charity regularly carries on a trade or business not substantially related to the organization's tax-exempt purpose, then the charity will have to pay unrelated business income tax on that income. In addition, if the charity earns too high a percentage of its overall revenue from unrelated business activity, it risks losing its tax-exempt status entirely.
Charities have become adept at using tactics from the business world to get money. By tying their missions to their practices, such charities make any earned revenue related to their tax-exempt purpose and therefore avoid unwanted scrutiny from those seeking to challenge their charitable status.
Want to start your investing journey? Check out The Motley Fool's Broker Center and find the best broker for you.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at firstname.lastname@example.org. Thanks -- and Fool on!