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This article, by Jeffrey Hurwit, originally appeared in the New England Museum Association News.


While this article provides an overview of laws relating to nonprofit commercial ventures, its aim is also to highlight opportunities and common pitfalls for entrepreneurially-minded museums. I frequently encounter misconceptions about the law that undermine or misdirect venture planning. To counter that, I'll first look at common myths and mis-steps in undertaking new ventures and propose some common sense approaches. I will then describe basic legal guidelines for commercial ventures, UBIT rules, and common UBIT exceptions for museums. The article assumes some familiarity with the concept of unrelated business income taxation (UBIT), but does cover some basics throughout.

Misconceptions About Museum Entrepreneurship

Misconception #1: There are Limits on Museum Commercial Activity.

In fact, there is no bar to the extent or nature of nonprofit business activities. To the contrary, there is tremendous legal flexibility and discretion for museums to earn profits. Generally, museums may earn and raise revenues like any for-profit corporation. The difference is not in how revenues can be generated, but in what can be done with them. Museum profits may not inure to private benefit, but must be used solely for museum purposes.

Thus, nonprofits sell pasta (like NYU School of Law), cookies (the Girl Scouts), or almost any product you can think of. They sell air rights (above MOMA, for $17 million), travel tours, insurance, function facility space, parking, used cars, and even money (bingo, Las Vegas Nights). Competing businesses may not like it, and thus care needs to be taken not to offend your own patrons and local retailers, but that is a community relations rather than legal issue.

The law is unlikely to change substantially in this area. Small business association lobbyists have failed in the U.S House of Representative to get changes in the law out of committee, and the Senate hasn't even come that close. Courts have also been extremely reluctant to create new law in this area or to infringe on the rights of free commercial speech.

Caveat: Impact on commercial activity will more likely arise from loss of local real estate tax exemptions. On a town-by-town basis, property tax abatement may continue to become more restrictive than federal or state tax exemption, and should therefore be factored into decision making involving facility or real estate ventures.

Resulting Misconception #2: Legal Concerns Drive the Venture Process.

Often, nonprofit business options are unnecessarily tailored to meet pre-conceived legal concerns rather than sound business planning needs. But since museums have such broad legal abilities, the legal form of the venture should follow its function, not, as is too often the case, the other way around. As you develop a business plan, it's the lawyer's job to structure a responsive organizational framework that protects your tax exemption and you personally.

It is true that if the venture becomes very successful, you may need to spin off the for-profit activities into a separate business subsidiary so as not to jeopardize your tax-exempt status, as discussed below. And if the venture is unrelated to your charitable purposes, you may also have to pay taxes on the unrelated business income. But these factors should be subsidiary to your primary business planning efforts.

Leading to Misconception #3: UBIT Concerns Drive The Venture Process.

In my experience, too many nonprofits are distracted by visions of non-taxable product sales. With the exception of real estate purchase and development, UBIT issues generally should not be at the forefront of venture planning. Instead, first determine the viability of the proposed venture as a business unto itself. Then, as a mechanical matter, determine on a product by product basis what is taxable under UBIT (discussed below).

Remember, UBIT is levied not on gross revenues, but on net income, like any other business, after the deduction of all related costs. So if a venture is not going to earn a profit, it doesn't matter whether it's taxable. Also, if a venture's feasibility hinges on whether you get to keep 100% or 70% of projected net income, you have to wonder if it's feasible either way.

Culminating in Misconception #4: Since We Designed the Venture to Avoid UBIT, Our Financial Objectives Don't Have to be Clear.

The most common error committed by staff and boards in undertaking commercial activities: Lack of consensus as to purpose.

Is the purpose of the venture to make money, further the museum's educational purposes, or a combination of the two? If the primary objective is revenue generation, then fulfilling the customer's wishes, as opposed to the museum's mission, should be paramount. Any educational benefits for customers should be understood by all involved as a by-product of the venture, not its raison d'etre.

If, however, you view the venture as education and public awareness as much as revenue production, you may be satisfied with a small net profit. When key participants within the board and staff have differing expectations in this regard, conflicts easily emerge regardless of the venture's financial or programmatic success.

The Legal Scheme and UBIT For Museums

Definition of UBIT. A single theme underlies UBIT rules. Simply stated, income derived by a museum from activities unrelated to its tax exempt purposes is taxed as if earned by a comparable for-profit entity. More technically, unrelated business income is defined as income derived from 1) a trade or business, 2) which is regularly carried on, and 3) which is not substantially related to the performance of tax-exempt functions. For taxes to be incurred, all three elements must be present.

Need for a For-Profit Subsidiary. If a museum derives a "substantial" percent of its income from unrelated activities, it risks loss of tax-exempt status. Neither the IRS or case law have yet clearly defined the term substantial. As a general rule, however, if unrelated income regularly falls within the range of 15-30% of museum revenues, you may wish to establish a for-profit subsidiary. Certainly, once unrelated income exceeds 50%, it is difficult to demonstrate to the IRS that the museum is organized primarily to further tax exempt purposes.

The Concept of Relatedness. The fact that income is used to further exempt purposes does not qualify the income as related; the income itself must be derived from furthering exempt purposes. For example, the sale of a feather pen does not further an art museum's exempt purposes, even though the proceeds are used for museum purposes. However, when sold by a museum of history, the use of the pen itself may further the museum's educational purposes and thus be a related sale.

For an activity to be considered related under the Internal Revenue Code, it must "contribute importantly to the achievement of tax-exempt purposes". In the museum setting, an activity meets this test if it either stimulates interest in the subject matter itself or encourages public visits to the museum.

As you can imagine, applying these subjective standards can be a difficult task. Clearly, the sale of books of art by an art museum furthers its educational purposes. On the other hand, the same museum's sale of scientific books is unrelated activity and therefore taxable. But even this simple example reveals a basic flaw in the UBIT scheme: it is impossible to draw the line between art and science. What about the sale of books on architecture, antique scientific instruments, or Hubble telescope photographs? This same problem arises in many areas of merchandise sales your museum might consider.

This example also illustrates the rule of "fragmentation", under which museums must determine the relatedness of each and every item sold, and account for each item separately. In practice, each museum makes an initial judgment as to the relatedness of an item. Then if the IRS ever challenges a particular judgment call, the museum then documents a reasonable and good faith basis for determining the object to be related. If the IRS disagrees, the museum pays back taxes and interest on the sales. However, barring bad faith or intentional wrongdoing, it is unusual for penalties to be assessed.

Corporate Purposes. Before undertaking a venture, many organizations neglect to review their own corporate purposes (as set forth in corporate documents such as Articles of Organization and Bylaws). But not only do sales have to be related to general tax-exempt purposes, but also to the purposes of the organization itself. To ensure that income from as many sources as possible is related, a museum's legal purposes should be as broad and encompassing as possible.

Reproductions, Adaptations, and Utilitarian Items. Due to conflicting previous IRS rulings, there is special confusion in this area. The current IRS view is that the test for all such sales is whether the primary purpose of the sale is to further the museum's mission or to generate income. Whether a particular item is reproduced or adapted from the museum's own collection is no longer determinative, but still may be a factor in assessing the museum's motivation in selling the item.

As to utilitarian items specifically, the prior rule was essentially that if an item was primarily utilitarian then it was unrelated to exempt purposes. The new standard, although more favorable to museums, requires almost psychic abilities to apply: If the dominant impression individuals gain from using the item relates to the subject matter of the original, then the sale is related. However, if the noncharitable use or function predominates, then the sale is taxable.

For instance, in one instance the sale of adaptations and interpretations were held not to be related because they did not encourage personal learning experiences about the museum. The taxable products included silverware, jewelry, rugs, lamps and furniture. However, in other cases, sales of collectible miniatures, wallpaper, fabric, china, other furniture, and even chandeliers and outdoor furniture have been held to be related. This was so, even though the products were used in the home, because they contained authentic design motifs, portrayed historical scenes, contained accompanying literature, and/or had educational value.

Common UBIT Exclusions for Museums

Even if a commercial venture constitutes unrelated activity, one or more specific statutory exclusions to UBIT may apply. The following is a sampling of exclusions most commonly used by museums. It is not a comprehensive list, so please check with counsel to see if others apply in your circumstances.

  • "Passive" Income, as opposed to income derived from the active conduct of a trade or business. Most importantly, passive income includes endowment and investment income, rents, and royalty sales. Thus, leasing excess office or exhibit space or renting function facilities within your museum does not ordinarily give rise to UBIT.

    As you might expect, however, there are two exceptions to these exclusions. First, if rental property is subject to a mortgage or other debt, part of the rental income (proportionate to the debt) is taxable. Second, rental income is taxable if the museum performs services beyond those ordinarily provided by a landlord, such as cleaning, set-up for events, or other personal services.
  • Volunteer Activities. If "substantially" all the work in generating unrelated income is performed without compensation, the income is not taxable. For instance, a museum store run by two full-time employees and fifteen part-time volunteers was ruled not to be substantially a voluntary effort. But another museum store operated 95% of the time by volunteers was held to be voluntary.
  • The "Thrift Shop" Exception. The selling of donated merchandise or goods is not considered an unrelated trade or business.
  • Activities for the Convenience of Patrons, and Employees. The operation of restaurants, snack bars, parking lots, and other amenities primarily for the convenience of patrons, members, and employees is excluded from UBIT.
  • Low Cost Items. The sale of certain low cost items, such as tee shirts and coffee mugs, is not taxable if the merchandise promotes or publicizes the museum. This is usually done by including the museum logo or other educational message on the items.
  • First $1,000. There is a specific deduction for the first $1,000 of net unrelated business income.
  • Limited Sales of Mailing Lists. The sale or exchange of membership or mailing lists by 501(c)(3) museums to other 501(c)(3) organizations is excludable from UBIT.


As you can see, UBIT classification is itself somewhat of an impressionistic work in progress. In dealing with these issues, arts and cultural organizations face the special difficulty of trying to respond to customer needs while remaining true to their self-perceived missions. But lest you think you face tough choices, one director of an experimental arts group told me that if they made money they knew they weren't focusing on their true artistic mission. In their case, financial success meant programmatic failure.

As your museum moves toward the next millennium (making possible the premier exhibit on "Traditional 21st Century Folk Art"), I wish you well in meeting the host of inter-related philosophical, strategic, and legal challenges ahead.