Looking at the title of this article, you may be thinking (as many people do) that nonprofits only receive money from grants and donations. Well, fortunately, that isn’t (always) the case! In fact, nonprofits can generate revenue much like for-profit entities, so long as they play fair and don’t operate fully as a for-profit. Let’s see how.
Types of Service Fee Models
There are 5 types of service fee models that a nonprofit can utilize to supplement its grant and/or donation funding, which can be especially helpful in not-so-great economic times. Remember, however, that at no time can your fee for service funding outweigh your public funding (i.e. your grants and donations). If it does, you’re cruising for some Unrelated Business Income Tax trouble! (More on this later).
- Mandatory Fees – This model is basically what it sounds like – the nonprofit expects a fee for services rendered or products sold. However, there is a huge (yes, huge!) caveat: all fees must be below the “market rate” for similar fees or products offered by for-profits. Note: All fees must be collected without coercion. This fancy word just means that you can’t pressure or bully someone into paying a fee. Obvi.
- Voluntary Donations – Unlike mandatory fees, this model is more subtle. The best way to define this model is with an example that involves a post-sale survey or receipt with language saying either “donations help ensure continued services” or “we count on contributions to keep our work going, and ask that you contribute whatever is appropriate for your budget to support the services we provide.”
- Requested Fees – This model is similar to voluntary fees, but it is more direct. An example would be a nonprofit whose website lists the actual costs associated with the organization providing the services or products. The idea is that, when paired with an ask for a donation, this will compel the customer or client to actually donate.
- Memberships – This model simply provides an incentive for customers or clients to be a “member” in some sort of program that provides them a benefit at a lump-sum fee. There can even be different levels of membership based on donation amount that carry higher perks or benefits with them.
- Hybrid – Often a nonprofit will need to use variations of these models for their own circumstance. In fact, some nonprofits may even segment their customers or clients, meaning that certain customers have a membership model and other customers have requested fees). Another example of a hybrid is a sliding scale model in which the amount of the fee is proportional to the person’s financial ability to pay (using some predetermined metric of income).
When deciding which model is right for your nonprofit, pricing is one of the primary considerations. Since the goal of nonprofits is not necessarily to make a profit, the common financial method used to determine pricing for nonprofit service fee models is a break-even analysis.
We know, this is about to get like an accounting class. So, for you number-adverse people out there, you can simply use an online break-even calculator. Once you have figured out your break-even point, you can determine your baseline fee to charge using the various models we discussed above.
But remember: fee amounts must always be below the fee amounts that a for-profit entity would charge for similar services or products.
Important Tax and Legal Considerations
You’ve determined your service fee model(s) and your pricing. Now it’s time to see if your plan is kosher with tax laws. *Insert dramatic drumroll here.*
The Internal Revenue Service (IRS) places restrictions on income generated by nonprofits. For the income to be tax-exempt (tax-free), it must be related to the nonprofit’s charitable purpose. However, in some cases, the IRS will allow a small percentage of a nonprofit’s income to be unrelated to its charitable purpose. For all you tax code nerds out there, this regulation is found in IRS Publication 598 and it’s called Unrelated Business Income Tax (UBIT).
In essence, the IRS requires that you pay taxes on “unrelated” income generating activities, just like any other for-profit business would need to. To avoid your service fees being taxed (a.k.a. subject to UBIT), the service must be substantially related to the nonprofit’s stated charitable purpose in the official documents filed with the Secretary of State. We have an article on this topic here.
A quick example of the difference: a nonprofit focused on animal rescue probably can’t open an expensive pet grooming salon for elite Pomeranians (or it would be charged UBIT), but it can open a pet grooming salon that, for little or no cost, helps train rescue animals and prepares them for their forever homes. See the difference? We hope so.
What’s Right For You?
No nonprofit is the same. As such, deciding which service fee model(s) to use can be a daunting task, especially in light of the tax and legal considerations. By reading this article, you have taken your first step in the right direction. But, as always, reach out if you need further guidance!
By: Zachary Avina – 03/21/18
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