A: Yes. Non-profits can make money, but there are some limits.

Limit 1: Let’s say you are a university making money by owning and operating a macaroni factory, you will need to pay a tax on the revenue generated by the factory because macaroni has nothing to do with higher education. (True story involving my beloved alma mater NYU Law!)[2]

In other words, if a non-profit’s business has no relation to its mission, the IRS will tax the business’s revenue. This is called the Unrelated Business Income Tax.[3] The IRS specifically requires that a business be “substantially related” to the non-profit’s mission. What might be substantially related? The Girl Scout cookie business is substantially related to the organization’s mission because it helps young girls develop business skills. Greystone Bakery provides jobs to the “hard to employ” population in Yonkers, NY.

Whether the IRS would be satisfied that a particular business has a substantial relation to a non-profit’s mission is a good question for a lawyer.

In the meantime, the macaroni story can serve as a guide to what the IRS considers an unrelated business.

Limit 2: Profit generated by nonprofits must be used to achieve the mission.[1]

This is probably best explained with an example. Business A has had an incredibly successful year. It has generated significant revenue. After covering its costs and funding new projects or enhancing existing operations, it has a surplus; money is left over. Business A can and may decide to distribute the surplus to its owners, so they can share in the business’s success.

Nonprofits are not allowed to distribute its profits to individuals in that way. The IRS prohibits this kind of personal benefit. The expectation is that any profit will remain within the organization to achieve the social mission. It is important to note here that this limit does not prevent nonprofits from compensating employees. It prevents them from handing out surplus money to individuals, as Business A might.

[1] Exact IRS language: “To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual.”

[3] Exact IRS language: “For most organizations, unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption.” The IRS may also levy a harsher penalty if the non-profit generates extensive revenue and only provides minimal charitable services.