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How OpenAI LEGALLY Switched from Nonprofit to For-Profit

Written by Ricky Nave in Business Entities & Structures,Taxes,Tech Industry

We all know that feeling of disappointment when you fail to hit your $1 billion nonprofit fundraising goal and only raise $130 million instead, but it’s how you deal with that disappointment that defines you as an entrepreneur.

Many people would take the easy route of just embezzling what they already had or asking their billionaire friends for more donations, but the team at OpenAI, well, they’re just built different. At a time when the hottest for-profit companies were losing money faster than nonprofits, the nonprofit OpenAI decided to become for-profit, and within a few months they were able to raise the $1 billion they needed.

And in fairness, they DID need it. Even back in 2017, long before anyone had heard of ChatGPT, the amount of computing power used by AI models was doubling every 3.4 months, so computing power was quickly using up all OpenAI’s donations.

Of course, the IRS doesn’t actually allow nonprofits to simply convert themselves into for-profit companies since that would allow fraudsters to trick people into donating money to a good cause, only to declare the next day that the money would actually be used to build a new casino. OpenAI got around this by keeping the nonprofit company, called OpenAI, Inc., in place, and creating a new for-profit company, called OpenAI, LP, as a subsidiary.

OpenAI, Inc. still owns the OpenAI trademark and has complete control over OpenAI, LP, but OpenAI, LP does all the work, generates revenue, and provides equity compensation to OpenAI employees and investors. The structure was actually a little bit more complicated, and between 2019 and 2023, the structure was changed a couple times so that now it actually looks more like this:

OpenAI business structure

The restructuring process left OpenAI’s cofounder and largest donor, Elon Musk, to question the legitimacy of OpenAI’s actions.

So is what OpenAI did legal?

The simple answer is “probably”.

There are no laws that ban nonprofit companies from owning for-profit companies. In fact, it’s quite common for wealthy entrepreneurs to spend their careers building profitable companies and then donate their stock in those companies to one or more nonprofits.

For example, Henry Ford created the nonprofit Ford Foundation and donated over 90% of the non-voting shares of Ford to the Ford Foundation. Eli Lilly, the founder of the pharmaceutical company Eli Lilly & Co, created a nonprofit called Lilly Endowment Inc and donated almost $90 million (equivalent to over $1 billion in 2023 dollars) of Eli Lilly & Co stock to the nonprofit. And Howard Hughes donated the entire Hughes Aircraft Company to the nonprofit Howard Hughes Medical Institute, effectively turning a large defense contractor into a untaxed charity.

However, while there are no laws that outright ban nonprofit companies from owning for-profit companies, there are three major legal restrictions.

Firstly, the for-profit subsidiary can create what the IRS calls “Unrelated Business Income” or UBI. UBI is income that a nonprofit generates from something unrelated to its core mission, and it’s taxed at the corporate tax rate even if the nonprofit is tax-exempt in general. For example, if a nonprofit hospital opened a car dealership to help fund itself, then any income the car dealership generated would be considered unrelated business income since car dealerships are unrelated to hospitals. That means all income from the car dealership would be taxed as if the nonprofit was a normal for-profit company.

In the case of OpenAI, however, UBI is probably not an issue since both the nonprofit and its for-profit subsidiary are working exclusively on artificial intelligence.

The second legal issue that a nonprofit can run into when it owns a for-profit subsidiary is a violation of fiscal responsibility. State law dictates that nonprofits have a legal duty to manage the money they are endowed with in a financially responsible manner. Forty-nine states (Pennsylvania is the hold-out) and D.C. have adopted versions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). UPMIFA typically requires that nonprofits diversify their investments in order to reduce risk, and owning the majority of a large for-profit subsidiary can often violate that requirement.

However, UPMIFA only applies to nonprofit investments that are made primarily for financial return. If a nonprofit wants to make an investment primarily in an effort to further its mission rather than for financial return, then UPMIFA does not apply. That means when the nonprofit OpenAI, Inc created the for-profit OpenAI, LP, it likely could have invested the vast majority of its money into the for-profit company without triggering UPMIFA since the for-profit company investment is directly related to the nonprofit’s mission of creating safe AGI.

Finally, the last big issue that a nonprofit can run into when it owns a for-profit company is called provide private inurement. Private inurement is legal term for a concept that everyone understands intuitively, and it’s what makes most people feel like it’s unethical for a nonprofit to become a for-profit.

Essentially, private inurement is when a nonprofit board member or employee is able to gain unearned benefits from a nonprofit by abusing their position of power, at the expense of the nonprofit’s mission. For example, if a board member of a nonprofit youth athletics club owned the facility used by the club and rented the facility to the club at far above market rate, that would be private inurement. If a nonprofit art gallery allowed board members to exhibit their art for free but charged other artists a fee, that would be private inurement too.

In OpenAI’s situation, there are all sorts of things that might be private inurement. At a basic level, using non-public research, funded by a nonprofit, to then create a for-profit company which is majority owned by the nonprofit, but also partly owned by employees of the non-profit, is arguably an unfair benefit to those employees. It’s a somewhat gray area of law though because while many nonprofits have been gifted majority shares of large companies, relatively few nonprofits have used their own money to fund new subsidiary startups which employ some of the nonprofit’s own employees.

OpenAI’s lawyers did their research though because they have basically gone as close as they can to the legal line without overtly crossing it. For instance, there was a legal case in 1980 where the IRS challenged a nonprofit church which compensated its minister through a revenue-sharing agreement. Ultimately, the IRS ruled that since the arrangement provided potentially uncapped compensation, it was unreasonable and therefore constituted private inurement. OpenAI apparently took note of that case because when it created its for-profit subsidiary, it capped the potential return to 100-times the initial investment amount. In an OpenAI blog article at the time, they wrote:

“We want to increase our ability to raise capital… while still serving our mission [to ensure that artificial general intelligence (AGI) benefits all of humanity, primarily by attempting to build safe AGI and sharing the benefits with the world]… No pre-existing legal structure we know of strikes the right balance. Our solution is to create OpenAI LP as a hybrid of a for-profit and nonprofit–which we are calling a ‘capped-profit’ company.”

OpenAI blog article from 2019

OpenAI’s employees did such a fantastic job with PR that it would almost make you think the capped profit structure was motivated by an innovative mixture of altruism and practicality rather than the legal boundary of a 1980 tax court case.

But is a 100-x return on your money really that different from an unlimited revenue share, anyway?

Only the tax court can say for sure. If OpenAI is ever taken to court by the IRS though, one thing that will actually help their case is the fact that Sam Altman was fired. That’s because Sam Altman getting fired proves that no single employee had THAT much control over OpenAI. Before the nonprofit OpenAI created for-profit OpenAI, it set in place certain checks and balances. Only a minority of board members (of OpenAI Nonprofit) are allowed to own equity in the for-profit OpenAI company at the same time. Furthermore, only board members who don’t own equity can vote on decisions where the interests of shareholders might conflict with OpenAI Nonprofit’s mission. That’s exactly what happened when Sam got ousted last week: A majority of non-equity owning board members were concerned that Sam was shipping ChatGPT upgrades faster than was safe, so they voted him out.

Why did OpenAI need to become for-profit?

By March of 2017 (just 15 months after incorporation), OpenAI’s leadership realized that staying a purely nonprofit company would be financially untenable. The amount of compuational resources that other AI companies were using to achieve breakthrough results were doubling every 3.4 months, and OpenAI wasn’t able to attract as many donations as they had originally anticipated. Raising money from investors seemed like the best option.

Who invested in OpenAI when it was created?

Originally, OpenAI was created as a nonprofit which means it didn’t have investors. However, several wealthy people and companies collectively donated about $130.5 million to the company. Those initial donors included:

  • Elon Musk
  • Peter Thiel
  • Greg Brockman
  • Sam Altman
  • Reid Hoffman
  • Jessica Livingston
  • Amazon Web Services (AWS)
  • YC Research
  • Infosys

Importantly, none of these donors gained any ownership in OpenAI through their donations since the company was a pure nonprofit at the time.

Who owns OpenAI now?

Once the for-profit OpenAI LP company was created, several people and companies invested.

OpenAI LP is owned by OpenAI, Inc (the original nonprofit OpenAI), Microsoft, Khosla Ventures, Tiger Global Management, Andreessen Horowitz, Bedrock, Reid Hoffman’s charitable foundation, and a holding company jointly owned by certain OpenAI employees.

OpenAI LP has since been restructured into OpenAI Holdings LLC, but the owners remain the same.

Meanwhile, OpenAI, Inc continues to be a nonprofit which means it is owned by nobody.

Is OpenAI a publicly traded company?

Neither OpenAI Inc nor OpenAI LP is a publicly traded company. OpenAI Inc is a non-profit which means it does not have stockholders, and OpenAI LP is a privately owned for-profit company owned by OpenAI Inc, the employees of OpenAI LP, and a few key strategic investors including Microsoft. However, since Microsoft is a publicly traded company, that that means you could indirectly invest in OpenAI by buying shares in Microsoft (NASDAQ: MSFT).

Does Microsoft own OpenAI?

Microsoft owns a significant equity stake in OpenAI Global, LLC. Between Microsoft’s 2019 investment of $1 billion into OpenAI and their secretive 2023 investment of up to $10 billion, Microsoft now reportedly owns 49% of OpenAI LP.

If Microsoft has invested $10 billion into OpenAI Global, LLC, then OpenAI’s “100x-capped-profit” structure means that Microsoft can profit by up to $1 trillion from its OpenAI investment.

Does Elon Musk own OpenAI?

No, Elon Musk does not own OpenAI. Elon Musk cofounded OpenAI Inc in 2015 with several other people. OpenAI Inc is a non-profit, and as part of his founding contribution, Musk donated $100 million to the company. Later, in 2019, OpenAI Inc formed a partially-owned subsidiary OpenAI LP (a for-profit company). However, Elon Musk did not receive any ownership stake in OpenAI LP.

What companies has OpenAI invested in?

OpenAI has invested in several startups including Descript (AI video editing software), Harvey (legal workflow software built on generative language models), Mem (an AI self-organizing workspace, starting with personal notes), and Speak (an AI language tutor).

Can nonprofits invest in for-profits?

Generally, nonprofits can own for-profit companies (e.g. as the result of a gift of stock) without restriction. However, nonprofits can only invest in for-profit companies under certain conditions.

Firstly, state laws apply. Forty-nine states (Pennsylvania is the hold-out) and D.C. have adopted versions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). However, UPMIFA only applies to nonprofit investments that are made primarily for financial return. If a nonprofit wants to make an investment primarily in an effort to further its mission rather than for financial return, then UPMIFA does not apply. For example, when the nonprofit OpenAI, Inc created the for-profit OpenAI, LP, it likely could have invested the vast majority of its money into the for-profit company without triggering UPMIFA since the for-profit company investment is arguably primarily for the furtherance of the nonprofit’s mission of creating safe AGI.

However, even if a contemplated investment is primarily motivated by a nonprofit’s mission rather than financial return so that UPMIFA does not apply, certain other laws still apply. Among these laws are:

References

[1] OpenAI creation & purpose announcement. December 11, 2015.

[2] OpenAI Blog: We’ve created OpenAI LP, a new capped-profit company. March 11, 2019.

[3] Tech Crunch: OpenAI shifts from nonprofit to ‘capped-profit’ to attract capital. March 11, 2019.

[4] MIT Technology Review: The messy, secretive reality behind OpenAI’s bid to save the world. February 17, 2020.

[5] OpenAI Startup Fund I, L.P. – SEC form D filing. October 28, 2021.

[6] CNBC: Microsoft announces new multibilion-dollar investment in ChatGPT-maker OpenAI. January 23, 2023.

[7] Microsoft Blog: Microsoft and OpenAI extend partnership. January 23, 2023.

[8] OpenAI VC Fund

[9] Nonprofit Law Prof Blog: Should OpenAI be tax exempt?

[10] Nonprofit Law Blog: Can a nonprofit own a for-profit? Can a for-profit own a nonprofit?

[11] Private benefit under IRC 501(c)(3)

[12] IRS Overview of Inurement/Private Benefit Issues in IRC 501(c)(3)

[13] IRS: How to lose your 501(c)(3) tax-exempt status (without really trying)

[14] OpenAI: Our Structure. June 28, 2023.

Appendix A: OpenAI Facts & History

OpenAI was founded in December of 2015 by a group of Silicon Valley legends including:

  • Elon Musk (cofounder of PayPal, SpaceX, Tesla, Neuralink, and The Boring Company)
  • Peter Thiel (cofounder of PayPal, seed investor in Facebook)
  • Reid Hoffman (cofounder of LinkedIn)
  • Jessica Livingston (founding partner of Y Combinator)
  • Sam Altman (a then-mostly-unknown wunderkid)

and others, with additional institutional funding from:

  • Amazon Web Services
  • YC Research
  • Infosys (an Indian multinational IT and consulting services company that publicly trades on the NYSE)

In 2018, Elon Musk resigned from his OpenAI board seat, citing a potential future conflict of interest with Tesla’s self-driving AI program.

In 2019, the nonprofit OpenAI company (OpenAI, Inc.) created a for-profit subsidiary (OpenAI, LP). The stated reason for doing this was to attract investors since the nonprofit OpenAI was finding it difficult to raise as much money as they needed (of the original $1 billion fundraising goal, OpenAI was only able to raise about $130 million).

Appendix B: Business Entity Records

As far as I can tell, all OpenAI business entities (both nonprofit and for-profit) are incorporated in Delaware and registered to do business in California. However, the exact structure seems to have changed more than once. Various for-profit subsidiaries seem to have been formed and then later restructured. The table below summarizes key publicly available business entity records for OpenAI.

Business EntityRecord Location (State)Record DateRecord Summary
OpenAI SPV I, LLCDelaware11/15/2023Incorporation / Formation
OpenAI OpCo, LLCCalifornia05/08/2023Registered to do business in CA
OpenAI Holdings, LLCCalifornia05/01/2023Registered to do business in CA
OpenAI Global, LLCCalifornia05/01/2023Registered to do business in CA
OpenAI Holdings, LLCDelaware03/17/2023Incorporation / Formation
OpenAI Investment LLCDelaware02/06/2023Incorporation / Formation
OpenAI Global, LLCDelaware12/28/2022Incorporation / Formation
OpenAI Holdco, LLCDelaware12/28/2022Incorporation / Formation
OpenAI Startup Fund I, L.P.California01/27/2022Registered to do business in CA
OpenAI Startup Fund GP I, L.L.C.California08/07/2021Registered to do business in CA
OpenAI Startup Fund GP I, L.L.C.Delaware07/28/2021Incorporation / Formation
OpenAI Startup Fund I, L.P.Delaware07/28/2021Incorporation / Formation
OpenAI Startup Fund Management, LLCCalifornia07/22/2021Registered to do business in CA
OpenAI Startup Fund Management, LLCDelaware07/16/2021Incorporation / Formation
OpenAI, L.L.C.Delaware09/17/2020Incorporation / Formation
OpenAI GP, L.L.C.California10/10/2018Registered to do business in CA
OpenAI, L.P.California10/10/2018Registered to do business in CA
OpenAI OpCo, LLCDelaware09/19/2018Incorporation / Formation
OpenAI GP, L.L.C.Delaware09/19/2018Incorporation / Formation
OpenAI, Inc. (Nonprofit)California01/07/2016Registered to do business in CA
OpenAI, Inc.Delaware12/08/2015Incorporation / Formation

Additionally, OpenAI has published limited additional information on their blog. For example, in an article from June 28, 2023, the OpenAI team published the following snippet from the operating agreement of one of their for-profit companies, OpenAI Global, LLC:

The same article goes on to say that “the for-profit [OpenAI Global, LLC] is fully controlled by the OpenAI Nonprofit.” That control is implemented through OpenAI GP LLC, which is wholly owned by the nonprofit.

What is Private Inurement? [Nonprofits]

Written by Ricky Nave in Finance,Taxes

Artistic representation of private inurement

Inurement is just another word for benefit. Private inurement is legal jargon for when a nonprofit board member or insider uses their control over the nonprofit to obtain personal benefits, at the expense of the nonprofit’s mission.

Example 1: Nonprofit pays above-market rent to board members

Texas Trade School was an educational nonprofit. Five members of the board of directors received above-market-rate rental income from the nonprofit. This was private inurement.

Texas Trade School v. Commissioner, 30 T.C. 642, aff’d. 272 F.2d 168 (5th Cir. 1959)

Example 2: Zero-interest loans to a board members’ family

A nonprofit private unaccredited law school was operated by two brothers, Theo and Martin Fenster, and members of their family. Martin used his control of the organization to provide his family with an interest-free unsecured loan to purchase a home and furnish it. That was private inurement.

John Marshall Law School and John Marshall University v. United States, 81-2 USTC 9514 (Ct. Cl. 1981)

The concept or private inurement is important because it jeopardizes a nonprofit’s tax-exempt status with the IRS. Section 501(c)(3) of the Internal Revenue Code provides an exemption from federal income tax for organizations that are “organized and operated exclusively” for religious, educational, or charitable purposes, but ONLY as long as “no part of the net income [of the organization] inures to the benefit of any private shareholder or individual.”

Essentially, a nonprofit must be exclusively formed and operated to benefit the public, not specific individuals, in order to qualify for the 501(c)(3) income tax exemption. However, the real world is a messy place. According to an IRS text on the topic, “in the charitable area, some private benefit may be unavoidable. The trick is to know when enough is enough.”

Treasury Regulations describe the anti-inurement requirement in more detail as follows:

“An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals… [If an organization] fails to [be operated exclusively for one or more exempt purposes], it is not exempt [from federal income tax]…The words ‘private shareholder or individual’ in section 501 refer to persons having a personal or private interest in the activities of the organization.”

26 CFR 1.501(c)(3)-1 subparts (a) and (c)

Courts have focused on the word “private” in the above excerpts. “Private” is held to mean the antonym of “public”. In other words, a private individual is distinguished from the general public. Of course, any individual who receives goods or services from a charity derives benefit. But as long as that person received that benefit just for being a member of the public, rather than receiving a special benefit only available to insiders, then the benefit doesn’t constitute private inurement.

Example 3: Fee waiver for board members

A nonprofit art gallery allows gallery members to exhibit their artwork for a fee. However, the nonprofit’s board members can exhibit their artwork without cost. That is private inurement because although artwork exhibition is a benefit the nonprofit offers publicly to all its members, free artwork exhibition is not.

In other words, the private inurement rule restricts the ROLE in which a person receives benefits more than it restricts WHO can receive benefits. If a board member receives a benefit that the nonprofit also offers publicly, then that probably isn’t private inurement. It is the CAPACITY in which an individual derives financial benefit that will determine whether prohibited inurement exists.

We can summarize this with two core principles:

  1. An individual is not entitled to unjustly enrich himself at the organization’s expense, and
  2. Benefits directed to an individual as a member of a charitable class do not constitute unjust enrichment.

The second principle says that a member of a nonprofit hospital’s governing board can still be admitted to that hospital. The first principle says that such a board member cannot be billed at a discounted rate for their hospitalization. The first principle also prohibits a special nonprofit hospital from being formed with the intention of funneling 30% of the hospital’s resources towards a member of the nonprofit’s board who has a chronic illness.

Example 4: Dissolution rights to previously donated property

A husband and wife couple founded a nonprofit, the Religious Society of Families. One of the religious tenets of the nonprofit was that married couples had a duty as stewards of the earth which could be fulfilled by caring for and preserving a plot of land. The couple donated 50 acres of land to the nonprofit and made good faith efforts to attract other couples to occupy portions of the property. However, those efforts were unsuccessful. Because of that, the couple who donated the land still had 100% of the control of the organization, including the right to decide to dissolve the organization and the right to decide what would happen to the organization’s assets if it was dissolved. The IRS challenged the tax-deductability of the initial 50 acre donation at this point, and court reiterated that “the burden of proof is, of course, upon the petitioners to show entitlement to the charitable contribution deduction. They must show, inter alia, that their organization was operated exclusively for religious purposes.”

In the court’s final decision, they concluded “we are convinced of the sincerity of petitioners’ convictions… [but the problem is that] upon dissolution of the organization (an occurrence wholly within petitioners’ control) its assets will revert to the petitioners [or] at the least they will have ultimate authority over their disposition. Even though they may intend at this time to distribute the assets to some other exempt organization, there is not the irrevocable commitment which allows us to find it was ‘operated exclusively for religious purposes’ [or that] ‘no part of the net earnings [inures] to the benefit of any private [individual].”

Calvin K. Of Oakknoll v. Commissioner, 69 T.C. 770 (1979), aff’d by unpublished order (2nd Cir. 1979)

Contractual & Financial Complications

There is no prohibition against a 501(c)(3) organization hiring (for pay, as an employee, contractor, or otherwise) its founders, members, or officers. However, any transaction between a 501(c)(3) organization and a private individual in which the individual appears to receive a disproportionate share of the benefits of the exchange relative to the charity presents an inurement issue. Such transactions may include assignments of income, compensation arrangements, sales or exchanges of property, commissions, rental arrangements, gifts with retained interests, and contracts to provide goods or services to the organization.

Notably, modern compensation arrangements often include a variety of benefits in addition to salary. The general rule is that if the arrangements are indistinguishable from ordinary prudent business practices in comparable circumstances, a fair exchange of benefits is presumed and inurement will not be found. If the transactions depart from that standard to the benefit of an individual, then you have inurement.

For example, OpenAI has interpreted that guidance to mean that since equity is a standard part of tech startup compensation, then it is okay for high level OpenAI nonprofit employees to be compensated with equity in the for-profit subsidiary OpenAI, LP.

A somewhat comparable case from the past is Rul. 69-383, 1969-2 C.B. 113. In that situation, a revenue ruling determined that inurement did not occur. The situation involved a tax exempt hospital entering into a contract with a radiologist after arm’s-length negotiations. The contract specified that the radiologist would be compensated by receiving a percentage of the gross receipts of the radiology department. The revenue ruling concluded that the contract did not jeopardize the hospital’s 501(c)(3) status. In support of that conclusion, several relevant facts were cited:

  • The contract was negotiated on an arm’s-length basis.
  • The radiologist did not control the hospital.
  • The amount received by the radiologist under the contract was reasonable in terms of the responsibilities and duties assumed.
  • The amount received by the radiologist under the contract was not excessive when compared to the amounts received by other radiologists in comparable circumstances.

Of course sometimes, people try to disguise inurement as reasonable compensation. For instance, in the case “John Marshall Law School and John Marshall University v. United States (81-2 USTC 9514)”, a private, unaccredited, law school and college were operated by two brothers, Theo and Martin Fenster, and members of their families. The IRS revoked the 501(c)(3) exemption of both the law school and the college on the grounds that part of the net earnings of the organizations inured to the benefit of private shareholders or individuals. The Court opened its discussion of the case by noting that:

“The term ‘net earnings’… has been construed to permit an organization to incur ordinary and necessary expenses in the course of its operations without losing its tax-exempt status…The issue, therefore, is whether or not the expenditures JMLS paid to or on behalf of the Fenster family were ordinary and necessary to JMLS operations.”

The Court then went on to detail a series of interest-free, unsecured loans used by the Fensters to purchase a home and furnish it, noncompetitive scholarships granted to the Fenster children, and the payment of nonbusiness expenses for travel, health spa memberships, and entertainment of Fenster family members.

Other case examples of inurement include:

  • An organization paying someone excessive rent (Texas Trade School v. Commissioner, 30 T.C. 642 — 1959)
  • An organization receiving less than fair market value as part of a sale or exchange of property (Sonora Community Hospital v. Commissioner, 46 T.C. 519 — 1966)
  • An organization providing an inadequately secured loan to a private person (Lowry Hospital Association v. Commissioner, 66 T.C. 850 — 1976)

Another example of particular relevance to OpenAI is the case “People of God Community v. Commissioner” where the court decided that a percentage-of-earnings-share compensation arrangement for a minister was unreasonable compensation because there was no upper limit on the amount of compensation that the minister could receive. This is why OpenAI’s for-profit subsidiary caps investor returns at 100-times the initial investment.

Private Inurement vs Unrelated Business Income

Private inurement and unrelated business income are both situations that can negatively affect nonprofits. However, the two are very different. Private inurement refers to an inappropriate benefit that a nonprofit board member or insider receives from the nonprofit, at the expense of the nonprofit’s mission. On the other hand, unrelated business income is income that a nonprofit receives which is unrelated to the nonprofit’s mission and is therefore subject to taxation.

What is Unrelated Business Income Tax? [Nonprofits]

Written by Ricky Nave in Taxes

Unrelated business income tax (UBIT) is a tax on certain types of income earned by nonprofits. Essentially, most nonprofits must be chartered with a particular tax-exempt purpose that the IRS agrees to. Unrelated business income is any income that a nonprofit earns from activities NOT related to that tax-exempt purpose. Unrelated business income is taxed at the normal corporate tax rate.

Example 1:

Smart Kids is chartered as an educational nonprofit with the tax-exempt purpose of providing tutoring to kids in elementary school. The organization offers the tutoring at cost, but they also sell coffee to the public at the front of their building.

Since coffee sales have nothing to do with tutoring, the IRS will likely deem the income from the coffee sales to be “unrelated business income” which is subject to the unrelated business income tax. However, the income from selling tutoring services is still not taxed.

Example 2:

First Christian Church operates as a 501(c)(3) nonprofit. The church bought its property using a mortgage and rents out the space for events during the middle of the week in order to help cover the cost of the mortgage. That rental income is unrelated business income subject to UBIT.

Sponsorships: A Tricky Topic for UBIT

One of the most common ways that nonprofits inadvertently generate unrelated business income is from sponsorships. If a local business sponsors an event hosted by a nonprofit, the nonprofit is allowed to acknowledge the business’s contribution, thank them, and display the company’s logo. However, if the nonprofit crosses the line into “advertising” the sponsor’s business, then the sponsor’s donation suddenly becomes unrelated business income subject to tax.

The line between “sponsorship” and “advertising” is fuzzy. However, as a rule of thumb, the line is crossed when the nonprofit starts using “qualitative or comparative descriptions” when describing a sponsor’s business or products.

For example, if First State Bank sponsors a nonprofit youth sports event by providing a $10,000 gift, then it’s okay for the nonprofit to announce during the game:

“We want to send out a special thank you to First State Bank for helping to make this all happen. We are so grateful for their support.”

That’s fine. That’s still a sponsorship. However, suppose the announcement instead was:

“We want to thank First State Bank for sponsoring today’s event. With hassle-free checking accounts and the best customer service in the county, First State Bank has what you need.”

Now we’ve crossed the line into advertising because “hassle-free” and “best” are qualitative and comparative descriptions. Now the $10,000 donation becomes unrelated business income subject to tax at the corporate tax rate.

One issue that commonly comes up around sponsorships is whether or not a nonprofit can use a sponsor’s slogan if that slogan is itself somewhat boastful. For example: “First State Bank: Simple, Anxiety-Free Banking”.

The general rule for such slogans is to avoid using them UNLESS the slogan is a well-established part of the sponsor’s identity. For example, “Like a good neighbor, State Farm is there” is a very well established part of State Farm’s identity and has been in use for a long time, so it would be fine for a nonprofit to use that slogan.

In general, the IRS provides the “qualified sponsorship” safe harbor for nonprofits who want to guarantee that they don’t accidentally convert untaxed donations into taxable unrelated business income.

Special Rules for UBIT

In general, if a nonprofit generates income, there must be a substantial causal relationship to the achievement of the nonprofit’s exempt purpose(s), OTHER than the production of income, in order for that income to avoid being taxed. However, there are exceptions to that:

  • Passive income from interest, dividends, annuities, or royalties are NOT subject to UBIT.
  • Rental income from un-financed property is generally NOT subject to UBIT.
  • Rental income from financed property generally IS subject to UBIT.
  • If a nonprofit club provides goods or services (on a small scale) for the convenience of its members, that income generally will NOT be subject to UBIT.
  • Income from selling services which are performed mostly by volunteers are generally NOT subject to UBIT.
  • Income from the sale of goods donated to a nonprofit is generally NOT subject to UBIT.

Which Nonprofits Are Subject to UBIT?

It’s estimated that there are between 1.5 million and 2 million nonprofit organizations in the U.S., including churches, schools, charities, private foundations, political organizations, social clubs, and business associations. Most nonprofits ARE subject to UBIT on any unrelated business income. However, nonprofit corporations organized under Acts of Congress and which are now instrumentalities of the U.S. government (e.g. Federal Reserve Banks) are NOT subject to UBIT.

References

[1] IRS: Unrelated Business Income Tax

[2] IRC 511 – Imposition of tax on unrelated business income of charitable organizations

[3] IRC 512 – Unrelated business taxable income

[4] IRC 513 – Unrelated trade or business

[5] IRS confirms that a charity may provide consulting services for a fee to social sector organizations without incurring UBIT

[6] Does your church owe income taxes?

How to Read Housing Market Data

Written by Ricky Nave in Real Estate

The U.S. Department of Housing and Urban Development (HUD), the Census Bureau, the Federal Reserve, the National Association of Realtors (NAR), Redfin, and various other organizations publish extensive housing market data on a regular basis.

However, they frequently use different definitions for the variables they report, which can seriously mislead you if you’re not paying attention. For example, if you’re looking at an article that quotes the median home price last month, that might be referring to:

  • The median sale price of existing single family homes sold last month
  • The median sale price of new construction single family homes sold last month
  • The median sale price of ALL (existing & new construction) single family homes sold last month
  • The median listing price of single family homes currently on the market
  • Any of the previously mentioned measures, but for condos instead of single family homes
  • Any of the previous measures for condos and single family homes combined
  • Any of the previous measures for sold properties, but only for properties which were financed (i.e. excluding cash purchases, which account for over 40% of sales in some Florida markets)
  • Any of the previous measures for sold properties, but only for properties which were financed using a federally backed mortgage (e.g. an FHA loan)
  • Any of the previous measures, but only for properties listed on the MLS (i.e. excluding properties for-sale-by-owner and properties sold by real estate agents who aren’t members of NAR)
  • Any of the previous measures, but seasonally adjusted

That’s more than 100 different possible meanings for “median home price last month”, and those differences in definitions can paint very different stories of what’s happening in the housing market.

Example 1

According to NAR, the median home price in the U.S. rose 2.5% from $389,600 in September 2022 to $399,200 in September 2023. The NAR data table is shown below.

Meanwhile, FRED reports the median sales price of houses sold for the U.S. to be DOWN 7.9% from $468,000 in Q3 2022 to $431,000 in Q3 2023.

To be clear, NAR says home prices are up 2.5%, but FRED says they are down 7.9%. How is that possible?

The answer is that NAR is measuring the median sale price of EXISTING single family homes while the FRED series I mentioned is (despite the misleading label of “median sales price of houses sold for the United States”) only measuring the median sale price of NEW CONSTRUCTION single family homes.

In general, most single family home sales are EXISTING home sales rather than new construction. For example, in 2022, there were 641,000 new construction single family homes sold and 4.48 million existing single family homes sold. That means in the example above, the NAR data (reporting an increase in home prices nationally) is much more reflective of the overall housing market than the FRED data (which reported a sharp DECREASE in home prices nationally).

The Case-Shiller U.S. home price index also supports that argument since it showed a 2.6% home price increase from August 2022 to August 2023.

Example 2

According to the Miami Realtor Association, the median single family home sale price in Miami-Dade County increased 10.3% from $580,000 in October 2022 to $640,000 in October 2023.

However, that doesn’t mean homes in general became 10% more unaffordable. The Miami Realtor Association ALSO released statistics showing that the median condo sale price in Miami-Dade County only increased 5.9% from $387,000 in October 2022 to $410,000 in October 2023. And in Miami, unlike in the U.S. as a whole, there are more condo sales than single family home sales. That means the true median change in Miami home prices over the last year is closer to 5.9% than to 10.3%.

Summary

When you read a housing market report, always make sure you know which variable you’re looking at so that you aren’t misled.

Don’t look at condos as reflective of the overall U.S. housing market, but DO look at them as reflective of the overall Miami market. Don’t confuse new home price trends with existing home price trends. Don’t confuse trends in listing prices with trends in “sold home” prices. Etc. Now go forth, analyze the data, and make good investments.

6 Biggest MLSs (Multiple Listing Services) in the U.S. in 2022

Written by Ricky Nave in Money Maps & Rankings,Real Estate

An MLS is a regional database of properties listed for sale by real estate brokers in that region. There are more than 500 MLSs in the U.S. Below is a list of the 6 biggest MLSs in the U.S., as ranked by the total number of MLS subscribers during 2022.

1. California Regional MLS (CRMLS)

CRMLS was formed from the merger of multiple smaller MLS organizations, and CRMLS continues to pursue an aggressive merger strategy with the goal of aggregating all California listings into a single database. Sometimes political disagreements prevent a smaller MLS from merging with CRMLS, but in that case, CRMLS will often enter a data sharing agreement with that MLS instead so that its listings are still available in the CRMLS database.

Today, CRMLS has over 110,000 users, including real estate professionals from data sharing partner MLSs.

CRMLS is owned by California MLS, Inc. which is in turn owned by the California Association of Realtors, the California state counterpart of NAR.

2. Bright MLS

Bright MLS was formed in 2015 from the merger of 42 local association MLSs from parts of 6 states plus Washington D.C. Today, Bright MLS has over 95,000 subscribers.

Bright MLS coverage map

3. Stellar MLS

Stellar MLS is a for-profit corporation owned by various local Realtor associations and serving others. Shareholder associations therefore stand to benefit more than non-shareholder associations who are merely customers of Stellar MLS. Stellar covers many listings in central Florida and Puerto Rico. Today, Stellar MLS has about 58,000 users.

Stellar MLS coverage map

It’s worthwhile noting that while Florida is one of 3 states in which net listings are legal in certain situations, the largest MLS in Florida (Stellar MLS) does not allow net listings.

4. Miami MLS

The Miami Association of Realtors maintains Miami MLS which contains listings from the associations members as well as two data-sharing partners (including BeachesMLS which has 36,000 subscribers). Miami MLS covers 5 southeast Florida counties (shown below).

The Miami Association of Realtors has approximately 55,000 members across its 6 suborganizations:

  • Miami Residential
  • Miami Commercial
  • Broward-Miami
  • JTHS-Miami (in the Jupiter-Tequesta-Hobe Sound area)
  • Miami YPN (Young Professionals Network)
  • Miami Global Council

According to the Association, there were 31,627 transactions in Miami-Dade County in 2022. Across all 5 counties, that means Miami MLS probably facilitated roughly 60,000-90,000 transactions.

5. Midwest Real Estate Data (MRED)

MRED LLC is an MLS serving 15 different local Realtor associations in Illinois. Between 45,000 and 50,000 brokers and agents use MRED as of 2023. A coverage map is shown below.

Midwest Real Estate Data (MRED) coverage map

In 2022, MRED facilitated 127,434 transactions equating to $46.2 billion.

6. OneKey MLS

OneKey MLS was formed from the merger of MLS Long Island (MLSLI) and the Hudson Gateway MLS (HGMLS or HGAR) in 2020. Currently, OneKey MLS has over 45,000 agents and covers Long Island, the Hudson Valley, all 5 boroughs of NYC, and parts of Connecticut and New Jersey.

The 5 Biggest Lobbyists in the U.S. in 2022

Written by Ricky Nave in Money Maps & Rankings

These are the 5 organizations which spent the most money on lobbying in 2022, according to data from OpenSecrets.

1. The National Association of Realtors

The National Association of Realtors is the largest trade organization in America, representing over 1.5 million Realtors, the majority of whom are women. Last year, the organization spent $81.7 million lobbying to expand federal mortgage assistance programs, expand federal rental assistance programs, increase tax benefits for homeowners, and increase infrastructure spending.

2. The U.S. Chamber of Commerce

The U.S. Chamber of Commerce is a general business advocacy group that spent $81.0 million last year lobbying for business-friendly laws and regulations across all industries.

3. Pharmaceutical Research & Manufacturers of America

Pharmaceutical Research & Manufacturers of America is a trade association representing pharmaceutical companies. Last year, they spent $29.2 million lobbying for things like:

  • Lower copays on prescription drugs,
  • Lower pharmacy fees,
  • Extended patent protection for new drugs, and
  • Increased medicaid coverage of name-brand drugs.

They also vigorously lobbied against drug price regulations.

4. American Hospital Association

The American Hospital Association (AHA) is an industry association of nearly 5,000 U.S. hospitals. In 2022, the AHA spent $27.1 million lobbying for more medicare and medicaid funding, more insurance reimbursement of healthcare costs, fewer disclosure requirements for special deals that hospitals cut with different insurance companies, and less medical liability for hospitals and doctors.

5. Blue Cross Blue Shield

Blue Cross Blue Shield is a nonprofit association of 34 independently operated health insurance member companies that provide coverage to more than 115 million people. The group’s members and subsidiaries spent $27.0 million in 2022 to lobby for things things like lower prescription drug prices and more federal spending on medical R&D.