Unrelated Business Income Tax: Volunteer Labor Exclusion

volunteer labor exception

The volunteer labor exclusion permits nonprofits to operate social enterprises that do not generate unrelated business income. As its name suggests, unrelated business income tax (“UBIT”) is an excise tax on exempt organization’s unrelated business income. Generally, the IRS will tax trade or business activity which does not substantially relate to an organization’s exempt purposes.

However, Internal Revenue Code § 513(a)(1) excludes from UBIT unrelated trade or business activity which is performed without compensation.

Volunteer Labor Exception

When Does the Exclusion Apply?

The volunteer labor exclusion to UBIT applies when the exempt organization carries on an unrelated activities where performance of such activities are substantially uncompensated.

For these purposes the term “compensation” is interpreted broadly to mean both monetary and nonmonetary payments. Under this broad definition, a worker who obtains goods or services at a reduced price in return for their services may be considered compensated.

A few other examples of what the IRS may consider compensation are:

  • Tips received by workers in lieu of a salary (Exec. Network Club v. Comm’r, T.C. Memo 1995-21);
  • Third party/indirect compensation (S. Cmty. Ass’n v. Comm’r, T.C. Memo 2005-285); and
  • Free food or drinks (See Waco Lodge No. 166, Benevolent & Protective Order of Elks v. Comm’r, 696 F.2d 372 (5th Cir. 1983)).
Volunteer Labor Exception

In this context, for compensation to exist there must be a “but-for” connection between the payment and the services. Meaning, the payment would not otherwise be given but for the provision of the services. If a worker is compensated, the exclusion does not apply.

Overall, the IRS will consider the totality of the circumstances when applying the exclusion. The exclusion will apply only where the performance of services is a material income-producing factor in carrying on the business.

De minimus compensation may be permitted and all workers involved in the operation of the activities will be taken into account, not just the exempt organization’s workers. This includes workers involved in advertising the activity, the set-up and cleanup of the facilities, the actual operation of the unrelated trade or business, concessions, accounting and legal services, and security.

Best Practices to Safeguard Your Nonprofit from UBIT Using the Volunteer Labor Exclusion

Below are some best practices to safeguard your nonprofit from UBIT using the exclusion. These actions will bolster your case in the event of an audit.

Volunteer Labor Exception
  1. Calculate the percentage of hours worked by volunteers and by paid workers. Ensure that volunteer labor significantly outweighs paid labor.
  2. Do not permit tipping.
  3. If you plan to provide free food or drinks for volunteers, keep it to a minimum.
  4. Ensure volunteers are assisting with set-up, cleanup, advertising, and all other parts of operating the unrelated trade or business.
  5. Keep accurate and detailed records of the event, number of volunteers, job duties, etc. in the event of an audit.

Related Reading: UBIT Exceptions


Kyler Mejia is an associate with Caritas Law Group, P.C. Caritas Law Group, P.C. advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide as well as donors with regard to major gifts. To schedule a consultation, call 602-456-0071 or email us through our contact form

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