Question:
I’ve heard about other not-for-profit organizations selling NFT’s. What are these? and why would an organization do this? Are there tax implications that should be considered?
Answer:
NFTs (non-fungible tokens) are unique, digital items that hold value and are recorded on a blockchain for their original creators to buy, sell or trade. NFTs can be a variety of assets including digital art, videos, games, avatars, and event tickets. As NFTs are growing in popularity, many not-for-profit organizations and their supporters have begun to explore the idea of creating and utilizing NFTs as a fundraising vehicle. Below are some considerations when discussing the potential for the creation, receipt or sale of NFTs.
One significant use case includes creating and selling a piece of digital artwork. The artwork can be copyrighted which provides protection from the recreation or duplication of the creator’s asset. The digital artwork can be sold with or without the copyrights. By selling the NFT without the copyright, the not-for-profit organization would then be able to collect royalty revenue from the subsequent owners of the asset. However, the organization could also auction off the NFT for a single lump sum fundraising opportunity.
What implications should organizations consider when utilizing NFTs for fundraising?
When using NFTs for fundraisers, one main consideration for not-for-profit entities is the potential for unrelated business income tax on the proceeds. Three requirements must be met for an activity to be considered an unrelated business: it is a trade or business, it is regularly carried on and it is not substantially related to furthering the exempt purpose of the organization. Therefore, when planning fundraising activities with NFTs, not-for-profit organizations should consider the following:
- Would the NFT activities be considered a trade or business? The IRS definition notes that a trade or business generally includes any activity engaged to produce income from the sale of goods or services. As a sale of an NFT is likely engaged to produce income for the entity, NFT fundraising activities are likely to be considered a trade or business.
- How often are NFTs utilized for fundraising purposes? Organizations should consider if their activities are going to occur throughout the year or an annual fundraiser. If the organization chooses to engage in the sale of NFTs on an annual basis, it is unlikely that the organization will be subject to unrelated business income tax.
- Is the sale of NFTs substantially related to furthering the exempt purpose of an organization? For some organizations, such as art museums, these may be related to their mission. However, the sale of NFTs is not likely to further the mission of many not-for-profit organizations.
With the three considerations above, many organizations are likely to meet two of the three requirements for recognition of unrelated business income tax. Therefore, not-for-profit organizations should consider the frequency of their NFT activities and be aware of the potential for their NFT activities to be subject to unrelated business income tax.
There are also the initial start-up costs to consider which can include an up- front time investment into the design, planning phase, developer costs and selling costs. The time and costs can be substantial and there is no guarantee that the costs will be recovered.
As with any new opportunity, do your research. In addition to the opportunities, NFTs also have their share of risks. Please contact Kylie Thomas in CSH’s Not-for-Profit Tax Group if you have further questions related to NFTs.
