Transparency In Ministry

If a Church receives advertising or sponsorship/promotional income, the activity related to the income may be considered unrelated to the exempt purpose of the church.

Receiving advertising income may be unrelated business taxable income (UBTI), if the activity does not relate to the exempt purpose of the 501(c)(3) organization.

The IRS defines UBTI activity as follows:
1) the activity involved constitutes a "trade or business";
2) an activity that is "regularly carried on" by the organization; and
3) the conduct of the business is "not substantially related" (other than through the production of funds) to the performance of the organization's exempt function.

If the activity meets the above criteria, then the organization/church is required to report the income and pay the related tax utilizing the required forms.

What kind of tax form is used to report UBTI? See the subsequent post or contact us.

So what types of receipts affect UBIT???

The sale of religious publications or sermon tapes is generally related to the exempt purposes of a church. A bookstore is a little trickier.

We can eliminate any bookstore that is:

(1) Run by unpaid volunteers

(2) Provided only for the convenience of church members, or

(3) Selling only merchandise received as contributions.

We will assume the store is operating to make a profit and is open year-round. Therefore, if it does not meet one of the above exceptions, decide if the conduct of the store is related to the performance of an exempt purpose of the organization – such as education and training. The operation of the bookstore must contribute importantly to the accomplishment of that purpose.

Look at the location of the bookstore (is it inside the church?), sales of non-religious items (like pens or film), and hours the store is open.

Also, does the store conduct advertising and open its doors to the general public?

The tax may be imposed to eliminate the unfair competitive advantage the nonprofit organization would enjoy if they could sell products to the public in direct competition with taxable enterprises selling the same or similar merchandise.

Obviously, there is not one easy answer to this question, but hopefully this education will assist you in knowing what items to look for in evaluating your business activities.

Maybe We Do Have UBIT

If your exempt organization is making money other than from contributions, you need to consider the possibility that you have unrelated business taxable income (UBIT). In our previous blog, we listed three easy exceptions. Activities that don't pass those exceptions need to consider the following three tests.

First, look at whether or not the activity is a business. Generally, this is any activity carried on to make a profit from the sale of goods or services.

Second, determine if the business is regularly carried on. The purpose of the unrelated business income tax is to place an exempt organization’s business on the same tax basis as that of any taxable entity with which it competes. If a taxable entity would carry on a restaurant year-round but the exempt organization only operates a sandwich shop for one week, the business is not regularly carried on. An activity carried on only one day a week but on a year-round basis is considered regularly carried on.

Third, decide if the conduct of the business is related to the performance of the charitable, educational, or other exempt purpose of the organization. The organization’s need for income and how they spend the profits are irrelevant-this does not make it a related purpose. The business activity must contribute importantly to the accomplishment of an exempt purpose. Consider the size and extent of the activity in relation to the nature and extent of the exempt function that it serves.

Need an example? More to come….

Most churches and ministries believe everything they do is part of their overall mission to further the work of Christ. Therefore, there couldn't possibly be anything unrelated about their operations...or could there?

Many organizations operate book or music stores, concession stands, coffee shops, or teen game rooms. They may sell advertising spots in a magazine or rent space in their building. So they may, unknowingly, have unrelated business income subject to tax.

Let's look at how to determine if your organization has an issue.

We can first eliminate many activities because unrelated business taxable income (UBIT) does not include:

(1) Activities in which substantially all the work is performed by unpaid volunteers,

(2) Activities primarily for the convenience of members, students, or employees, or

(3) Selling merchandise received as gifts or contributions.

Many activities such as bake sales, thrift shops, car washes, and fundraising dinners are exempt due to these three exclusions.

If the activity does not meet any of these exceptions, there are three additional tests to consider, which we will cover in our next UBIT update...