Churches and religious organizations may engage in income-producing activities unrelated to their tax-exempt purposes, as long as the unrelated activities are not a substantial part of the organization’s activities . However, the net income from these unrelated business activities will be subject to the “Unrelated Business Income Tax” if the following three conditions are met:
- the activity constitutes a trade or business,
- the trade or business is regularly carried on, and
- the trade or business is not substantially related to the organization’s exempt purpose . (The fact that the orga- nization uses the income to further its charitable or religious purposes does not make the activity substantially related to its exempt purposes .)
However, there are exception to this tax. The income may not be subject to the tax if any of the following conditions are met:
- nearly all of the work done by the business is performed by non-paid workers(volunteers)
- the business activity is largely done for the convenience of the congregation
- the vast majority of items being sold were donated
According to the IRS, “In general, rents from real property, royalties, capital gains, and interest and dividends are not subject to the unrelated business income tax unless financed with borrowed money.” Listed below is an excerpt from Publication 1828 listing some common examples of what constitutes Unrelated Business Income: Advertising Many tax-exempt organizations sell advertising in their publications or other forms of public communication Generally, income from the sale of advertising is unrelated trade or business income . This may include the sale of advertising space in weekly bulletins, magazines or journals, or on church or religious organization web sites Gaming Most forms of gaming, if regularly carried on, may be considered the conduct of an unrelated trade or business . This can include the sale of pull-tabs and raffles . Income derived from bingo games may be eligible for a special tax exception (in addition to the exception regarding uncompensated volunteer labor covered above), if the following conditions are met: (a) the bingo game is the traditional type of bingo (as opposed to instant bingo, a variation of pull-tabs); (b) the conduct of the bingo game is not an activity carried out by for-profit organizations in the local area; and (c) the operation of the bingo game does not violate any state or local law. Sale of merchandise and publications The sale of merchandise and publications (including the actual publication of materials) can be considered the conduct of an unrelated trade or business if the items involved do not have a substantial relationship to the exempt purposes of the organization Rental income Generally, income derived from the rental of real property and incidental personal property is excluded from unrelated business income . However, there are certain situations in which rental income may be unrelated business taxable income:
- if a church rents out property on which there is debt outstanding (for example, a mortgage note), the rental income may constitute unrelated debt-financed income subject to UBIT . (However, if a church or convention or association of churches acquires debt-financed land for use in its exempt purposes within 15 years of the time of acquisition, then income from the rental of the land may not constitute unrelated business income .)
- if personal services are rendered in connection with the rental, then the income may be unrelated business taxable income, or
- if a church charges for the use of the parking lot, the income may be unrelated business taxable income
Parking lots If a church owns a parking lot that is used by church members and visitors while attending church services, any parking fee paid to the church would not be subject to UBIT . However, if a church operates a parking lot that is used by members of the general public, parking fees would be taxable, as this activity would not be substantially related to the church’s exempt purpose, and parking fees are not treated as rent from real property . If the church enters into a lease with a third party who operates the church’s parking lot and pays rent to the church, such payments would not be subject to tax, as they would constitute rent from real property . Whether an income-producing activity is an unrelated trade or business activity depends on all the facts and circumstances. For more information, see IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations Sources: IRS Publication 1828, Clergy Financial Resources Clergy Financial Resources is a national accounting and finance organization serving churches and clergy since 1980. They have an unparalleled tax expertise on the complex issues associated with clergy tax law, clergy taxes, clergy compensation and church payroll. Clergy Financial Resources is a valuable resource for clergy, churches and denominations.< Back
Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.
This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.
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