As a general rule, churches do not pay federal corporate taxes. This is by virtue of a church enjoying federal tax-exempt status under Section 501(c)(3) of the federal tax code.
While churches are exempt from business taxes for their activities consistent with their exempt (religious) purposes, churches sometimes engage in activities that are unrelated to their exempt purposes, and may therefore become subject to federal taxation.
Many questions arise for churches when it comes to tax liability for income other than standard donations. May a church operate a bookstore, a coffee shop, or other vendor services? May a church lease part of its building and land for use by an outside business? Does it matter what kind of business it is? Does it matter how the church uses the money brought in by these activities?
A church receives unrelated business income (“UBI”) when it engages in a trade or business that is regularly carried on, yet not substantially related to one or more of the church’s exempt purposes.
There are some exceptions from the usual definition of UBI. A church may sell donated items without realizing UBI. A church may engage in activities operated by volunteers and avoid concerns of UBI. A church may earn interest on bank accounts or other investments without falling into UBI requirements. Also, a church may rent building space without falling into UBI liability as long as “substantially all” of the church’s property continues to be used for its nonprofit purposes. Put in more simple language, as long as 85% of the church’s real property use is for its exempt purposes, it can lease space without concerns of tax liability. Further, any leasing of space that is not “debt-financed” is protected from tax liability.
Some forms of income have been deemed UBI by taxing authorities. Church income from the lease of broadcasts towers located on church property is taxable UBI. Income from parking lots located on church property is also taxable UBI.
Sometimes churches mistakenly believe that as long as they use any income received from trade or business activities to pay for legitimate religious exempt expenses, they are shielded from UBI taxation for that income. This is not the case. Merely using income for nonprofit purposes is not sufficient to prevent the income from being subject to UBI taxation.
Another common error is to label UBI income as a “donation” in an attempt to avoid tax liability. Such a label will not be outcome determinative upon review by the Internal Revenue Service. The standard test for UBI will be applied.
UBI analysis can be tricky, and a church may need to consult with a tax or legal professional in order to properly determine if a certain activity subjects a church to tax liability.
If UBI comes into play then the church must file the appropriate tax return (Form 990-T, “Exempt Organization Business Income Tax Return”) in order to report and pay the proper taxes.
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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