When a church receives a financial benefit in the form of business income, a number of perhaps unexpected challenges can crop up—particularly with regard to taxes. According to the IRS, income that issues from a source that is not considered to match the purpose of a church is classified differently than exempt income pulled in by church-purpose activities. Such Unrelated Business Income—which may come from coffeehouse proceeds, from the renting of church property, or from other such forms of activity—can be taxed despite an organization’s tax-exempt status, particularly when it exceeds $1000. In this case, the organization is required to file a Form 990-T, and must also pay estimated tax when the tax amount for the year is expected to break the $500 limit.
When determining whether a source of income is to be considered coming from a “non-church” purpose, the IRS takes three factors into consideration:
• Whether the income was earned by a business or a trade. When a church brings in income from a sale of services or goods—in addition to the donations normally linked with church activity—the business income may be taxed as unrelated to the church’s tax-exempt purpose.
• Whether the church engages in regular business activity of this sort. The standard point of comparison will be whether the church’s involvement in the business or trade activity is comparable to a secular business’s involvement. Particularly if the income is ongoing—such as from a year-round bookstore or gift shop, or from a parcel of land that is continually leased—the IRS is likely to determine it to be Unrelated Business Income for taxation purposes.
• The most complex factor is whether the income-earning activity is related to the church’s tax-exempt purpose or not. To remain tax-free, the income must be closely linked to that purpose—commonly including activities such as evangelism, teaching, or preaching and ministry activities. An insightful attorney can be an invaluable asset in determining the proximate relation of such activities, and in assisting the church in avoiding litigation based on a misallocation or failure to pay tax on required funds.
When a church or nonprofit organization in Arizona needs legal advice about Unrelated Business Income, Provident Law’s church and nonprofit attorneys are here to help. We are part of the Church and so we understand the Church. We stand ready to counsel and serve charities, foundations, churches and other types of nonprofit organizations—providing broad transactional and general counsel services. Contact us to learn more.